AN Idea that worked . How service tax became revenue lifeline for the Govt

When Manmohan Singh introduced service tax at a meagre 5 per cent while presenting the 1994-95 Budget, little did he know that it would become one of the biggest sources of revenue for the government in the years to come. Levied only on three items then — telephones, non-life insurance and stockbrokers — the tax brought in ₹407 crore in the first year. And in FY17, the fiscal before it was merged with the Goods and Service Tax (GST), its collection stood at a whopping ₹2,47,500 crore.

“From the Government’s perspective, service tax not only worked well, but turned out to be a major source of revenue, bringing in one-third of the indirect tax collection. The success of any tax is not limited to the revenue it generates, but also the investment climate it creates. By and large, the services sector has witnessed a phenomenal growth in the last two decades, pointing to the success of this tax,” says Anita Rastogi, Partner-Indirect Tax at PwC India.

Well taxed

The introduction of service tax find its roots in recommendations of the Dr Raja Chelliah Committee on Tax Reforms, which called for the imposition of the tax to broaden the indirect tax base. And it served that purpose well.

After economic liberalisation in 1991, a host of MNCs were setting up shop in India and taxing their services was a logical move at a time when services were bringing in 40 per cent of the country’s GDP. After 1994, the Government went on to add more services to the taxable list, including hospitality, transport, broadcasting, financial and real estate services. By the year 2016, the services sector was the major economy driver, clocking a growth of 66 per cent.

“With the growth in export of services, the sector also generated foreign income. The last few years have also witnessed a phenomenal growth of digital and e-commerce related services. This move of the Government turned out to be extremely rewarding as the focus of the Indian economy became more service oriented in the decades to come,” says Rashmi Deshpande, Associate Partner at law firm Khaitan & Co.

Aditi Nayar, Principal Economist at ICRA, points out that service tax was one of the fastest growing components of the Government’s major tax revenues in FY08, displaying a robust CAGR of over 19 per cent between FY08 and FY17. “This partly benefited from the expansion of the list of taxable services,” she says.

While 116 services were being taxed up to 2011, all services were taxed post 2012 with the introduction of negative list (of services which were not taxable). The Budget 2016 imposed Krishi Kalyan Cess on all taxable services at 0.5 per cent, which put the effective service tax rate at 15 per cent.

One with GST

However, last year, with the introduction of GST, service tax lost its identity and merged with the mega tax. “It was a good idea to bring services into the ambit of GST. That is very much in line with international practice of considering goods and services as one for the purpose of taxation,” says Crisil Chief Economist Dharmakirti Joshi.

Deshpande points out that the biggest advantage of merging the two was the availability of credit, which was restricted in the VAT and service tax regime. “Moreover, in many sectors, the problem of identification of a particular transaction whether amounting to ‘goods’ or ‘services’ led to a plethora of litigation, which seemed to have resolved to some extent,” she says.

According to Rastogi, today’s taxpayers have expanded their horizons and the same asseesee supplies both goods and services. “So by putting him onto multiple administration, even in GST, would not have served any purpose. Services did not warrant exclusion from GST and has been rightly merged with other taxes,” she adds.

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