The Indian Business Support Services (“BSS”) industry may soon face a setback due to the recent ruling of Authority of Advance Ruling (“AAR”) in the case of M/s Vserv Global Private Limited (“Vserv”).
In the said ruling the AAR held that the BSS rendered by Vserv does not qualify as ‘export of service’ and alas are in the nature of arranging or facilitating supply of goods or services between the associated enterprise (“AE”) and third party customers, falling in the category of intermediary services, hence liable to Goods and Service Tax (“GST”) at the rates specified therein.
Usually these type of rulings are applicable only to the applicant, however they can have persuasive value and the logics & principle of law laid down in the rulings can be used in future cases.
Therefore if the implications of this ruling are not timely clarified, it will make the Indian BSS industry non-competitive in the global market, ultimately resulting in loss of revenue, jobs and customers.
Synopsis of the case
Vserv is incorporated to provide BSS to its AE in Hong Kong. The AE is engaged in trading of chemicals and other products.
Some activities that Vserv would undertake for and on behalf of the AE is as follows:-
For these activities Vserv will come into picture only after finalization of Purchase/Sale order by the AE.
Apart from these services, Vserv will also maintain records of employees of AE, their payroll processing etc. All the payments to third parties like, supplier, Inspection Agency, Shipping Line, employees etc. will be done directly by AE and Vserv will maintain accounting of the same.
Vserv requested the AAR to decide as to whether the aforesaid services proposed to be rendered qualify as ‘Zero Rated Supply’ in terms of Section 16 of the Integrated Goods & Service Tax Act, 2017 or not.
Vserv, in its submissions to AAR relied on an important case law of GoDaddy India Web Services (P.) Ltd.,  67 taxmann.com 324 dated 04-03-2016 due to similarity of the facts.
However, AAR after considering all the facts and submissions made, ruled out that the facts of the case under consideration are not similar to the facts of M/s GoDaddy and held that Vserv arranges or facilitates the supply of goods between the foreign AE and the third party customers of the foreign AE and thus, would qualify as an ‘intermediary’ under the provisions of the IGST Act, 2017, thus making it liable to pay GST at the rates specified therein.
Issue of concern
The concept of intermediary is prone to misinterpretation and in spite of number of cases of service tax regime settling the definition, the GST department is creating disputes for exporter of services, giving conflicting AAR rulings.
In view of the consideration of the aforementioned ruling and its possible impact on the other players in the industry engaged in BSS or similar services, NASSCOM (“National Association of Software and Service Companies”) has also expressed its concern that this ruling may affect more than 5000 outsourcing operations with some 3,50,000 employees.
Decoding the impact of the ruling
A levy of 18% GST on activities related to business support services will completely derail the cost dynamics of the BSS model that operates on thin margins and increasingly face challenges from other low-cost jurisdictions such as the Sri Lanka, Indonesia and Philippines.
It is true that dichotomy exists between the purposes and methodologies of various laws & legislations in the Indian economy, however this ruling without differentiating has equally impacted the stand taken in each law & legislation.
The re characterization of nature of activities in GST has created a manifold effect and has hit the Indian BSS industry at various fronts.
Limiting our focus on the impact of this ruling from Transfer Pricing perspective, we will discuss in detail below as how the re characterisation of nature of activities under GST will hit the entities from Transfer Pricing point of view.
1st Hit – Change in Functions, Assets & Risks
One of the most important criteria to determine the arm`s length price (“ALP”) involves analysis of functions, assets and risks (“FAR”).
The analysis of FAR allows a full understanding of the economic value added activity carried out by each entity and their characterization.
Any change in functions performed, assets employed and risks assumed leads to change in FAR.
A typical FAR of the entities engaged in Business Support Service and Intermediary Services industry is reproduced below for illustrative purpose:
|Intermediary Services Industry||Business Support Service Industry|
|Particulars||Indian Entity||AE||Indian Entity||AE|
|Formulating business plan||√||√|
|Key business decisions||√||√|
|Marketing / Advertising Strategy||
|Identifying potential customers||
|Building Customer relationship||
|Delivery / Shipping||√||√|
|After sales support / Customer Support||
|Payroll Management of AE||
|Management of customer accounts of AE||
|Accounting of AE||√||√|
|Foreign Exchange Risk||√||√|
|Service Liability Risk||√||√|
On perusal of the above discussed FAR, it can be well inferred that the basic / standard Functions and Assets materially differs in both the industries.
Hence the players in the BSS industry needs to be beware of the upcoming litigations if they does not realign its functions and assets based on the new characterization and continues with the old characterization.
2nd Hit – Margins
As per Section 92F of the Income Tax Act 1961, arm`s length price is defined as “price which is applied or proposed to be applied in a transaction between persons other than associated enterprises in uncontrolled conditions”.
As per the above mentioned definition it can be understood that the price charged by the entity in lieu of the services to be provided, to be at arm`s length should be either comparable with the price charged from 3rd party i.e. internal comparable uncontrolled price (“CUP”) or price charged by another 3rd party from other 3rd party i.e. external CUP.
In the Indian scenario the average range for arm`s length price for Business support services industry is 8 – 16% and for intermediary services industry is 3-10%.
Since the functions to be performed have been altered due to re characterization from BSS to Intermediary service, it has become pertinent to relook at the remuneration model and adjust the compensation margins accordingly.
Technically the remuneration should increase due to increase in functions but as it can be observed that the arm`s length price range is between 3 – 10% only for intermediary service industry which is much lower than the arm`s length range of 8-16% of Business support service industry.
It is interesting to note here that due to change in the characterisation, functions has increased but the markup to get remunerated has decreased. Therefore it has become a loose – loose situation for the Indian businesses engaged in BSS industry who will get re characterised due to this ruling.
3rd Hit – The Associated Enterprise
Para 7.45 of Action 8-10 by OECD defines low value adding intra group services as:
“…services performed by one member or more than one member of an MNE group on behalf of one or more other group members which –
The Action 8-10 by OECD in the case of low value adding intra group services recommends to use simplified method to remunerate the service providing entities.
The simplified method is premised on the proposition that all low value-adding service costs incurred in supporting the business of Multi National Entity group members should be allocated to all those members.
Hence the cost plus remuneration model becomes the most suitable method to remunerate the low value adding service providing entities.
Here the actual problem arises.
Both BSS and intermediary service providing industry falls within the ambit of low value adding service providing entities. Hence mostly all the entities related to these industries follow the cost plus model.
Therefore any increase in the cost base of the company may lead to increase in the burden to the overseas parent entity as then the foreign AE will be required to remunerate more.
The above discussed hit can be better understood with the help of the following illustration:-
|Pre Ruling scenario||Post ruling scenario||Change|
|Increase in total expenses due to additional tax burden (after considering the impact of Input tax credit)||–||10||10|
|Total Cost Base||100||110||10|
|Mark up @ 15%||15||16.5||1.5|
|Total Revenue to be billed||115||126.5||11.5|
Hence it can be observed that the revenue to be billed to the foreign AE has increased due to increased cost base because of additional tax burden thus ultimately leading to an additional fund flow burden on the foreign AE.
4th Hit – Taxability of Indian Entity
And just when the companies thought it couldn’t get any worse, comes the Income tax in action. Already hit by the excess burden of GST cost, the company is required to pay tax on excess revenue received due to increased cost base, thus leading to camouflaged cascading tax effect.
Hence it is highly possible that the above ruling can prove to be a catastrophe for the Indian business environment.
The Indian Business Support Service Industry is struck between the devil and the deep sea. In current situation the other companies in the industry are left with two options:-
1. To accept the ruling, modify its characterization in Transfer Pricing, Realign the FAR & Margins accordingly and start paying GST under Goods and Service Tax at the rates specified therein.
2. To not accept the ruling and continue with the current characterization under both Transfer Pricing and GST; and maintaining robust documentation and supportings to substantiate the stand taken.
At first the industry could hope that the issue could be taken up by the GST Council or clarified by the GST Implementation Council.
Nevertheless if no timely clarification is issued then the company can always adopt the more favourable approach i.e. the second option but in that case there is always a room for disputes and litigation.
However the one in dispute can always argue that interpretation of the law is a subjective matter and it can differ from judge to judge. There has been countless instances where different high courts have given entirely different interpretation on the same provisions of law.
Also it is a settled position that language of statutes has its limitations, hence at times it fails to convey with clarity the intention of the legislature giving rise to ambiguity.
Considering the above proposition and limitations of interpretation of law it can be anticipated that sooner or later some clarification shall be issued by the government / GST council or the ruling shall be overruled by the higher judicial authorities regarding the characterization of entity based on the nature of services it provides to prevent the BSS industry from bleeding and dying eventually.
Notes:- 1. OECD (2015), Aligning Transfer Pricing Outcomes with Value Creation, Actions 8-10 – 2015 Final Reports, http://dx.doi.org/10.1787/9789264241244-en
2. Organisation for Economic Co-operation and Development (“OECD”)
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