The IT and IT-enabled service (IT/ ITES) industry is one of the country’s major sources of foreign exchange income and has additionally created jobs over the last couple of decades. Indian IT has progressed a lot and competes with the world’s best. However, it now faces newer challenges owing to the Indian taxation structure in general and the recently introduced negative list of service tax in particular.

Taxation of services has undergone a paradigm shift from selective-based to negative list-based with effect from July 1. Negative list-based taxation of services envisages taxing all services provided for a consideration except those specified under the negative list. Also, a declared list of services has been prescribed to identify activities under the service tax ambit.

Most of the services provided by IT companies were already subject to service tax. Services provided to overseas customers qualified as export under certain conditions, which also allowed refund of service tax paid on input services, although with delay in sanction from tax authorities.

The new regime continues to levy service tax on services provided to the Indian customer. However, to qualify for export of services, a service provider should analyse the place of provision of services. According to the Place of Provision of Services Rules (PPS), if the service is provided outside India it would be eligible as export if certain other conditions are fulfilled too.

Indian IT companies are operating through branches in other countries and, accordingly, these branches are part of the same legal entity. The new law specifically enunciates that branch and head office will be construed as two separate entities for taxation of services. Thus, activities carried out by the Indian head office to branch offices located outside India and vice-versa may attract service tax where the place of provision of service happens to be in India.

Typically, the head office and branch have transactions in the form of reimbursement of expenditure, which would not be subject to the PPS rule, and if the place of provision of service happens to be in India, the Indian head office may be required to pay service tax.

The services provided by an Indian entity to an overseas customer wherein the place of service is outside India and payment in foreign exchange would qualify for export of services. However, if the services are provided to its branch office outside India, it would not qualify for export of services. One may, therefore, consider carrying out overseas business through a subsidiary instead of a branch.

According to Rule 9 of PPS, for services provided by an intermediary, the place of provision would be the location of the provider. The term intermediary refers to anyone who arranges or facilitates provision of service between two or more persons, excluding the person who acts on his account. Accordingly, for call centres that facilitate provision of services between the foreign client and the end customer, the question arises whether they can claim the benefit of export of servicess.

The declared list of services includes activities relating to software development, customisation, upgradation and so on. Accordingly, as under the old regime, all services relating to software — whether packaged or customised — would be subject to service tax.

One would have expected the Government to take this opportunity to rationalise the much-debated double taxation of software (that is, VAT and service tax), but to the disappointment of the industry, the issue remains unresolved.

(Sachin Menon is Partner, KPMG)

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