The Budget 2012 was followed by a radical change in the service tax regime, in the form of Negative list based taxation of services. The scheme is a clear precursor to the impending Goods and Services Tax (GST) regime, and conceptually is a welcome move. It seeks to broaden the service tax net and hence, obviates the need for increasing tax rates to augment Government coffers.

Like any other new levy, the Negative list based regime is expected to evolve over a period of time. It marks a fundamental departure from the erstwhile scheme of taxation on both substantive, as well as procedural aspects. Still in its infancy, the regime has thrown up certain challenges and ambiguities, which the industry expects Finance Minister P. Chidambaram to resolve in Budget 2013.

Exemptions

Take for instance, the list of exemptions under the new scheme. While some of the erstwhile exemptions available to infrastructure sector (roads, dams, airports) have been continued under the new regime, certain ambiguities have arisen due to change in the terminology used. There are certain changes in the language of such exemptions, on which legal experts can spend days to interpret the underlying intent (e.g. earlier services ‘in respect of’ specified infrastructure activities were exempt, now services ‘by way of’ such specified activities are exempt. One view is that the latter expression is much narrower in ambit than the former). The industry expects these aspects to be clarified, and the earlier exemptions to be restored.

Another area where relief is expected is the partial reverse charge scheme. Certain services, if provided by an individual, HUF, Firm or AOP, are now taxable either wholly or partly in the hands of service recipient. This has not only added to the compliance costs of such service recipients, but in certain cases (e.g. in dealings with small contractors) compliance has become extremely difficult, if not impossible.

Also, while the reverse charge mechanism was meant to cover unorganised sector, in many cases, it has had a significant impact on organised players as well. For instance, in case of large infrastructure projects, it is common for companies to pool in their resources and form unincorporated joint ventures/AOP to execute the project. Under the partial reverse charge scheme, service tax is only partly discharged by such AOPs on the works contract being executed, resulting into excess credit/adverse cash flow situation. Thus, the entire scheme needs to be revisited to ensure that the Government’s objective of enforcing compliance is met without any operational challenges for the taxpayers.

Clarity needed

The new regime has also significantly revamped the place of supply rules, which are primarily meant to ascertain when a given transaction would qualify as export/import. While the new rules seek to adopt some of the internationally accepted best practices, more clarity/relief is required in some cases. This includes taxation of services provided by intermediaries, cross-border transactions between Head Office and branch/PO.

Then there are other aspects, such as treatment of composite supplies, licensing of intangibles (e.g. software, trademark), where the industry expects certainty of tax treatment. These are typical areas where the risk of double taxation continues in the form of VAT and service tax, despite the implementation of the Negative list regime.

Negative list based taxation has taken the existing regime much closer to GST, in so far as taxation of services is concerned. It would have given the Government enough experience and confidence to deal with services under GST. The Budget offers a good opportunity to iron out the anomalies/challenges from the new scheme, to make it more taxpayer-friendly, and conducive to business.

The views and opinions expressed herein are those of the authors and do not necessarily represent the views and opinions of KPMG in India.

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