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Traded service needs no tax, please
November, 22nd 2006

Should the government levy service tax on advice offered by management consultants in India to their clients abroad, say private equity firms contemplating acquisitions here?

Several tax administrators feel that such advice should attract service tax. This would be a mistake and reflects the lack of clarity that still persists on identifying what constitutes export of a service.

If the buyer of the management consultants advice, say the PE firm, has a permanent establishment in India, then there is little scope for confusion. The sale of advice is deemed, by administrative convention, a domestic sale, eminently eligible for levy of service tax.

When the buyer of the advice has no permanent establishment in India, and the payment is made in foreign exchange, there is no case for levying service tax on this bit of service export. The reason some tax authorities put forward for taxing such a service sale is that private equity firm uses the advice in India, thus rendering it a domestic sale, on the ground that when a service is consumed in India itself, it is not considered an export. This argument does not quite hold.

On receiving the consultants advice on the suitability of an Indian company for acquisition by the private equity firm, there are a number of possible responses. If the advisory says dont buy, and the PE firm fails to execute an acquisition in India, it would definitely have used or consumed the advice.

If the advisory is positive on the acquisition, the PE firm could still decide not to go ahead with the acquisition, for reasons unrelated to eligibility of the target acquisition.

Tourism, the usual kind and the emerging medical variety, are obvious examples. For reasons of administrative convenience, such service exports have not been exempted from taxation.

When a tourist buys a tube of toothpaste, she pays sales tax. When she buys a hair-do from a largish seller of beauty services, she would pay service tax as well. In countries that have implemented a goods and services tax, often goods purchased locally and taken outside, that is, not consumed locally, are eligible for tax reimbursement. Rarely does this extend to services.

Take a specialised service like film editing or dubbing. It is consumed when the service is rendered. So, if someone comes to India to get films processed, or a tender document or a complex legal contract drawn up, India would be exporting services under Mode 2, but Indias taxation policy would treat these transactions as domestic transactions.

What differentiates an export from a domestic transaction is whether the purchase is by a non-resident or not. Sale of a good or a service as a result of which foreign exchange accrues to the economy should be counted as an export.

As Indias service exports grow in volume and complexity, there would be a need to tailor administrative convenience to the basic logic of commerce.

If a foreigner comes to India to buy a specialised service competitively priced in this country, that service sale has to be recognised as an export. Countries export goods and services, not taxes. So exported goods are shorn of taxes, by draw-back, exemption or other means. Traded services deserve similar treatment.

In that case also, the service exported from India would have been consumed. The use of the advisory consists, therefore, in management decision-making based on the advice rendered, not its execution.

This decisionmaking takes place abroad. When the PE firm receives a positive buy advisory and then goes ahead to purchase the target company in India, for any tax authority to rule that the advice has been consumed in India would be conflate execution with management decision-making. That would be an error.

In any case, it is time the government brought taxation in line with the requirements of emergent trends in global trade. In the ongoing talks on trade in services at the WTO, one class of service trade is labelled as consumption abroad, falling under the second of the four modes in which service exports take place, according to WTO convention. The foreign buyer of the traded service in question travels to the exporting country to consume that service there.

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