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VAT and service tax for your business
January, 02nd 2012

Indirect tax, being the major contributor to Government revenue (in particular levy of taxes on manufacture (excise duty) and sales (sales tax) of goods), has always been an in-focus area for industries, the departments and professionals who mediate between the two.

While the Union List of our Constitution empowers the Union Government to levy excise duty, taxation on sale of goods falls under the State List.

However, the burgeoning growth in the service sector exposed the short-sightedness of the existing tax regime. Besides, the cascading effect of the sales tax was long overdue for remedy.

INTRODUCTION OF SERVICE TAX AND VAT

The deficiencies in the Central Sales Tax Act, 1956, and the Central Excise Act, 1944, led to the introduction of Service Tax in 1994 and Value Added Tax (VAT) in 2005, seeking to efficiently regulate taxation on the sale of goods and services.

No doubt these introductions were welcomed, but multiple questions arose. Chief among them was the question: When and to whom are these taxes applicable?

Sadly, so many years since their induction, the answers to these questions still remain hazy and ambiguous.

To whom is Value Added Tax applicable?

When a person decides to manufacture or produce a product for sale and not for self-consumption, he has to pay excise duty. However, he is allowed to add the excise duty he paid during production to the final cost of the product and pass it off to the buyer.

Similarly, when the buyer takes the same product, makes modifications or additions and sells it to another person, he has to pay excise duty on the whole product again while making these changes as if he has produced the entire product on his own. Again, he can pass it off in the cost of the product to the next buyer.

At the end stage, when the product is sold to the final consumer, the seller has to pay sales tax which, again, he can collect from the final customer.

This sequence of taxing the same product again and again through the entire tax chain is called the cascading effect of tax.

With the introduction of Value Added Tax (VAT), each member of the above sales chain need not pay tax on the entire product again. Tax has to be paid only on the amount of value added to the product at every stage of production.

To whom is Service Tax applicable?

Service tax is applicable, at the risk of sounding like a truism, to anyone who provides a taxable service. Whether your service is taxable or not is a question that can be answered by looking into the relevant notifications, issued by the department from time to time.

But broadly, most services today have been brought under the Service Tax net. You need not pay service tax if your annual revenue is less than Rs 10 lakh, however.

Can I be taxed under both Service Tax and VAT?

As per the decision of the Supreme Court in Bharat Sanchar Nigam Ltd vs. UOI, an entity cannot be taxed on both service tax and VAT at once for the same product, as that would amount to punitive double taxation.

However, in practice, this can tend to happen, and many companies face sleepless nights on this account. Many products/services available today are actually a combination of both a product and a service, such as a mobile recharge coupon, which actually went up to the Supreme Court for clarification.

This becomes relevant to the hundreds, if not thousands of e-commerce entities that are springing up across India. Each has to study whether it is offering a product for sale, or a service of offering that product for sale.

To conclude with an illustration of when you may have to pay both Service Tax and VAT, if I a purchase t-shirts from a company X and sell them online to a customer by charging a convenience fee for home delivery, I will actually have to pay:

a. VAT on the sale of the t-shirt and

b. Service tax on the convenience fee charged for delivering the product home

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