Operational Issues Arising Under Reverse Charge Mechanism Scheme of Service Tax

CA. Pradip R Shah

e-mail:pradip@pradiprshah.com

An overview

1. Service tax is supposed to be paid by the service provider (SP). However, in some of the cases like import of services, payment to transporter for transport of goods by road, etc., the liability to pay tax has been cast on the service recipient (SR). Budget 2012 has made large number of changes in the scheme of taxation with respect to Service Tax (ST). Of the many changes, a major change has been with respect to extension of the Reverse Charge (RC) mechanism to many other services. Notification No.15/2012-Service Tax, dated 17th March, 2012 notifies the following taxable services and the extent of service tax payable thereon by the person liable to pay ST.

1.1 Apportionment of ST liability between the SP and SR is proposed as follows:

Sl	Description of a service	% of ST payable by the person providing service	% of ST payable by the person receiving the service
1	Insurance business	Nil	100%
2	Transportation of goods by road	Nil	100%
3	Sponsorship	Nil	100%
4	Arbitral Tribunal	Nil	100%
5	Individual advocate	Nil	100%
6	Support service by Government or local authority	Nil	100%
7	renting or hiring of any motor vehicle designed to carry passengers on 🙁a) abated value. (b) non-abated value	Nil 60%	100 % 40%
8.	Supply of manpower for any purpose	25%	75 %
9.	Works contract	50%	50%
10	Any taxable services provided by any person who is located in a non-taxable territory and received by any person located in the taxable territory.	Nil	100%

1.2 Justification for Amendments – D.O.F. No 334/1/2012-TRU, dated 16th March, 2012 Department of Revenue (Tax Research Unit) explains the rationale for the above provisions as follows:

C.2. Reverse charge provisions:

12. Secondly it has been noticed that a number of registrants collect the tax but do not pay the same to the Department. This is a serious loss of the revenue, even though the compliant section at the recipient’s end is often not benefited. To ensure proper collection, while not inconveniencing small business, a new scheme is proposed to be introduced.

13. To give effect to this new reverse charge mechanism, some changes have been made: firstly, a proviso has been added to sub-section (2) of section 68 and both, the service provider and service receiver will be considered as persons liable to pay the tax on notified taxable services and to the extent specified against each one of them.

15. It is clarified that the liability of the two persons is for respective amounts and is not influenced by compliance or the lack of it by the other side. Service provider is allowed Cenvat credit of tax paid by him on inputs and input services. The respective portions have been attempted such that the credits available will be well below the amount required to be paid by such persons. In extreme situations the small service provider is also being allowed the refund of unutilized Cenvat credit, if any, available with him. Suitable changes will be made in Cenvat Credit Rules to this effect.

Analysis of the proposed changes

2. So far barring a few cases SP was the only person liable to make payment of ST under RC mechanism. However, henceforth in respect of certain services as enumerated in the table above, both, i.e., SP and SR will be required to pay ST. Total ST liability as determined in respect of each service provided is required to be apportioned and discharged by SP and SR. Following issues may arise under the proposed scheme:

(a)  How to compute quantum of tax liability?

(b)  How to apportion the same between the SP and SR?

(c)  What will happen if the SR does not accept the full amount of ST liability and deducts certain portion of value of services provided? Who will determine the revised amount of ST liability?

(d)  How to give effect to the CENVAT credit?

(e)  What will happen if SP fails to discharge his part of the liability?

(f)  What will happen if the SR fails to meet his part of ST liability?

(g)  What will happen if the volume of service provided by SP is less than Rs. 10 lakhs and is not required to pay ST?

(g)  What will happen if SR is not liable under the ST?

(i)  What will happen if the SR has paid the advance for services to be provided by SP in future?

Let us examine each of the above issues in detail.

3. Computation of tax liability of Service Provider

3.1 To be carried out in four steps:

3.1-1 First step – The first step will be to compute tax liability by the SP in respect of each service rendered. It means that the SP will have to determine ST liability with respect to each invoice issued.

3.1-2 Second step – In the second step, invoice to be raised will contain total tax liability in respect of the particular invoice and apportionment of the same as provided.

3.1-3 Third step – In the third step, since the SP will be providing the same type of services to all the SRs, balance amount of ST as appearing in various invoices will be his total tax liability.

3.1-4 Fourth step – In the fourth step, amount of the CENVAT credit for which he is entitled to will be deducted from the total tax liability as determined under third step.

3.2 Case of acumulation of Cenvat credit – Since tax liability will be lower than what it was earlier, there may be a case the wherein there may be accumulation of the CENVAT credit. In that case, the question of refund of excess CENVAT credit may arise.

Apportionment of ST liability

4. SP will have to apportion the tax liability as computed in the invoice. Apportionment of tax liability will have to appear in the invoice so that SR can discharge it. Invoice to be issued in this respect can appear somewhat as follows :

4.1 Example of an invoice – M/s MPS, a partnership firm, supplying manpower service has provided service to M/s X Pvt. Ltd. of value of Rs. 10,00,000. Invoice to be raised in this respect will be as follow:

M/s MPS Labour Contractor
To: M/s X Pvt. Ltd.
Invoice No.	Date:.			Rs.	Rs.
Being the charges for manpower supplied for the month of ______.					10,00,000
Add: Service Tax
Rate (at)	12.00%	2.00%	1.00%
	1,20,000	2,400	1,200	1,23,600
Less:ST liability to be borne by SR in terms of Notification No., 15/2012 @75.00%	90,000	1,800	900	92,700
Net ST Payable by SP	30,000	600	300	30,900	30,900
				Total	10,30,900

4.2 Tax liabilities of M/s MPS and M/s X (P.) Ltd. in above example – As can be seen from above, total tax liability of M/s MPS will be of Rs. 30,900 as against Rs. 1,23,600 which would have been under the existing provisions. Tax liability of M/s X Pvt. Ltd. will be of Rs. 92,700. M/s X. Pvt. Ltd. will have to pay Rs. 92,700 to the Government instead of M/s MPS.

5. Computation of tax liability of Service Receiver

5.1 SR liable to pay ST on receipt of invoice from SP – On receipt of the invoice from SP, the SR will check its correctness and, if found in order, will have to discharge the same by making its payment before 5th of the next month. It should be noted that no deduction can be made by SR on account of CENVAT credit. SR will have to make payment of the entire amount of liability. On making of its payment, SR will be entitled to claim CENVAT credit in respect of the ST paid by him subject to the provisions of the CENVAT Credit Rules.

5.2 When can SR claim credit of amount shown by SP in invoice – A question that may arise here is whether SR can claim credit for the amount of tax liability as appearing in the invoice of SP in the month in which invoice is received or in the month in which ST is paid?

Deductions/adjustments in Invoice Value by SR

6. What will happen if SR makes adjustment and deducts certain portion of the invoice value. Naturally, ST will also get changed accordingly. If SR intimates the same in time to SP and both the parties agrees to it, there will not be any problem. However, the scenario will change when there is a time gap or there is no communication between SR and SP. Such cases do happen in real life which will result into excess payment of tax. For example, in the above case, X Pvt. Ltd. makes adjustment in the invoice raised and the amount gets reduced to, say, Rs. 9,00,000. In that case, total tax liability will change. X Pvt. Ltd. will make adjustment and make the payment of ST on 75% of ST arising on Rs. 9,00,000, i.e., Rs. 83,430 as against Rs. 92,700. If for any reason, it is not communicated to MPS and the time for payment of tax has fallen due, MPS will have to pay Rs. 30,900 as against Rs. 27,810. Thus, total amount received by the Government will be Rs. 1,14,330( i.e., Rs. 83,430 + Rs. 30,900) as against Rs. 1,11,240 (i.e., Rs. 83,430 + Rs. 27,810). In all, the Government will be receiving Rs. 3,090 more. It is for the reason that MPS has paid ST of Rs. 30,900 as against Rs. 27,810. What recourse MPS will have to take to get back excess amount paid of Rs. 3,090? It will have to make adjustment for excess amount paid as laid down in Rules 6(4A) and (4B) of the Service Tax Rules.

7. CENVAT credit of SP and SR

7.1 Cenvat credit of SP – A question may arise how to claim CENVAT credit of SP. In the above case, ST liability of SP will be Rs. 30,900. For example, CENVAT credit entitlement of MPS is Rs. 25,000. In that case, ST liability of MPS will be Rs. 5,900 (i.e., 30,900 – 25,000). If CENVAT credit entitlement of MPS is, say, Rs. 35,000, net amount of ST liability of MPS will be Rs. NIL. An amount of Rs. 4,100 will be carried forward.

7.2 An example – As far as X Pvt. Ltd. is concerned, it can claim CENVAT credit of Rs. 30,900 in the month in which invoice is received. A question may arise with respect to Rs. 92,700, i.e., ST liability component falling on X Pvt. Ltd. Can it be claimed in the month in which the invoice has been received or after making payment of the same, i.e., next month.

SP’s failure to discharge its ST liability

8. What will happen if in the above case MPS fails to discharge its liability of Rs. 30,900? Whether the ST Department can ask X Pvt. Ltd. to pay Rs. 30,900? No, as per the Notification, ST liability of X Pvt. Ltd. has been fixed at Rs. 92,700. Therefore, it cannot be asked to pay Rs. 30,900 pertaining to MPS. ST Department will have to recover Rs. 30,900 from MPS only. It cannot be recovered from X Pvt. Ltd.

SR’s failure to discharge its ST liability

9. What will happen if in the above case X Pvt. Ltd. fails to discharge its liability of Rs. 92,700? Whether the ST Department can ask MPS to pay Rs. 92,700? No, as per the Notification ST liability of MPS has been fixed at Rs. 30,900. Therefore, it cannot be asked to pay Rs. 92,700 pertaining to X Pvt. Ltd. ST Department will have to recover Rs. 92,700 from X Pvt. Ltd only. It cannot be recovered from MPS.

When SP would not be liable for ST

10. It may so happen that SP may be availing of basic exemption limit of Rs. 10,00,000. In that case he will not be liable to pay ST. A question that may arise whether, in that case, SR will be liable to pay ST? For example, in the above case assuming that MPS is entitled to basic exemption limit of Rs. 10 lakhs. Therefore, naturally it will not be charged ST. In that case, X Pvt. Ltd. will not have to pay any ST, even though it is a Pvt. Ltd. Co.

When SR would not be liable for ST

11. This is going to be the most difficult situation for various business entities. It may so happen that SR may not be covered under ST provisions, as they may not be providing any services. For example, an entity carrying on trading activities only. Let us take another case, that of an entity providing services total value of which is Rs 10 lakhs and, therefore, entitled to basic exemption.

(a)  Whether SR will have to obtain registration under ST?

(b)  Whether SR will have to file periodical ST return?

11.1 ST registration – As far as obtaining ST registration is concerned, it will be compulsory for SR to obtain ST registration number. This is for the reason that for the purpose of making the payment, ST registration is compulsory.

11.2 Filing of periodical return – As far as filing of periodical return is concerned, SR will have to do so as provided in ST Rules.

Payment of advance by SR to SP-issues involved

12. Most complex issue will arise in the case when SR makes payment of advance to SP in lump sum. As we know, in a large number of cases, SR is required to pay advance to SP. In terms of provisions of Rule 3 of Point of Taxation Rules (PoTR), SP is required to pay ST on the same as it is considered as provision of the service. Rule 4A(1) of Service Tax Rule (STR) requires the SP to issue an invoice within 30 days of receipt of any payment towards the value of service. This will raise various issues as shown below:

(a)  At what point of time SR will have to pay the ST? Will it be on receipt of invoice from SP? Will it be the month in which advance is being paid to SP?

(b)  Should SR deduct the amount of tax as attributable to him and pay the balance amount?

(c)  Is it necessary for SP to make separate computation for tax liability and issue invoice accordingly?

(d)  Can SP split up the amount of advance received towards value of service and tax? If so, how?

(e)  At what point of time SR can claim CENVAT credit in respect of which advance has been paid?

Before examining these issues in details let us take a hypothetical case, as it will help in understanding it better.

12.1 Example – Assume that proposed provisions have come into effect from 1-7-2012. M/s Y Pvt. Ltd. makes payment of an advance of Rs. 1,00,000 on 29th July, 2012 to M/s PPF, a firm providing services which are subject to RC mechanism. Cheque issued by Y Pvt. Ltd. is received by PPF on 4th August, 2012. PPF issues an invoice for advance received on 31st August, 2012.

12.2 Payment of tax by SR – A question that will arise is, since payment of advance is considered as provision of service attracting payment of ST, SP is required to issue invoice. This may take sometime. It may so happen that during the intervening period of receipt of advance and issue of invoice, date for payment of tax or filing of periodical return may fall due.

12.3 Issues involved in example (12.1 above) – In the above example, should Y Pvt. Ltd. make payment of tax on 5th August, 2012? Or should it wait till it receives invoice issued by M/s PPF, i.e., say first week of September, 2012?

Issue of Invoice by SP

13. This is going to be the most complex exercise. For which amount invoice is to be issued by SP? Should the amount received be considered as excluding tax liability of the SP and SR? In that case, both the SP and SR will have to pay following amount as ST :

Rate of Tax	12.36%			Rs.
ST Liability of	Value of Service –>			100,000
SR, i.e., Y Pvt. Ltd.	75.00%		9,270
SP, i.e., M/s PPF	25.00%			3,090
				103,090
Less: Advance Received				100,000
Balance to be received from Y Pvt. Ltd.				3,090

13.1 Example 1 – In this scenario, in addition to advance paid of Rs. 1,00,000, Y Pvt. Ltd. will have to make payment of Rs. 3,090 to M/s PPF and Rs. 9,270 to the Government to discharge its liability. Thus, it will be paying in all Rs. 1,12,360.

13.2 Example 2 – What will happen if Y Pvt. Ltd. insists on that it is not ready to bear any burden other than Rs. 1,00,000 already paid? In that case, the computation will be as follows :

Rate of Tax	12.36%			Rs.
ST liability of :-	Value of Service –>			89,000
SR, i.e., Y Pvt. Ltd.	75.00%		8,250
SP, i.e., M/s PPF	25.00%			2,750
				91,750
Less: Advance Received				100,000
Balance to be paid to Y Pvt. Ltd.				(8,250)

13.3 Example 3 – As can be seen from above, advance paid of Rs. 1,00,000 will result into tax liability of Rs. 8,250 for Y Pvt. Ltd. At the same time, it will have to recover Rs. 8,250 from M/s PPF. For obvious reasons, this may not be acceptable to Y Pvt. Ltd.

13.4 Example 4 – Let us see another scenario wherein Y Pvt. Ltd. can keep its outflow fixed at Rs. 1,00,000. In that case, it will work out as follows:

Rate of Tax	12.36%		Rs.
ST Liability of	Value of Service –>		89,000
SR, i.e., Y Pvt. Ltd.	75.00%	8,250
SP, i.e., M/s PPF	25.00%		2,750
			91,750
Less: Advance Received			89,000
Balance to be (paid) received from Y Pvt. Ltd.			2,750
Total Payment by Y Pvt. Ltd.
To M/s PPF towards service			89,000
To M/s PPF towards ST			2,750
To the Government towards its liability			8,250
Total outflow			100,000

 Conclusion

14. The issues likely to arise under this scheme have been highlighted in the above paras. There are many other issues which the assessees will face in discharging their ST liability. A question that may baffle the taxpayer is the objective of having such a complex tax provision. According to Tax Research Unit (TRU) the objective of introducing it is that a number of registrants collect the tax but do not pay the same to the Department. This is a serious loss of the revenue, even though the compliant section at the recipient’s end is often not benefited. To ensure proper collection, while not inconveniencing small business people, a new scheme is proposed to be introduced.

14.1 Two main issues – There are two main issues, viz., loss of revenue and inconvenience to small business sectors. Let us examine each of these issues.

14.1-1 Loss of Revenue – It is a fact that a large number of assessees who collect the tax and do not pay it to the Government. Many of them do not even file ST-3 return. Is this the remedy for solving the problem? What is the guarantee that the SR will pay the tax? Secondly, this provision covers limited number of companies as SRs. What about other cases of SRs wherein such things will continue to happen? Will they be permitted to occur?

14.1-2 Inconvenience to small business sectors

14.1-2-1 They have limited resources – We have seen the problems involved and additional compliances required to be made by SRs. To what extent it is correct to presume that all the limited companies are large ones? There are hundreds of small businesses having corporate structure but which are small ones and having limited resources. Will this not add to their burden?

14.1-2-2 How to check tax evaders – As all of us know, till the ST Department carries out in-house changes in its administration large scale evasion of tax will continue to take place. What is required is sincere efforts to catch the tax evaders. Have any serious attempts been made in that direction so far? ST Department is having data of all the registrants with it. It is a known fact that majority of them do not file ST-3 return. In how many cases notices have been issued for non-filing of return? In how many cases coercive actions have been taken to recover tax from defaulters and tax evaders?

14.1.3 A word of caution

To sum-up, the top priority should be given to carry out large scale changes internally giving a clear message to the tax evaders to stop indulging into such activities rather than putting more and more burden on already harassed honest tax-payers. In the long-run, such provisions will make more and more honest taxpayers dishonest and tax professionals wealthier!

[This article appeared in [2012] 21 taxmann.com 223 (Article)]