The Hindu Business Line : Taxing service exports: Give up selective approach

As there is no service tax on any earnings in foreign exchange for `taxable service', some exporters of services are puzzled about the new foreign trade policy's exemption from tax of services exported. The whole issue is still nebulous, says G. Srinivasan.

THE New Foreign Trade Policy unveiled by the Commerce Minister, Mr Kamal Nath, has unwittingly stirred a hornet's nestwhen it mentioned, as one of its far-reaching moves and by way of procedural simplification, that "all goods and services exported, including those from the domestic tariff area (DTA), shall be exempt from service taxes."

Currently, there are no legislative provisions defining export of services as the issue is still under study, with the Finance Ministry putting on its Web site the draft rules on export of services to get the views of stakeholders and other experts. The factual position is that there is no service tax on any earnings in foreign exchange for `taxable service'. No wonder, some exporters of services are puzzled about the exemption from tax of services exported when the whole issue is still nebulous.

A little more clarity in the Commerce Ministry's policy announcement on what it means by "services exported shall be exempt from service taxes" would have helped clear the haze. Service exporters with substantial stakes, such as management consultants, may not then have had to demand clarification on "the misleading announcement" in the Trade Policy about exemption of service tax on all goods and services exported from the country.

The draft rules for export of services — released for public comment on August 19 — seek to define, for the first time, "export of taxable service" and extend exemption to such exports and offer rebate of tax paid on the inputs. The idea is to facilitate not just export of taxable services without payment of service tax but also to allow rebate of service tax or excise duty paid on input used in providing the exported service.

Be that as it may, when the country's successful business process outsourcing (BPO) industry could not stomach its operations abroad turning costly when the mandarins threatened to tax them, there was a lively debate about the expedient need to discriminate core and non-core activities of BPO companies and tax them accordingly.

The idea behind this division for tax purposes was to ensure that in its over-zealousness to mop up revenue, the Finance Ministry does not kill the goose that lays golden eggs, as foreign companies would outsource their work elsewhere if the tax burden is passed on to them by the companies that do the BPO workhere.

If the Finance Ministry is dazed by the clout of information technology czars and is compelled to study the core and non-core activities of BPO companies for tax treatment, management consultants are understandably miffed that as per the draft rules, management consultancy services, if they are used in relation to commerce or industry, would constitute "export of taxable service", if the recipient of the service is located outside India.

If the foreign recipient of the service has a commercial or industrial establishment or an office in India, he/she shall not be deemed to be located outside India and, hence, service tax becomes applicable. If the services covered in the former are not used in or in relation to commerce or industry, then the recipient should be located outside India at the time of receipt of the service.

In market research services, these would qualify as "export of taxable services" only if they are performed partly or wholly outside India, regardless of the location of the service recipient.

According to Mr G. Shanker, former President, Institute of Management Consultants of India, the competitiveness of Indian consultants would be affected under a dispensation where foreign consultants would be able to travel into India and not be subject to service tax, as they would be earning their fee outside India.

As Indian consultants play a crucial part in attracting FDI and in helping foreign firms set up operations in India, this rule would only stymie their efforts, management consultants contend. If exporters of services are to be exempt from taxes — or, where taxed on inputs used, would qualify for rebate — there should be no discriminatory treatment among high-end, value-added services that are exported, they justifiably say.

As the issue involves inter-sectoral equities between goods and services, the Finance Ministry in the 2004-05 Budget laid out amendments to make rules for defining export of taxable services and providing exemption to such exports and rebate of tax paid or payable on exported taxable services and their inputs.

Here are the cornerstones on which these draft rules are based:

Any service provided in relation to export of goods shall be treated as export.

Specified services pertaining to immovable property are to be treated as export, if the said immovable property is located outside India.

In specified services which involve a physical activity, if the service is performed outside India, they shall be treated as export. To avoid disputes and for the sake of simplicity, even if such a service is partly performed outside India, it shall be treated as export of service.

Other services rendered to an industrial or commercial user located outside India shall be treated as export unless it has any establishment or office in India. Services rendered to non-industrial or non-commercial users would be treated as export, if the recipient is located outside India at the time the service is received.

Taxable services can also be exported on payment of service tax; later rebate of the tax paid may be claimed.

Rebate of service tax or excise duty paid on inputs used in providing taxable services exported shall also be available.

Services account for a wide spectrum of heterogeneous activities, ranging from the traditional trade and transport to the knowledge-intensive New Economy activities.

Nobody disputes that taxes should not be exported and, as such, exporters of service should be spared the tax burden, either through exemption or, where they are taxed on inputs used, they should quality for rebate.

But fiscal experts unanimously contend that taxation of services and its integration with taxes on goods is also important from the angle of fair distribution of the tax burden across sectors.

The prevailing tax system unfortunately places heavy burden of indirect taxes on the commodity-producing sectors and relatively fewer burdens on services, leaving the former uncompetitive and inefficient. Thus, to get rid of taxes on inputs and capital goods and relieve taxes on exports, it is crucial that indirect taxes on services are extended and integrated with those on goods, is crucial.

It is not for nothing that the Reserve Bank of India's latest Annual Report singled out the objectives of levying a service tax. These include:

* shrinking of the tax base as the share of industry in GDP decreases while that of services expands;

* failure to tax services distorts consumer choices and encourages spending on services at the expense of goods;

* untaxed service traders are unable to claim VAT (value added tax) on service inputs, which encourages businesses to develop in-house services, fostering further distortions; and

* most of the services that are likely to become taxable are positively correlated with expenditure of high-income households and, therefore, service tax improves equity.

The RBI reckons collections from service tax have recorded a steady rise, from Rs 410 crore in 1994-95 to Rs 8,300 crore in 2003-04. Yet, they accounted for only 4.4 per cent of the total tax receipts of the Centre (0.3 per cent of GDP) in 2003-04.

At present, service tax is levied on 71 items, including 13 additional services that the 2004-05 Budget brought in to realise a higher receipt of Rs 14,150 crore through this tack. The Government has already given in to the orchestrated pressure mounted by truck owners and exempted them from this impost, thus already making a dent in its tax receipt kitty on this count.

Even as service tax is seen as the tax of the future, the country's apex bank holds that the inclusion of all value-added services in the tax net would yield a larger amount of revenue and make the existing tax structure more pliable. No doubt, the increase in the share of the services sector in GDP holds the key to larger revenue generation, as this sector, including construction, accounted for 56.2 per cent of GDP last year, having steadily risen from 38.3 per cent in 1970-71. Experts feel that relieving tax on inputs and zero-rating the taxes on exports is not possible unless all the services are taxed. For this, the present selective approach by the authorities needs to be given up in favour of a rational approach to taxation of services that has the widest possible coverage.

But this strategy calls for bringing more services into the tax net if the authorities' intention, as outlined in the National Common Minimum Programme of the United Progressive Alliance (UPA) Government, is to make funds available for financing the country's creaking infrastructure, both physical and social, besides undertaking public work programme to generate employment to more people.

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