TIOL Research Team

NEW DELHI, AUG 25, 2009: THE one single case which is all set to redefine the cross border transactions in services has reached the Tribunal. Predictably, the huge demand of Rs 126 crores made against the software giant, Microsoft Corp ( India ) Pvt Ltd was confirmed by the original authority. On May 12, 2008, TIOL carried a special story on this issue in our article titled “The ‘real' and ‘surreal' tax demands besiege Microsoft in India!” We focussed on the service tax demand notice issued to Microsoft India Pvt. Ltd wherein a tax demand of Rs. 126 crores was raised and penalties of equivalent amount were proposed to be levied on the company by denying the benefit under Export of Services Rules, 2005.

In fact CBEC issued a Circular 111/2009-ST dated 24.02.2009 to clarify that for services classified under Category III of Export of Services Rules, 2005, in terms of Rule 3 (1)(iii) thereof, the relevant factor is the location of the service receiver and not the place of performance. It was further clarified that the phrase ‘used outside India ' is to be interpreted to mean that the benefit of the service should accrue outside India . So for category III services, the Board clarified that it is possible that export of service may take place even when all the relevant activities take place in India so long as the benefits of these services accrue outside India.

Immediately, after issue of this Circular, in DDT 1060 dated 25.02.2009, we reported the clarification issued by CBEC through this Circular under the caption “ Export of Service Rules – CBEC clarifies the obvious – 126 Crores demand on Microsoft becomes a bunch of waste papers”. A favourable clarification by the Board, a couple of case laws and prima facie case on limitation would normally entail complete waiver, but in this case, the company was directed to deposit Rs. 70 crores within four weeks as an interim measure.

Microsoft India Pvt. Ltd, a subsidiary of Microsoft Operation Pvt. Ltd, Singapore was appointed to provide various technical support services including marketing of Microsoft products in India (and other countries designated as part of the ‘territory' as defined in the agreement) by the Singapore entity in terms of an agreement entered into between the two entities. Both the Indian and Singapore entities are subsidiaries of Microsoft Corporation, USA. As per this agreement, the types of services to be provided by the Indian entity was broadly classified into four categories viz., product support services & consulting services, marketing of Microsoft products, resident guest employee services and other intercompany services. The remunerations for these services were provided to the assessee on a cost plus basis by the Singapore entity as outlined in the agreement.

The assessee claimed that their services, predominantly classifiable under the taxable service category of ‘Business Auxiliary Service' have to be regarded as exports in terms of Export of Services Rules, 2005 in as much as the Singapore entity was the ultimate beneficiary of the services rendered by the assessee in India . The Commissioner of Service, New Delhi was not impressed with these claims and confirmed the tax demand of Rs. 126 crores with equivalent penalties by disallowing the assessee ' s contentions in this regard on the premise that service tax being a destination based consumption tax, all the services rendered by the assessee were consumed by the ultimate clients/customers located in India and hence cannot be regarded as export of services.

Aggrieved by this huge tax demand and levy of penalties, the assessee approached CESTAT for redressal. Before the CESTAT, the senior counsel appearing on behalf of the appellant inter alia contended:

++ That the phrase 'used outside India' has to be interpreted to mean, if the service recipient is located outside India, the services are used outside India, notwithstanding the place of performance of services being in India.

++ That the controversy is now set at rest vide Board's Circular No.111/05/2009-ST dated 24.2.2009 wherein the Ministry has clarified that the relevant factor for category-III [Rule 3 (1) (iii)] is the "the location of the services recipient" and not the "place of performance". The phrase 'used outside India ' is to be interpreted to mean that the benefit of the services should accrue outside India .

++ That the Commissioner in his order had clearly conceded that the service recipient is located outside India and does not have an office in India and the appellants have received the payments only in foreign exchange.

++ That the issue is no longer res integra in view of the Board's Circular and the decisions of CESTAT in the case of ABS India Ltd. vs. CST, Bangalore 2008-TIOL-2102-CESTAT-BANG and Blue Star vs. CCE, Bangalore 2008-TIOL-716-CESTAT-BANG wherein it was held that as long as the recipient of service is located outside India, it cannot be said that the service is delivered in India or used in India. The services are utilized only outside India and therefore would be eligible for the benefit of export of services.

++ That the Delhi Bench of CESTAT in Gap International Sourcing India Pvt. Ltd. vs. Commissioner of Service Tax 2009-TIOL-249-CESTAT-Del granted absolute stay of tax demands on an identical issue on the ground that service recipient is located outside India .

++ Major portion of the tax demands are hit by limitation since the department had periodically sanctioned refund claims, export rebate etc on these services.

Revenue represented by its counsel and assisted by the departmental representative negated these contentions and supported the order passed by the Commissioner. It was argued that the appellant performed the entire services for their clients/customers availing such services located in India for which the service tax liability arose in India even though principal of the appellant was located outside India . It was contended that the location of principal is immaterial since the ultimate beneficiaries of services were located in India . It was urged that Revenues interest shall be prejudiced if the demand raised in the Order-in-Original is not ordered as pre-deposit during the pendency of this appeal.

After deliberating on the facts of the case, relevant provisions of the statute and the case laws relied upon by both the parties, CESTAT made the following observations:

++ There is no ambiguity that legislature intended that service is said to have been exported if the same is consumed outside India . Therefore, in no uncertain terms "export of service" shall mean that the outcome of service should have been consumed outside India . But in the instant case it does not seem to be so, when the ultimate consumers of the said services were located in India only.

++ Supreme Court in the case of All India Federation Of Tax Practitioners vs. UOI 2007-TIOL-149-SC-ST held that service tax is a value added tax which in turn is both a general tax as well as destination based consumption tax leviable on services provided within the country.

++ Place of performance of service is decisive for determining event of taxability as well as incidence of tax. The appellant appears to have performed service in India for ultimate consumption there of in India by its clients/customers in India . Ultimate outcome of service having been exhausted in India , there appears to be no export of such services since efforts in India generated service recipients in India only. The foreign principals discharged post service contractual obligations.

++ Prima-facie it appears that the interpretation of law by the CBEC in its Circular dated 24.2.2009 runs counter to the ratio laid down by Apex Court in All India Fedn. Of Tax Practitioners case. Though this Circular may be binding on the authorities below it is not binding on the CESTAT.

++ The decisions relied upon by the appellants counsel are contrary to the law laid down by the Apex Court in the All India Federation Of Tax Practitioners case.

++ There was no case made out to show that irreparable injury or undue hardship shall be caused to the appellant if no full waiver is granted.

Stating thus and following the ratio of Apex Court decision in Dunlop India's case 2002-TIOL-156-SC-CX and having regard to the appellant's pleadings that certain portion of the demand was hit by limitation and in view of the fact that certain amounts were sanctioned as refunds by the department, the assessee was directed by the CESTAT to pre-deposit Rs. 70 crores within four weeks from the date of receipt of this order.

The significant aspects that emerge from this order and the points to be pondered are :

++ The definition of ‘business auxiliary service' is turned on its head by stretching the aspect of ‘client' to include ultimate users/consumers as well. When services are provided by the service provider on behalf of the client, how far is it justified to determine the tax liability based on the consumption of services by the ultimate third parties i.e. consumers or to put it another way will the concept of destination based consumption tax hold good for ‘business auxiliary service' as defined in its current form?

++ Moreover, if the service is provided on behalf of the client then is it not the client who is the ultimate beneficiary irrespective of who consumes the service? Is this not fundamental to client-service provider relationship? How far is it justified to make a sweeping application of Apex Court 's judgment in All India Federation of Tax Practitioners case to business auxiliary services where three parties are involved in the transaction? If the ratio of this case can be applied to determine export / import of services by merely relying on the concept of destination based consumption tax, then why there is a need to separately notify the export / import of services rules?

++ If we disregard the above two propositions, then conversely, how can the services received from commission agents located outside India by exporters of goods/services, be taxable in India in the hands of the recipients in India? By applying the ratio of this latest CESTAT judgment , such services rendered outside India, by the service providers located outside India to recipients in India cannot be subjected to levy of service tax because such services are not consumed in India in the strictest sense. Is the Revenue ready to forego service tax in such instances based on its strict interpretation of the principle of destination based consumption tax?

++ While Board's Circular in the instant case explicitly favours the assessee, is it not incumbent upon CESTAT to give effect to the Circular which is in favour of the assessee irrespective of the fact that the Board's Circulars are not binding on CESTAT and higher Judicial Forums? While assessees are at liberty to challenge Board Circulars which are not in their favour before CESTAT or high Judicial Forums, conversely, CESTAT or higher Judicial Forums should give effect to those Board Circulars which are in favour of the assessees without disregarding them and certainly the departmental representatives cannot take a position that such Board Circulars are not binding on the Revenue.

++ While there is absolutely no doubt that pleadings of undue hardship is the criterion for determining the quantum of pre-deposit or waiver thereof, is it not incumbent upon the CESTAT to take into consideration the judgments which are overwhelmingly in favour of the assessee? After all, merely because there is a huge demand against an assessee and the assessee does not plead any financial hardship, if the case is prima facie in favour of the assessee given the fact that there are several judgments in their favour on this issue, then is it appropriate to order pre-deposit? This is the ratio of the decision of Allahabad High Court in ITC Ltd vs. CCE (Appeals) Meerut –I 2004-TIOL-53-HC-ALL- CX. wherein the High Court made the following observations:

“While considering the application for stay/waiver of a pre-deposit, as required under the law, the Court must apply its mind as to whether the appellant has a strong prima facie case on merit. In case it is covered by the judgment of a Court/Tribunal binding upon the Appellate Authority, it should apply its mind as to whether in view of the said judgment, the appellant is likely to succeed on merit. If an appellant having strong prima facie case, is asked to deposit the amount of assessment so made or penalty so levied, it would cause undue hardship to him, though there may be no financial restrain on the appellant running in a good financial condition. The expression “undue hardship” has a wider connotation as it takes within its ambit the case where the assessee is asked to deposit the amount even if he is likely to exonerate from the total liability on disposal of his appeal. Dispensation of deposit should also be allowed where two views are possible. While considering the application for interim relief, the Court must examine all pros and cons involved in the case and further examine that in case recovery is not stayed, the right of appeal conferred by the legislature and refusal to exercise the discretionary power by the authority to stay/waive the pre-deposit condition, would be reduced to nugatory/illusory.”

The order of the Tribunal, though a stay is sure to open a Pandora's Box. It may not be surprising if the Circular No 111/2009 is withdrawn by the Board. Wild imaginations will now flow through the field formations and the biggest hit would be the BPO sector where most of the units operate as STPI units and claim refunds. Now they will be under scanner and have to face notices by giving a go by to the Export of Service Rules and the Board Circular.

(See 2009-TIOL-1325-CESTAT-DEL in 'Service Tax')