A look at service tax implications on the IT sector, post-Budget 2006
The IT services sector has witnessed tremendous growth in the last decade, fuelled by an increasing number of business expansions, acquisitions and greenfield projects funded both with domestic and foreign private investment.
Some of the services typically rendered by the IT companies include application development (AD), application management (AM), consulting and testing services, performed either offshore (in India) or onsite (at the client location outside India).
Service tax is currently levied on about 100 notified taxable services. The current rate of service tax is 10.2 per cent. However, the same would become 12.24 per cent from a date to be notified.
Liability to pay service tax would depend on whether a service falls under taxable service, non-taxable service or taxable service but exempt categories. Evidently, no service tax liability results in the latter two cases. When service tax was introduced, the Government consciously kept the IT industry outside the service tax net. However, during the last decade, there have been several attempts to levy service tax on specified IT services.
The applicability of service tax on IT services prior to Budget 2006 is presented in Table 1. And the impact of Budget 2006 is shown in Table 2. However, since majority of IT services are exported out of India, even if taxable, exemption applicable for export of service would have to be explored.
As per Export of Service Rules, 2005, introduced with effect from March 2005, export of "taxable service" is exempt from service tax. For this purpose, "taxable services" are categorised into three broad categories: i) services in relation to immovable property; ii) services for which at least part performance should be outside India; and iii) services in respect of which the service recipient should be located outside India.
Typically, maintenance or repair service (MAS) and technical testing and analysis (TTA) services would fall under the second category, and business auxiliary service (BAS), management consultancy and consulting engineering service (CES) would fall under the third category.
Important conditions that are required to be satisfied in the second category of services are:
a) at least part performance of the service is rendered outside India;
b) the service is delivered outside India; and
c) the consideration for service is received in convertible foreign exchange.
Generally, the only condition that is required to be satisfied in the case of a taxable service falling under the third category of services is that the service recipient should be located outside India.
Though these appear to be simple conditions to be satisfied for qualifying as export, a deeper analysis would throw up many challenges.
Consider the following examples:
i) Maintenance or repair service carried out from India and uploaded into the client server from India.
The challenge in this case would be to prove that part performance takes place outside India, as it can be argued that no part of the performance takes place outside India.
ii) Testing of software done in India and exported out of India would face the challenge of proving the occurrence of part performance outside India.
iii) Software developed in India for a customer located in India, but which is used outside India by the customer for, say, his branch office outside India. The challenge in this case would be to prove that the actual service recipient is located outside India, though the customer located in India is a only contractual service recipient.
Thus, though commercially a transaction could qualify as export, however, the same need not necessarily be characterised as exports from service tax perspective.
In April 2005, the Government brought a rebate mechanism in service tax to relieve by way of refund input service tax/Cenvat embedded as a cost in the final exports. Rebate can be claimed on export of "taxable service" for which consideration is received in foreign exchange.
As seen earlier, many IT services were brought to service tax in this Budget and to that extent, perhaps, export of such taxable service may be eligible for rebate of input service taxes. However, business support service is yet to be notified as a service for qualifying under export for the purpose of export of service rules.
(The author is a senior tax professional in Ernst & Young.)