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Taxing trade in cross-border services
November, 17th 2006
Unlike goods, international supply of services cannot be settled at the border. For imported services, the place of supply of services rule is broadly formulated to achieve the destination principle.

Globalisation dissolves geographical boundaries to facilitate free flow of trade and commerce. Tax policies cannot be immune to this change. The Indian taxation system was till recently confined to taxation of goods. Increasing share of services in the economy necessitates taxing of not only goods but also services.

Non-taxation of services, which contribute more than 54 per cent of GDP, can seriously distort the growth of the manufacturing sector. Revenue from service tax has risen from Rs 400 crore in 1993-1994 to Rs 24,000 crore in 2005-06.

Integration of the global economy warrants common domestic market. Value Added Tax, primarily, aims at developing an integrated common domestic market with uniform tax policies and procedures.

Subject to taxation

Transactions involving goods and services are subject to taxation. Different rules apply to the place and time of supply of goods and services. The treatment of cross-border supply of goods and services is also different for taxation purposes.

The place of supply does not matter when the transaction takes place within a single jurisdiction and both the supplier and receiver belong to that jurisdiction.

When a transaction takes place in more than one tax jurisdiction, as in the case of cross-border transactions, the place of supply assumes significance for tax purposes.

Under international law, the physical sovereignty of states is virtually unrestricted. In Australia, for instance, the services consumed by Australian citizens even outside the country are liable to be taxed. For example, any transportation services, even if used outside its territory, can be taxed entirely by the country from where the transport service passes.

Destination principle

Under General Agreement of Trade and Tariffs (GATT), the tax on goods moving across frontiers is collected at their destination and provides for non-discriminatory treatment of imported goods. The destination principle ensures that there is no double taxation. But supply of services cannot be so easily settled. For imported services, the place of supply of services rule is broadly formulated to achieve the destination principle, that is, taxation of services in the country of actual use.

Services used or exploited outside the country obviously fall under the category of export of services. The service tax on imported services is payable by the recipient. Therefore, it is necessary to define the place where they are chargeable to tax. This shall be the place where the business of the person receiving the service is established or where he has the permanent address.

Exception to general rule

The first exception to this rule is services connected with immovable property. That is, for services services relating to land, the place of supply is where the land is located irrespective of the location of the service provider or recipient. In case of repairs and maintenance of immovable goods, the place of supply would be where the services are physically carried out. Insurance services are normally treated as being supplied where the customer is established.


Many exemptions have to be provided in respect of services supplied to customers outside the country of the supplier. In such cases, the place where the supplier has established his business is the primary point of reference.

In case of some services, the tax is liable to be paid where the final consumer of a service is are located. If the service tax is charged where the supplier is established, the supplier of such service can easily move the office to low-tax locations. Services consisting essentially of the application or realisation of personal qualities, knowledge or skills fall under this category. In taxation of services, even transactions between the head and branch offices are treated as supply of service, if they are separately registered.

Place of supply

For certain services, the place of supply is the establishment of the customer. For commercial advertisement services, the place of actual use is the key.

In the case of services of consultants, data processing and the supply of information to customers outside the country, the place of supply is where the customer has his business or has an establishment to which the service is supplied.

Many services are taxable in the hands of customers. This is in accordance with the destination principle. For example, commodity broker services, stock broking services, insurance broking services, and employment recruitment agencies making arrangements of supply of staff.

The vital question is whether double taxation, non-taxation or distortion of computation occurs. For this, the concept of effective use and enjoyment of the service and the place where it takes place has to be taken into account.

R. Sekar
Devendra Mishra
(The authors are members of the Indian Revenue Services. The views are personal.)

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