Output service - does deletion of explanation in Rule 2(p) changes the intention of the Rule?

What the Rule says?

Rule 2 (p) of Cenvat Credit Rules - defines output service as follows (prior to amendment):

Output Service means any taxable service provided by the provider of taxable service, to a customer, client, subscriber, policy holder or any other person, as the case may be, and the expressions 'provider' and 'provided' shall be construed accordingly.

Explanation - for removal of doubts it is hereby clarified that if a person liable for paying service tax does not provide any taxable service or does not manufacture final product, the service for which he is liable to pay service tax shall be deemed to be the output service.

The Govt. vides Notification No. 8/06 NT dt. 19/04/2006 has omitted the above explanation under the rule, which is felt to be the cause for the ambiguity and dispute. The explanation seems to have been deleted to scuttle or deny payment of service tax through Cenvat account by the persons making payment of service tax (as recipient of services) under the provisions of Rule 2(d) of Service Tax Rules, 1994. Through various clarifications issued by different authorities an interpretation/stand has been taken to the effect that the persons covered under Rule 2(d) invariably have to discharge their service tax liability only through cash (TR 6 Challan)

This article attempts to analyse the fallacy of such interpretation, especially because of the definitions given under 2(q) and 2 (r) of Credit rules.

What is the need for explanation?

If we examine the credit rules we can identify the following categories of persons who are likely to be covered under the ambit of the credit rules for availing credit provided under the rules:

1. a manufacturer

2. a service provider (only providing service )

3. a manufacturer and also a service provider (eg. manufacturers of telecom towers/equipment, who also undertake Commissioning, installation service, or Maintenance or Repair service)

4. Persons (other than the above three), who is not a service provider and not a manufacturer, but liable to pay tax under Rule 2(d) (eg. A distributor or dealer who pays the transporter for obtaining goods and pays service tax on GTA service in terms of rule 2(d))-

5. a manufacturer and also a person liable to pay tax under Rule 2(d) ( eg. all manufacturers registered under GTA )

If we peruse the Cenvat Credit rules and specifically Rule 2(p), it is clear that there is no dispute with regard to eligibility of credit by the categories of persons covered under Sl (1) to (3) above. The whole dispute is around eligibility of credit to the persons mentioned under Sl.No (4) and (5) - who are liable to pay service tax as per Sec.68 (2) of Finance Act, 1994 and by virtue of being covered under Rule 2 (1)(d) of Service Tax Rules,94, though they do not provide such service on which they pay tax. The very purpose of inserting the above explanation under rule 2 (p) is to extend cenvat benefit even to person falling under Sl.No. (4) and (5) above.

A categorical stand has been taken by the department that the service on which these persons pay tax as not falling under the scope of definition of “output service”, and this stand is seen as ratified by the removal of the controversial “ explanation” under rule 2 (p). However, it is felt that notwithstanding the deletion of the “explanation “, the rule 2 (p) coveys the similar meaning, if the following sub-rules of rule 2 of Cenvat rules are taken into view:

Rule 2(q) Person liable for paying service tax has the meaning as assigned to it in clause (d) of sub-rule (1) of rule 2 of the Service Tax Rules, 1994

Rule 2(r) Provider of taxable service includes a person liable for paying service tax.

The above definitions under rule 2(q) and 2(r) of cenvat rules are there obviously to amplify other provisions contained in the rules, especially the provisions of- Rule 2(i) “ input service “, Rule 2(p) “ out put service “, Rule (3) “ Cenvat credit “, where in the words “ provider of taxable service” appears”.

Rule 2 (l) “ Input service” means any service-

(i) used by a provider of taxable service for providing an out put service ; or

(ii) used by the manufacturer……………………and includes services used in relation to ………………………………

Rule 2 (p) Output Service means any taxable service provided by the provider of taxable service, to a customer, client, subscriber, policyholder or any other person, as the case may be, and the expressions ' provider' and ' provided' shall be construed accordingly.

Rule 3 (1) A manufacturer of producer of final products or a provider of taxable service shall be allowed to take credit (herein after referred to as the cenvat credit) of ………….. (i)……………………………………………………

(ix) the service tax leviable under section 66 of the Finance Act;

To interpret the words “provider of taxable service” appearing in the above definitions, one has to take into consideration the words already defined in the rules. On interpolation of the definitions given in Rule 2(q) and Rule 2(r) in the above definitions, they may read as follows:

Output Service means any taxable service provided by the provider of taxable service, including a person liable for paying service tax, to a customer, ……………………… and the expressions 'provider' and 'provided' shall be construed accordingly.

Cenvat credit (1) a manufacturer of producer of final products or a provider of taxable service, including person liable for paying service tax, shall be allowed to take credit…………….

From the above it is clear that the all the above definitions, especially the definition of output service, seek to cover within its ambit even the service on which person liable to pay tax under rule 2 (d) also. Hence, it is felt that the continuation or deletion of the ‘explanation” under rule 2(p) do not make any difference to the above meaning the rule conveys.

It may still be argued that the service on which a recipient pays tax cannot be treated as “output service’, since service receiver (person liable for paying service tax) cannot said to be providing any service to a customer, client, subscriber, policyholder or any other person, This argument do not hold water if we closely examine the persons covered under Rule 2 1(d).

(The text of Rule 2(d) has been given at the end of this article, so that the continuity of discussion is not lost. Please see end of this article for the rule as it appears in the statute after recent amendment)

On close examination of rule Rule 2 (1)(d), it may be possible to divide the persons covered there under into two categories:

(i) Persons specified under sub-clauses (i) & (ii) of Rule 2(d)- who are also covered under the definitions given in Sec.65 of FA, 94 as service providers and as such directly liable for payment of service tax even without declaring under rule 2(d).

(ii) Persons specified under sub-clauses (iii) to (vii), who are not actually service providers, but made liable to pay the tax under the provisions of the Act and under the rule 2 (d).

It is opined that there is no necessity of declaring the persons covered under category (1) above under Rule 2 (1)(d) of ST Rules any longer, because even otherwise also such persons – for eg. BSNL, MTNL, Insurance Companies- are liable to pay service tax by virtue of being covered under Sec.68 (1) read with Sec.65 of FA,94. It is only in the case of persons falling under category (2) above to be declared under rule 2 (d), otherwise no service tax liability is fastened on persons receiving service.

As the person under category (1), above, are service provider by themselves there is no need to resort to the definition under rule 2 (r) in order to be an “output service provider” by such persons. Therefore, it can be said that rule 2(r) is consciously inserted in cenvat rules keeping in view the persons falling in the category (2), above, only to extend the benefit of credit to the person liable to pay tax also. Hence, the expressions - to a customer, client, subscriber, policyholder or any other person, as the case may be- appearing in the definition of output service, is not to be treated as applicable to person liable to pay service tax- persons falling under sub-clause (iii) to (vii) of rule 2 (d)- to whom rule 2(d) is operative in real sense, and these person would not provide the service for which the tax liability is fastened on them by virtue of specifying under Rule 2 (d).

By looking at the issue with the above background, it translates to mean that it is the conscious decision of the Government, to include even such persons – persons liable to pay tax under rule 2 (d)- as provider of out put service. This intention cannot be realized unless “input service” and “out put service” are interpreted as covering persons paying tax under rule 2(1)(d) also. This is the very purpose - sub-rule (q)- person liable for paying service tax and (r)- provider of taxable service, seems to be there in the Cenvat Rules. Otherwise there is no need to have them in the rules, and they cannot be said to be there for ornamental sake without any utility or purpose.

In other words, the definitions under rule 2(q) and 2(r) of cenvat rules shall have utility and purpose only when rule 2(p) is interpreted in such a way that it covers even the service on which a person pays tax under rule 2(d) also as “output service” and such persons are also treated as provider of taxable service (output service provider) even though such service (on which tax is being paid by them) is not being provided by them. These sub-rules do not have any utility other than for the purpose above.

To put the point straight, let us take the following example:

General Insurance Company pays service tax on the following services:

(1) On insurance premium – as service provider

(2) On commission paid to agents (branch offices) - as person liable to pay tax under rule 2(d)

Let us assume that the branch offices purchase some input services like training to agents, mandap services for such training, telephones, courier, etc (which fall in the inclusive clause of input service definition)

In the example above, any interpretation that the branch offices- paying tax (as person liable to pay tax) on agents commission – are not eligible to take credit on in put services and use such credit to discharge their tax liability, I am afraid, does not hold water and untenable before law for the simple reason that input service definition (read with rule 2(r)) clearly conveys the meaning that it includes any service used by person liable to pay tax also within its ambit. Applying the same analogy, the service on which tax paid would automatically become output service and such taxpayer will be an output service provider.

In fine, it is opined that a plain reading of sub- rule 2(p) in tandem with sub- rule (q) and (r) would convey the meaning that “output service “also includes service on which tax is paid under rule 2(d) of ST Rules and such persons should also be construed as “ output service” provider. Thus as long as the sub-rules 2(q) and 2(r) are there in the Cenvat rules there is scope for other interpretation such as above. Further, these sub-rules create a vested right in the person (paying service tax under Rule 2 (d)) to utilize cenvat account for such payment, and any instructions to deny such right, given by statute, would not stand scrutiny of law. The deletion of explanation would not change this position.

P.S. As per Sec. 66 A of FA, 94 the services on which recipient in India pay tax by virtue of Sec. 66 (A) read with Rule 2 (d) (iv) shall be treated as if the recipient had himself provided the service in India, accordingly all provisions of this chapter are applicable.

(The author is working with the Department & the views expressed are personal)