Service Tax Rules – A Transition from Cash to Accrual Basis

CA Lalit Munoyat

The Union Finance Minister, Dr. Manmohan Singh, introduced Service Tax on the 28th February, 1994. A separate Chapter V was introduced in the Finance Bill, 1994 for imposing Service Tax on three specified services:

1) Stock brokers;

2) Telephones; and

3) Insurance, other than life insurance services.

Important Note:

The finance Bill 2011 has enacted Point of Taxation Rules, 2011 which cover the provisions of payment  of service tax on accrual basis insted of the hitherto adopted cash basis system. The implication of this changeover has been examplified in the attached Excel File which contains practical examples of all the rules from 3 to 8 of the Point of Taxation Rules, 2011.

The readers are advised to open the Excel file to see the practical examples of the rules 3 to 8 . To go to the MUST READ Excel file please visit the following link:-

Download Point in taxation+ SERVICE TAX RULES 1994- AMENDMENTS

The levy started w.e.f. 1^st July 1994. The Service Tax collections have shown a steady rise since its inception in 1994. While it was Rs.  410 crores in 1994-95 , it has reached a figure of Rs. 58422 crores in the year 2009-10 and the budget 2011-12 plans to raise a sum of Rs. 82000 Crores. The net share of service tax to total tax revenue for 2011-12 is estimated at 12.34%. The total number of taxable services have also increased from 3 in 1994 to 118 (approx.) for the year ending 31^st March 2011..

The provisions of the Service Tax are implemented  by many rules one of them being Service Tax Rules, 1994. The development of the rules over the period 1994-2011 kept pace with the amendment in the main provisions of the Act. However one rule that remain unaltered over this period was RULE 6 which provided for the Payment of service tax. It stated that The service tax shall be paid to the credit of the Central Government immediately following the calendar month in which the payments are received, towards the value of taxable services :

(With Cess @ 3% the applicable rate of service tax is 10.30% but the cess of 3% is  being ignored only for better apprehension the calculation and for academic purposes only, though the same is legally applicable).

This Rule 6 ensured that the payment of service tax to the government was linked to the receipt of the same by the service provider. For example if a service provider provided taxable services for Rs. 15 Lakhs and charged service tax @ 10%  i.e. Rs. 1.50 Lakhs on 1^st April 2011. The payment was received only on 30^th June 2011. In this case the service tax of Rs. 1.50 was required to be paid only by 5^th July 2011. This was done to ensure that an assesses were not put to undue financial hardships by requiring them to pay the tax out of his own pocket before the actual receipt of the same. It hardly made any impact on the tax sources of the government because the revenue from service tax in 1994 was hardly Rs. 410 Crore. But the revenue soaring to Rs. 58422 crores in the year 2009-10 and the budgeted revenue for  2011-12 being equal to a sum of Rs. 82000, the government could hardly afford to postpone the collection of the tax till the same is received by the service provider. In a value added tax system, the duty/cess/tax is liable to be paid to the government on Invoice Basis i.e. within the time permitted from the date of invoice.  This means once an invoice is prepared for sale absolute, without any condition, the trader will have to pay the applicable tax charged in the invoice irrespective of the fact that the trader has not received the payment of his invoice. The first system of accounting i.e. receipt based levy is called Cash System of Accounting, while the other invoice based levy is called Accrual Basis of Accounting. Generally traders follow the accrual basis while professionals follow Cash System of Accounting. While Traders have generally been following Accrual basis of accounting, they are going to be least affected by the change of system of collection of taxes but this change of system will hit the professionals hard because they may have to adopt a hybrid system of accounting : Accrual basis for Service Tax and Receipt basis for other receipts. The activity of business is of a continuous nature with a constant inflow and outflow of funds. The trader can buy on credit and sale on credit, the same is not the case with Service Activity which is of a discrete nature. The flow of funds in and out of the activity is not of a continuous nature and that they are interminent in nature based on the provision of a self contained service. In our above example if the service provider had only Rs. 15 Lakhs for providing of service and he spent the whole of it in providing the service and the payment of which is realised after a gap of say, 5 months. But he has to pay the service tax of Rs. 1.50 Lakhs just after say , 25 days, then where is he going to get the sum of Rs. 1.50 lakhs to be paid as service tax. Borrow it with interest for 4 months. However, the government has its own problem in cash system. While an assessee is permitted to avail credit of service tax on Input service immediately, he can postpone the payment of service tax on output service till the same is received, say after 5 months. The government thus ends providing tax free funds to an assessee for 5 months, which can never be the logical case when a levy is introduced. All in all, the government had no option but to go for Accrual System of accounting for service tax as is the case in all other systems of taxation.

For moving from Cash System to Accrual System, Notification No. 3/2011 dated 1^st March 2011 was introduced w.e.f. 1^st April 2011 so as to remove all references to “Completion of taxable services” to “Provision of taxable services” and “Payment are received towards the value to taxable services” to “Service is deemed to be provided as per the rules framed in this regard”

The concept was more clearly brought out by the insertion of a new rule “Rule 5B” to the Service Tax Rule 1994. The new rule provides as under:

“5B. Date for determination of rate.- The rate of tax in case of services provided, or to be provided, shall be the rate prevailing at the time when the services are deemed to have been provided under the rules made in this regard.”.

So the focus has shifted from receipt of the payment of service tax to Deemed Provision of Services as per rules to be made. In order to give effect to this provision, the government has framed “Point of Taxation Rules, 2011” vide notification 18/2011 w.e.f. 1^st April 2011 according to which Rate of Service Tax shall be the rate at the time when services are deemed to have been provided. So the discussion now converges around the meaning of “Point of Taxation at which Services are deemed to have been provided” because it is that Rate of Service Tax prevailing at that point in time when a service shall be deemed to have been provided.

“Point of taxation” has been defined by these rules to mean the point in time when a service shall be deemed to have been provided;

The scope of the entire scheme of Point of Taxation Rules, 2011 was sought to be explained by D.O.F.No.334/3/2011-TRU dated the 28th February, 2011 in the following terms:.

“Point of Taxation Rules, 2011 have been framed vide notification 18/2011-ST and made effective from 01.04.2011. These rules determine the point in time when the services shall be deemed to be provided. The general rule will be that the time of provision of service will be the earliest of the following dates:

1) Date on which service is provided or to be provided

2) Date of invoice

3) Date of payment”

How simple is the procedure to determine the above dates is explained by trying a humble effort to analyse Rules 3 to 8 of the Point of Taxation Rules, 2011

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Compiled By:

CA Lalit Munoyat

B.Com.(Hons.), CS., FCA, DISA

munoyat@gmail.com

98201 93508

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