The Government has recently issued a circular to clarify the position on service tax and CENVAT credit with respect to two categories of taxable services namely, works contract services and renting of immovable property services. This circular has, in part, caused considerable disquiet.
In regard to works contracts, the tax is leviable on the value equivalent to the gross amount charged for the contract, after deducting the value of the transfer of property in goods involved in the execution of the works contract which is leviable to VAT/sales tax. This is in accordance with the Service Tax (Determination of Value) Rules, 2006. However, the said Rules did not impose any restriction on the availability of input CENVAT credit pertaining to such goods which did not form part of the value of the taxable service. There was thus an anomaly. The clarification issued by the Government has addressed this position by stating that the provider of the taxable service of works contract is not eligible to take credit of the excise duty paid on such goods. This clarification is logical.
Another issue in relation to works contract service was that of shifting of the classification of a works contract related service, earlier classified under other categories of taxable services, to this new definition. Now, the Works Contract (Composition Scheme for Payment of Service Tax) Rules, 2007, provides an option to pay service tax at 2 per cent of the gross amount charged for the works contract. The service provider opting for this scheme needs to exercise the option prior to payment of service tax. The problem pertains to contracts entered into prior to 01.06.2007, being the date of coming into force of the definition, on which service tax had already been paid for payments received under the erstwhile headings. The issue was whether a service provider could revise the classification of the existing service to that of works contract service and choose to pay service tax for the amounts received on or after 01.06.2007 under the composition scheme.
The Government has clarified that the classification of a taxable service is determined based on the nature of service provided and vivisecting a single composite service and classifying it under two different headings, depending upon the time of receipt of the consideration, is not legally sustainable. In this view, a service provider who had paid service tax prior to 01.06.2007 is not entitled to change the classification of the single composite service for the purpose of payment of service tax on or after 01.06.07 and is hence not entitled to avail of the benefit of the composition scheme. This clarification is also unexceptionable.
However, the clarification made in relation to the service of renting of immovable property is difficult to fathom. It states that a provider of the taxable service of renting of immovable property is not eligible to avail CENVAT credit of the service tax paid on procurement of commercial or industrial construction services. These services are required to put up the facility of immovable property, on which rentals are charged and with regard to which, the service tax is paid. The clarification that such construction-related services are not input services does not appear to be in line with the provisions of service tax law. Services obtained for constructing immovable property, which is intended to be let out to earn rentals, are clearly input services for the output service of renting of the said property and are hence eligible for input credits.
The logic in seeking to deny the above credit has been that the immovable property to which the construction service relates is neither subject to central excise duty nor to service tax and input credit can be taken only if the output is a service or goods and since immovable property is neither service or goods, input credit on construction services cannot be taken for the output service, namely renting of immovable property. The point to be made here is the fact that the input service relates to immovable property and cannot be a ground to hold that credit is not available. There are several other categories of input services which would relate to office premises and buildings in which business is housed and from where the business is consequently carried out. These services continue to be eligible for input tax credits notwithstanding that they are qua immovable property. Indeed, it can be argued that in the instant case of renting of commercial property, the nexus between the input construction services and the output services of renting is far stronger than in the situation where such input services are with regard to output services which have no nexus with the immovable property in the nature of office buildings etc other than the fact that the business is carried on therefrom. Also, there is no provision in the service tax law which enables this arbitrary distinction to be made. This particular clarification therefore appears to be of doubtful legal basis and needs to be put to legal challenge. It is hoped that the Government of India sees it fit to withdraw this part of the circular.
The author is Leader, Indirect Tax Practices, PricewaterhouseCoopers.