By TIOL Research Bureau

THE software industry worldwide has been going through a rough patch for some time now. So is the Indian software sector. Insiders in the Indian software sector feel that the duo of 'Rahu' & 'Ketu' seems to be besieging this sector like guerrillas! On top of all this, the taxmen also seem to be catching up with some of the 'real' as well as 'surreal' demands. A good example of a 'real' case is the income tax order confirming a huge demand against the Grace Mac Corporation, USA which holds the IPR for all Microsoft products. And the 'surreal' one is the Delhi Service Tax case against Microsoft only where a demand of Rs 126 Cr has been slapped.

Let's visit the Service Tax Show Cause Notice by taking a hard look at the finer details. A demand has been made to Microsoft (India) Pvt Ltd on the income received from M/s Microsoft Operations Pte Ltd ( MO), Singapore.

Microsoft India (Pvt) Ltd has entered into a “Market Development Agreement” with MO, Singapore under which the former will use its best efforts to further the interest of MO and maximize the markets for Microsoft products in India, Bhutan, Nepal and Maldives. For such service, Microsoft (India) Pvt Ltd will issue invoices in USD on MO Singapore. Microsoft (India) has been treating such income as export of service tax (under Business Auxiliary Service) and therefore has not paid any service tax on the income received.

It is the case of the Department that the service cannot be considered as export of service. The grounds taken are:

++ The services of marketing of Microsoft products rendered by MSIPL are performed and used in India for furtherance of business of Microsoft, Singapore;

The service tax is a destination based tax and particularly in case of exports, the place of performance of the service is very crucial for deciding whether the service is covered under export of service or not.

The services provided by MSIPL are marketing and support services of Microsoft products in India. In order to find out the consumption of services, the key criterion should be where the market is located (for marketing) or where the user is located (for customer support). It is evident in both the cases, the answer is India.

In respect of the services provided by MSIPL for Indian customer, the services clearly fall outside the purview of export in the light of Board's Circular F.No B1/4/2006-TRU dated 19.4.2006 which states that services consumed in India do not fall within the scope of export of services.

While demanding the above service tax from MSIPL, perhaps the Delhi Service Tax Commissionerate has done a great favour to various other Indian Companies who are at present paying service tax on the commission paid to foreign agents who procure the orders / market the products manufactured in India. It is not uncommon for many Indian exporters to engage the services of overseas marketing agents who will procure the orders for the goods exported from India. The exporters pay the marketing charges or commission for the services rendered by these marketing agencies. This is exactly the reverse of the Microsoft case, where the Microsoft products are marketed in India by MSIPL for some consideration. In both the cases, the service falls under Business Auxiliary Service. However, in case of Indian exporters the service tax is demanded in many places under the provisions of Section 66A of the Finance Act and the Taxation of services provided from outside India and received in India Rules 2006.

To know more on this, let us examine the provisions of Export of services Rules 2005 and The Taxation of Services (Provided from Outside India and Received in India) Rules, 2006, which were conveniently ignored by the Delhi Service Tax while raising a huge demand on MSIPL.

All the taxable services have been classified under three categories for deciding whether they are export / import of services. For the first category, the services are treated as export only if the immovable property is located outside India (for eg, services like an Architect, or interior decorator etc). For the second category, the services are treated as export only if they are performed outside India. Even if partly performed in India and partly performed outside India, these are treated as export of services. For the third category of services, it is not the immovable property, nor the place of performance that decides whether it is export or not. These services are considered as export if they are provided to a recipient located outside India or provision of such services to a recipient located outside India at the time of provision of such service. Similarly under the Taxation of Services (Provided from Outside India and Received in India) Rules, 2006, the third category of services are treated as received in India only if be such services as are received by a recipient located in India for use in relation to business or commerce.

Fortunately or unfortunately, Business Auxiliary Service ( Section 65(105)(zzb)) falls under the third category of the services in both the export of service rules 2005 and the taxation of services provided from outside India and received in India rules 2006, and which services have no reference to place of performance of the service. Since the Taxation of Services (Provided from Outside India and Received in India) Rules, 2006 are identical to the Export of Service Rules, all these years, the department has been demanding service tax on commissions paid by the Indian Manufacturers to overseas agents under the reverse taxation provisions by treating these  services as “received” in India”. Though the service is provided outside India, since it falls under the third category of service, it is enough if the recipient (Indian manufacturer) is located in India. TIOL has learnt that even DGCEI has issued several notices under this category and even made many spot recoveries. Many Indian exporters have obtained Service Tax registration and are regularly paying service tax on this service.

Even the recent Notification No 17/2008-ST dated 1.4.2008 which extended the list of services eligible for refund of service tax in respect of export goods has clearly recognized this service as taxable in India. The relevant entry of the Notification reads:

Section 65(105)(zzb)       

Services provided by a commission agent, located outside India, and engaged under a contract or agreement or any other document by the exporter in India, to act on behalf of the exporter, to cause sale of goods exported by him

Thanks to Delhi Service Tax Commissionerate. Now the Indian manufacturers are not required to pay any service tax on the commission paid to the overseas agents. All they have to do now is to show a copy of the SCN issued to Microsoft and say that “when the commission received for marketing a foreign product in India is not export of service and the service cannot be treated as received in Singapore, then there is no case for demanding service tax from them on the commission paid to the overseas agent for marketing Indian products abroad as these services cannot be treated as ''RECEIVED IN INDIA”

Thank you Delhi Service Tax……

Tailspark: And the issue is, as they, no more res integra. The Bangalore bench of the Tribunal had already decided a similar issue in favour of the assessee and held that booking orders in India for clients in other countries, is indeed export of service. Please see M/s BLUE STAR LTD Vs THE COMMISSIONER OF CENTRAL EXCISE, BANGALORE - 2008-TIOL-716-CESTAT-BANG.