Service tax can lay claim to being the only tax in the country that is a revenue-grosser without having a legislated Act. This could be because the tax was introduced as a residual entry in the Constitution – Entry 97, List 1. It could remain unlegislated when the taxing provisions of Service Tax get subsumed in the Central GST. Having brought in the tax as a simple measure, it was deemed to be indirect in nature and the administration of Service Tax was handed over to the Central Excise Department administering a complex Central Excise Act. The complexity doubled when the Service Tax Credit Rules were morphed with the Cenvat Credit Rules in 2004 after having been stand-alone for two years.

Service and Manufacture

Service and manufacture are not look-alike twins. After having struggled to get a definition of manufacture for ages, the consensus was that when a new product comes into existence, it can be deemed to be manufacture. On the other hand, any activity could be called a service which could be one of the reasons a definition of service was never attempted and cherry-picking of services to be taxed was resorted to. The difference between the two is perceptible when we consider the stage of payment of the tax— central excise duty is payable on manufacture while service tax is payable on receipt of payment from the service receiver. Completion of manufacture is tangible while completion of service in many cases is probably only visible. The inputs used for manufacture will invariably not exist after the product is rolled out, but the inputs used for providing a service may be visible and available even after the service has been provided. Disputes are natural if one attempts to integrate only one portion of both these varied laws— the input tax credit( ITC).

The allowability of ITC on all inputs till the product is manufactured was never in doubt while inputs post-manufacture were disallowed. The Service Tax Credit Scheme envisaged an across-the-board ITC on all input services prior to its integration with the Cenvat Credit Rules. Post-merger, post-manufacturing expenses are being disputed and input tax credits are being permitted only on items that are directly related to the business though Rule 2(1) permits both direct and indirect expenses. This could affect entities that have both manufacturing and service elements and those that are eligible to claim refunds.

Amendments in Budget 2011

The draft Goods and Services Tax (GST) law envisages an across-the-board input tax credit mechanism which would result in only the value-addition being taxed at every stage. Having opted for a dual-GST model, input tax credit on services and manufacture can be de-linked in the Budget by restoring the provisions of the Service Tax Credit Rules. If and when GST takes over, these Rules would have to be amended to make necessary provisions for pure-play manufacturers, pure-play service providers and entities that have a mix of both. Rule 2(1) could be amended to provide for disallowance of ITC only on personal expenses which is typified in ample cases in India as a telephone at the residence of the Managing Director. The intent of the Cenvat Credit Rules gets diluted when ITC is permitted on canteen services provided in the cafeteria, but denied on security charges for personnel manning the gates of the same entity. Budget 2011 offers an opportunity to provide clarity on ITC for the present and future.

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