Service Tax Liability of Importer on Ocean Freight Services

This article discusses a recent decision by the Hon’ble Gujarat High Court in Sal Steel Ltd. & others v. Union of India, Special Civil Application 20785/2018, whereby the High Court has set-aside Notification Nos. 15/2017-ST and 16/2017-ST, both dated 13.4.2017 that imposed service tax liability on Ocean Freight Services on the importer present in India in Cost, Insurance And Freight (“CIF”) Contracts.

FACTS

M/s. SAL Steel Ltd. (Lead “Petitioner” in the facts of the present case) is a Company inter alia engaged in the business of manufacturing goods such as: Sponge Iron, Ferro Chrome, Silico Manganese and Ferro Silicon etc. For this purpose, the Petitioner requires various raw materials and inputs, including Steam Coal, Chrome Ore, Iron Ore and Chrome Ore Concentrate; which are regularly imported also by the Petitioner. The orders for purchase of such materials are placed by the Petitioner to foreign suppliers on CIF basis. The responsibility and obligation of the sellers/suppliers under CIF contracts has been to deliver the concerned materials to the Petitioner by bearing cost, insurance and freight by such sellers/suppliers.

In case of CIF contract, the overseas supplier engages the vessel owner/operator for transportation of goods to India. The appointment of the vessel/ship and also payment of transportation charges i.e. ocean freight of such vessel owner/operator are made by the overseas supplier in CIF contract. The service of transportation of goods by vessel is thus received by the overseas supplier from the foreign going vessel owner/operator in CIF contract. Whereas, FOB (i.e. free on board) is a contract of sale between the foreign supplier and the local importer, where the importer would engage the vessel/ship owner or operator for importing goods into India. In FOB contract, the service of transportation of goods by ship or vessel is received by the importer in India, whereas such service is rendered by the owner/operator of the foreign going vessel. Thus, the basic difference between FOB and CIF contract is that the service of transportation of goods by vessel/ship is received by the importer in FOB contract, whereas such service is received by the overseas supplier in case of CIF contract.

Services tax is payable by the provider of services, barring the exception provided under Notification No.30/2012-ST dated 20.6.2012 (“Reverse Charge Notification”). The Reverse Charge Notification provided for instances where the service recipient shall be liable to pay service tax. The Parliament had put service of transportation of goods by an aircraft or a vessel in Negative List under Section 66D of the Finance Act, 1994 as amended on 1.7.2012. By virtue of Clause (p)(ii) of Section 66D, services by way of transportation of goods by a vessel from a place outside India upto the Custom Station of clearance in India were not chargeable to any service tax. Further, the Parliament omitted the above referred Clause (ii) of Clause (p) of Section 66D with effect from 1.6.2016. Accordingly, services by way of transportation of goods by an aircraft or a vessel from a place outside India upto the Custom station of clearance in India came to be excluded from the Negative List; and consequently such services were chargeable to service tax with effect from 1.6.2016. However, the Central Government has issued a Notification No.25/2012-ST dated 20.6.2012 (“Mega Exemption Notification”); and at Sl.No.34 of this Mega Exemption Notification, services received from a provider of service located in a non-taxable territory by a person located in a non-taxable territory was fully exempt. Since the overseas seller/supplier of the goods when the goods were exported to India was located in a non-taxable territory and the vessel owner/operator who actually transported the goods to India was also located in a non-taxable territory, ocean freight in case of CIF contracts still continued to be exempt from collection of service tax even after 1.6.2016 by virtue of Sl.No.34 of the above referred Notification. Under Rule 2(1)(d) of the Service Tax Rules, 1994, the expression “person liable for paying service tax” has been defined and by virtue of Notification No.2/2017-ST dated 12.1.2017, the Central Government inserted Clause (EEC) under Rule 2(1)(d) thereby laying down that the person in India who complied with Sections 29, 30 or 38 of the Customs Act, 1962 with respect to goods transported by a vessel from a place outside India upto the Custom Station of clearance in India was the person liable to pay service tax on such services. In this regard, Section 29 of the Customs Act, 1962, refers to the obligations of the person-in charge of a vessel or an aircraft entering India from any place outside India. Section 30 of the Customs Act also refers to the obligations of such person for submitting Import General Manifest and the like documents. Section 38 refers to the powers of the proper Customs officer for requiring person-in-charge of any conveyance carrying imported goods for production of any document or answer any questions. Thus, ordinarily, the shipping agent of the vessel owner is the person responsible for complying with said provisions of the Customs Act, and was the person liable to pay service tax on ocean freight.

All the above referred provisions show that the importers like the Petitioner in India were not liable to pay any service tax on ocean freight in case of CIF contracts, because transportation service by using a vessel or ship was not rendered to the importers in CIF transactions.

ISSUE:

On 13.4.2017, the Central Government issued two Notifications beingNotification Nos. 15/2017-ST and 16/2017-ST, both dated 13.4.2017 (“Impugned Notifications”), having been brought into force from 23.4.2017. By virtue of Notification Nos. 15/2017-ST, the Central Government has substituted certain Explanations in the original Notification No.30/2012-ST dated 20.6.2012. Explanation-V so substituted/inserted vide this Notification Nos. 15/2017-ST provides that the importer as defined under Section 2(26) of the Customs Act shall be the person liable to pay service tax in respect of services provided by a person located in non-taxable territory to a person located in non-taxable territory by way of transportation of goods by a vessel from a place outside India up to the Custom station of clearance in India. By virtue of Explanation-V so inserted, it would mean that the importer of goods would be liable for paying service tax on ocean freight in case where the service of transportation of goods in a vessel was provided by the vessel owner/operator to the overseas supplier-seller in CIF transactions. Further, by Notification No. 16/2017-ST, Clause (EEC) of Rule 2(1) (d) of the Service Tax Rules has been substituted, and there also the importer as defined under Section 2(26) of the Customs Act is made liable to pay service tax on ocean freight in cases like CIF transactions. A new Sub Rule i.e. Sub Rule (7CA) has also been inserted in Rule 6 of the Service Tax Rules by this Notification, thereby providing that the value of the ocean freight may be calculated at the rate of 1.4% of the sum total of CIF for paying service tax thereon. Thus, the effect of the amendments vide the other Notification No. 16/2017-ST, is also the same i.e. an importer like the Petitioner is made the person liable to pay service tax on ocean freight in case of CIF transactions, though the service of transportation of goods in CIF transactions is rendered by the ship owner/operator to the overseas seller/supplier, and not to the local importer.

Upon noticing that service tax on ocean freight was not paid by the Petitioner as an importer even for the imports made on and after 23.4.2017, the GST Department issued a Show Cause Notice No. VI(a)/8-38/CEA/CIR-VI/Gr.29/2017-18 dated 28.6.2018 (“SCN”), proposing to recover Rs.33,09,220/- as service tax from the Petitioner on the ocean freight portion of imports made from 23.4.2017. This show cause notice was based on the Impugned Notifications and proposed for charging interest and imposing penalties under various provisions of the Finance Act, 1994.

Contesting the validity of the SCN, the Petitioner herein challenged the constitutional validity of Impugned Notifications before the Gujarat High Court, on the ground the importer was made liable to pay service tax on services by way of transportation of goods by a vessel from a place outside India upto the Custom station of clearance in India even in case of CIF contracts, even when the local importer in such CIF transactions is neither the service provider nor the service recipient for imported goods. The four main propositions raised by the Petitioner were:

(i) Under the Finance Act, 1994, levy of service tax is imposed on services rendered in India, and not for services rendered and/or consumed outside India, and therefore the above provisions providing for collection of service tax on extraterritorial events are ultra vires. 

(ii)  Service tax can be collected from the service provider or service receiver (under reverse charge system); but the importer is a third party in CIF transactions, who is neither serviced provider nor recipient of service. Therefore, the provisions for payment of service tax by a third party are ultra vires. 

(iii)  No power is conferred upon the Central Government under the Finance Act, 1994 for charging extraterritorial events, and therefore the provisions are ultra vires the rule making power of the Central Government. 

(iv) No power for fixing value of a taxable service is conferred upon the Central Government under the Finance Act, 1994, and therefore Rule 6(7CA) of the Service Tax Rules inserted vide Notification No. 16/2017-ST, is ultra vires the rule making powers and also the machinery provision of Section 66.

SUBMISSIONS BY THE PETIONER

It is relevant that Rule 2(EEC) of the Service Tax Rules, 1994 provides as follows:

“2(EEC) in relation to services provided or agreed to be provided by a person located in non-taxable territory to a person located in non-taxable territory by way of transportation of goods by a vessel from a place outside India up to the customs station of clearance in India, the importer as defined under clause (26) of section 2 of the Customs Act, 1962 (52 of 1962) of such goods.”

It was contended by the Petitioner that the charging Section 66B of the Finance Act provides for levy of service tax on the value of “services”, other than those specified in the Negative List. The term “service” is defined under Section 65B(44) to mean any activity carried out by a person for another for consideration. Thus, service is an activity carried out by a person (i.e. the service provider) for another person (i.e.  the receiver of service).  Only two parties are recognized by the Parliament in regard to “service” viz. the service provider and the recipient of service. Whereas, Section 68(a) of the Finance Act lays down that every person providing taxable service to another person shall pay service tax; and thus the primary obligation to pay service tax is on the person providing such service. Further, by virtue of Sub Section (2) of Section 68, the Central Government has power to shift the liability to pay service tax; the method which is popularly known as reverse charge mechanism, under which service tax is collected from the recipient of service. Notification No.30/2012-ST dated 20.6.2012.  issued under Section 65(2) of the Finance Act is for reverse charge system; and the table under para (II) of the Notification shows that the Central Government has shifted the burden to pay service tax to the person receiving the service  by virtue of Col.No.4 of the table. Thus, the reverse charge system under Section 68(2) of the Finance Act permits the Central Government to collect or recover service tax from the receiver of service, though the primary charge is on the person providing taxable service by virtue of Sub Section (1) of Section 68.

It was contended that the importers in CIF contracts i.e. the Petitioner herein are neither service providers nor service receivers in respect of transportation of goods by a vessel from a place outside India up to the Customs station of clearance in India. Section 68(1) and also the Reverse Charge Notification under Section 68(2) permit the Central Government to collect and recover service tax only from the person providing the service or from the person receiving the service, and not from a third party. The rule making power of section 94 also does not permit the Central Government to make rules for recovering service tax from a third party who is neither the service provider nor the service receiver. Therefore, the impugned provisions i.e. Rule 2(1)(d)(EEC) and Explanation-V to Notification No.30/2012-ST dated 20.6.2012.  are ultra vires Section 65B(44) defining “service” and Section 68, and also Section 94 of the Finance Act.

The main question before the Gujarat High Court was whether the actions of the Central Government of issuing the Impugned Notifications and imposing service tax liability on the local importer/third party (who is neither the service provider nor the service receiver) in CIF Contracts amounted to ‘excessive delegation’ and would amount to misuse of its power?

ANALYSIS AND FINDING

It was submitted that the Gujarat High Court in Commissioner, Surat-I v. Patel Vishnubhai Kantilal & Co., 2012 (28) STR 113 (Guj.), the Court discussed the ‘rule of construction’ of a charging section and held that before taxing any person it must be shown that he falls within the ambit of the charging section by clear words used in the section. If a person has not been brought within the ambit of the charging section by clear words, he cannot be taxed at all. Therefore, as the Central Government in the present case had itself admitted that the importers in India are not persons receiving service of sea transportation, and that it is the Central Government’s case that the Indian importers were “indirectly” receiving such service and hence were persons liable to pay service tax on such service, it is clearly a case where the Central Government propose to charge service tax from the third parties i.e. the Indian importers by implication, and not by clear words of the charging section. The impugned provisions creating a charge of service tax on third parties, even when the Finance Act only provides for levy and collection of tax either from the person providing service or from the person receiving service and are thus, beyond the charging provision, and also beyond the Rule making power under Section 94 of the Finance Act. It was further contended by the Petitioner that the Impugned Notifications violate the principle of excessive delegation as discussed by the Supreme Court in General Officer Commanding-in-Chief  & Anr. v. Dr. Subhash Chandra Yadav & Anr., AIR 1988 SC 876. It was held therein that rules framed under the provisions of a statute form part of the statute. In other words, rules have statutory force. But before a rule can have the effect of a statutory provision, two conditions must be fulfilled, namely, (1) it must conform to the provisions of the statute under which it is framed; and (2) it must also come within the scope and purview of the rule making power of the authority framing the rule. If either of these two conditions is not fulfilled, the rule so framed would be void.

The Gujarat High Court noted that the Central Government does not fulfill these two conditions in the present case. The High Court also noted the decision of the Delhi High Court in Indian Association of Tour Operators vs. Union of India, 2007 (5) G.S.T.L 4 (Del.), wherein it was held that “an essential legislative function cannot be delegated to the executive. It has to be exercised by the legislature. It was emphasized in the decision in Vasu Dev Singh v. Union of India (2006) 12 SCC 753 that a statute can be amended, partially repealed or wholly repealed by the legislature only. The philosophy underlying a statute or the legislative policy, with the passage of time, may be altered but therefore only the legislature has the requisite power and not the executive. The delegated legislation must be exercised, it is trite, within the parameters of essential legislative policy. The question must be considered from another angle. Delegation of essential legislative function is impermissible. It is essential for the legislature to declare its legislative policy which can be gathered from the express words used in the statute or by necessary implication, having regard to the attending circumstances. It is impermissible for the legislature to abdicate its essential legislative functions. The legislature cannot delegate its power to repeal the law or modify its essential features. “

To this effect i.e. on the issue of excessive delegation, the High Court further noted its own decision in Prabhat Cotton & Silk Mills Ltd. v. Union of India, reported in 1982 (10) E.L.T. 203 (Guj.), Commr. Of C. Ex. & Cus, Surat-I v. Patel Vishnubhai Kantilal & Co., the decision of the Madras High Court in Lucas TVS, Madras v. Assistant Collector of Customs, Madras & Ors., 1987 (28) E.L.T. 266 (Mad.) and the decisions of the Hon’ble Supreme Court in Union of India vs. S. Srinivasan, 2012 (281) E.L.T. 3 (S.C.). and GVK Inds. Ltd. vs. Income Tax Officer, 2017 (48) S.T.R. 177 (S.C.).

In light of the above decisions, the High Court was of the view that the Impugned Notifications indeed amount to excessive delegation at the hand of the Central Government by imposing tax on a third part that is neither the service provider nor the service receiver. It held that being ultra vires the language of the Finance Act, 1994, the same are liable to be stuck down. Therefore, the High Court has set aside Rule 2(1)(d)(EEC) and Rule 6(7CA) of the Service Tax Rules and Explanation-V to Reverse Charge Notification No.30/2012-ST dated 20.6.2012.  and consequently, the proceedings initiated against the Petitioner, for collecting service tax from them as importers on sea transportation service in CIF contracts, were quashed. It is to be seen how the Hon’ble Supreme Court will view this decision of the High Court.