Service Tax – How free is the free issue?

CA Sandesh Mundra

Taxability of free Issue Material has been a very controversial issue especially in the service tax regime. Earlier under the erstwhile positive list era of service tax, where the construction sector enjoyed the benefit of 67:33 rule (Notification No. 15/2004), the service providers started planning the transactions in a way that the major purchases were being shifted to the client account. This was with a view to reduce the impact of service tax on the activity. To plug the said loophole, department amended the notification 15/2004 vide notification no. 4/2005 so as to say that even if the client to whom the services are being rendered provides certain materials free of cost, the same would form part of the gross value of the consideration only for the purpose of calculation of service tax under the abatement scheme.

Now since the amendments under the act was made applicable immediately instead of only for the fresh contracts entered into after the amendment, all the contractors whose contracts were already under progress started facing the wrath of this notification from their clientele. This was so as no client was willing to reimburse the extra component of service tax on the free issue material by strictly interpreting the clauses of the agreement which in several cases were in their favour.

Thus several big contractors like L&T, Nagarjuna, Jaihind Projects etc, were not left with an option but to raise their voice against the department’s action of raising demands on the value of free issue material incorporated in their contracts. They thus decided to appeal. Although they were bound to loose at the first appellate forum knows for its biased attitude when it comes to protecting the government revenue, forgetting their quasi judicial responsibility. Interestingly the matters started receiving different interpretations by the difference benches of CESTAT. The president of CESTAT was thus not left with any option but to constitute a higher bench to resolve the matter and preserve the dignity of this forum. Finally the three judge bench of CESTAT in the case of Bhayana BHAYANA BUILDERS (P) LTD. vs. COMMISSIONER OF SERVICE TAX, DELHI reported at 2013 (32) S.T.R. 49 (Tri. – LB) delivered a thumping verdict in the favour of the assessee. The verdict was thumping as the judgement had read down the notification bringing in a mechanism to add value of free issue material by interpreting the same as against the principles laid down under Section 67 of the Finance Act, 1994. This truly is the characteristic of our legal hierarchy where Constitution is at the top, act comes second the rules are even below the acts. So unlike in the real life, here a child can-not go against his own father.

Now the moot question that arose was whether this judgement would even apply to the post negative list regime which now had a new rule mechanism for works contracts under Rule 2A of the Service Tax (Determination of Value) Rules, 2006 , but with the same Section 67 in place.

Well we as professionals may normally tend to have a very protective attitude towards our clients and may thus not advice them to follow this judgement, for some of these reasons :-

o   It is a judgement of Tribunal which can be run down by high court or Supreme court in the future.

o   With new rule framework in place, which is now using different set of words, it will again be a battle of sorts to convince the lower authorities

o   Even on the principles of equity, it seems fine to add the value of free supplies in determining the service tax liability.

However, I am sure that some of our professional brothers, would like to take this gamble by advising their clients not to pay any service tax on value of free issue supplies as the act and in particular Section 67 has remained the same even now.