February 14, 2011

CENVAT Credit Rules mired in unlimited legal controversies – after all, what are 'input services'!!??

By Mahesh Jaising and Kunal Wadhwa

THE CENVAT credit scheme was envisaged as a beneficial scheme intended to prevent cascading effect of taxes. The legislative intention has always been to assign a broader meaning to the kind of “input services” covered under the purview of this scheme. This is apparent from the definition of input services, which includes services directly or indirectly used for provision of output services as well as activities relating to business.

This intention can also be inferred from the press note dated August 12, 2004 issued by the Ministry of Finance, prior to introduction of the CENVAT Credit Rules, 2004 (“CENVAT Rules”), through which the draft rules were circulated for inviting comments from trade and industry.  This note clearly states that “In principle, credit of tax on those taxable services would be allowed that go to form a part of the assessable value on which excise duty is charged” . 

It should be noted that the above interpretation has been readily endorsed by Courts, in the past. There have been a plethora of judgments by the CESTAT and the High Courts (read as Bombay High Court to be particular) holding that the definition of “input service” is wide enough to cover a range of services so that the chain of input credit enables avoidance of tax costs for businesses. This intention has also been brought out in various other circulars and clarifications by the Government of India.

Issue

The Bangalore Tribunal in the case of Kbace Tech Pvt Ltd v CST, Bangalore - 2010-TIOL-564-CESTAT-BANG has questioned the basis for claiming CENVAT credit on input services used by a service provider by stating that definition of “input service” under the CENVAT Rules goes beyond the scope of rule making power provided in Finance Act, 1994 as relevant to service providers. Even though the issue involved in this case was discussed earlier on TIOL, we have attempted to highlight the specific steps required to address the issue by the Central Government, particularly during the present Budget exercise.

To recap, the matter related to refund of unutilized CENVAT credit of input services under Rule 5 of the CENVAT Rules. While remanding the matter to the adjudicating authority, the Bangalore Tribunal opined as follows:

++ Section 94 of the Finance Act, 1994 inter alia allows the Central Government to make rules to grant:

++  Credit of services tax paid on services consumed for providing taxable services

++  Rebate of service tax paid on services consumed for providing taxable services which are exported out of India

++  Accordingly, the Tribunal inter alia ruled that the definition of “input service” under the CENVAT Rules goes beyond the scope of rule making power provided in Finance Act, 1994, which speaks of “ services consumed for providing a taxable service ”.

++  Based on the above, it was stated that the Central Government can provide for credit/ rebate of service tax paid only in respect of services consumed for providing export of services.

++ Since the Act specifically allows rules to be framed only for “services consumed for providing taxable services”, the CENVAT Rules cannot be framed to provide for credit/ rebate of service tax in respect of services which are not consumed in providing output services like “activities relating to business such as accounting, auditing, financing, recruitment and quality control, coaching and training, computer networking, credit rating, share registry, and security ” .

++  The term “consumed” is not defined, similar to the term “service” itself, in light of the intangible character of these terms. Keeping this in mind, the Central Government had intended to provide a wider interpretation to these terms. As stated earlier, this has been widely acknowledged by the Courts. Special mention should be made to the Mumbai High Court in the case of Coca Cola India Private Limited (2009-TIOL-449-HC-MUM-ST), which held that service tax is a destination based consumption tax similar to value added tax.

++  Both of the above, ie, the intangible nature of services which does not enable a direct one-to-one correlation of input vis-à-vis output, and the consumption tax concept, indicate that the intention of the Government is to interpret the scope of the term “input service” widely.

++ Separately, in the context of refund of CENVAT credit, the Central Government had, in Budget 2010, retrospectively amended Notification 5/06-CE(NT) dated March 14, 2006 but no such amendment was made to the Act nor Rule 5 of CENVAT Rules.

Recommendation

While there may be technical/ legal arguments to doubt the correctness of the Kbace decision , keeping the intention and framework of the CENVAT Rules, it is recommended that retrospective amendments should be made to Section 94 of the Finance Act, 1994 to ensure that narrow construction of CENVAT provisions should be avoided.

The Bangalore Tribunal ruling has potentially impacted the momentum of processing of refund claims at the ground level and undone the positive steps taken by the Central Government to restore faith in its policy on zero rating exports. Further, it has opened an avenue for a fresh interpretation to be taken on CENVAT credit availed on input services by all services providers and manufacturers. All of this would only result in unwarranted and prolonged litigation.

Hence, it is recommended that Section 94 of the Finance Act, 1994 should be suitably amended to

++ Align the Central Government's rule making powers regarding input services, with the actual legislative intention, reflected in the current CENVAT Rules; and

++ Similar amendments may be made to clause pertaining to rebate/ refund of input services.

This is especially relevant for refund claims under Rule 5 of the CENVAT Rules, where the Central Government has recently taken steps to expedite refund claims by issuance of Circular no 120/01/2010 dated January 19, 2010 and the retrospective amendments to the Notification 5/ 2006 dated March 14, 2006 through the Finance Act, 2010.

Hence, it is recommended that Section 94 should be amended to read as follows:

“(eee) the credit of service tax paid on services used in or in relation to providing a taxable service , or duties paid or deemed to have been paid on goods used in or in relation to providing a taxable service…

…(hh) rebate or refund of credit of service tax paid or payable on taxable services used as input services or duties paid or deemed to have been paid on goods used by a provider of taxable services, for exporting such taxable services out of India .”

  (The authors are Chartered Accountants and are associated with BMR Advisors. The views above are personal)