Taxman's eye on cross-border services

Amit Kumar Sarkar Updated - November 15, 2017 at 02:08 PM.

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Imagine a person outside India providing a service to his client in India. Would you consider this service liable under Indian service tax law? If yes, who would have to pay the service tax — the service provider or the recipient?

These fundamental questions have been under discussion between lawmakers and administrators over the past decade. After much deliberation, the lawmakers decided, in their prudence, to introduce Import and Export Rules encapsulating the principles of what could be considered as “import” and “export” of services.

Inspired by EU

Such an approach remained rudimentary, as the rules distinguished between different types of services and prescribed different parameters to govern whether they are “imported” or “exported”.

However, this year's Budget has proposed to replace the Import and Export Rules with the draft ‘Place of Provision of Services Rules, 2012' (PPS Rules). On first read, it appears that the European Union's VAT legislation remains an inspiration for Indian lawmakers suggesting these changes.

Export of service

So what are the proposed rules all about? Earlier, industry was required to group all taxable services into three broad categories — namely, services related to location of property; location where performance is said to have taken place; and location of the service recipient.

Now, a general principle is proposed for all types of services — namely, location of the service recipient. While the previous Import Rules created a “deeming fiction”, where inbound services from a head office to a branch office (in India) would be considered taxable, the proposed structure replicates the same to indicate that outbound services from branch office to head office outside India may be considered as export.

The previous step-model of identifying service tax implications (namely, classify activity — identify category for import/ export — apply law) is now broad-based into a set of conditions.

For instance, earlier a stockbroker's services would fall under the “performance” basket. Thus, if the physical performance of the stockbroker's service is said to be within India, even if the broker earns foreign exchange, it was difficult to claim export of service benefits. According to the proposed structure (unless not covered specifically under the PPS Rules), it is possible to claim export of service benefits, as the stockbroker is said to be “exporting” if the service receiver is located outside the taxable territory.

Inter-State services

The PPS Rules are likely to cause sectoral shifts in the manner in which the jurisdiction and levy of service tax would be interpreted. For instance, the services provided by a business entity in Jammu and Kashmir to a recipient within India would be liable to service tax, which would, however, be paid by the recipient. This “shift” does serve to remove ambiguities on transactions with service providers/ clients within Jammu and Kashmir.

A careful study of the proposed structure is necessary for industry to fully appreciate the extent and manner in which taxation of cross-border supply of services is envisaged.

The PPS Rules also introduce the concept of identifying location of “use and enjoyment” of services to determine “taxable territory”. This is a significant condition, given the possible differences in interpretation between industry and Revenue on this alone.

The proposed PPS Rules is a peephole into the future, and expected to directly influence the manner in which cross-border supply of services would be interpreted for levy of service tax.

It is also likely that these principles, if not appropriately interpreted by industry, will likely cause a negative surprise once GST is introduced (especially on inter-State supply of services).

Amit Kumar Sarkar is Associate Director – Tax Practice, Ernst & Young

Published on May 13, 2012 13:29