Taxation of IP services turns nightmarish for many
April, 14th 2007
In September 2004, the government imposed service tax on intellectual property (IP) services which covered technical collaboration agreements (TCA) between foreign companies and their Indian subsidiaries.
In such agreements, the foreign company is the service provider as it allows the Indian subsidiary to use its patent. The Indian subsidiary, which is the service user, pays royalty to the parent company.
Service tax is generally paid by the service provider. However, the onus of paying the tax rests with the user of the service if the service provider is outside India. This norm holds good for TCAs.
The taxation of IP services has, however, sparked off a spate of disputes between companies and the revenue department. These centre around classification and valuation of IP services, especially in a composite contract. Some tax experts reckon that if revenue authorities decide to classify a service under one category, it cannot be taxed again under a different category. Revenue authorities do not seem to concur with this stand.
The result: a slew of Indian subsidiaries that have inked TCAs with their parent companies have recently received show cause notices to pay service tax for periods prior to September 2004 when IP services were out of the tax net.
Some services rendered by these companies before September 2004 have been categorised as consulting engineering services and tax demands have been raised retrospectively. A recent example is an order passed by a Commissioner of Central Excise Pune in a case involving a TCA between a US-based farm equipment major and its Indian subsidiary.
The parent company had inked a TCA with its Indian subsidiary to provide product design, technical knowhow and other related services. The revenue department issued a show cause notice (SCN) asking the company to pay service tax for past periods. The rationale: some of the services fall under the category of consulting engineers.
The company, on its part, contended that it had started paying service tax from September 2004 on IP services. It held that there was no case for levying tax on consulting engineering services as the objective of the agreement was to transfer the right to use technology.
The Commissioner, however, went by the broad principles enunciated by a Special Bench of the Tribunal in a dispute between fertiliser cooperative IFFCO and the revenue department. The essence of the ruling was that service tax could be imposed separately on IP services and consulting engineering services in a composite agreement involving transfer of technical know how and technical assistance.
The Pune-based company has now been asked to pay service tax retrospectively. The dispute does not end here. The company has the option to appeal against this order.
This is just one example. Other manufacturing companies in Pune and other zones too are locked in disputes of a similar nature with the revenue department. This is threatening to snowball into a major controversy.
A senior tax official reckons that IP services are taxable in their own right. However, if the Indian subsidiary receives any other service that falls under a different category, it will have to pay service tax under this head as well. According to T R Rustagi, former Joint Secretary in the finance ministry, the real problem in such cases is valuation, especially when the charges are composite. Whether a service is one or more will be known after examining the facts of each case. The presence of a service may not be in dispute, but valuation could pose problems, he says.
TCAs vary from company to company. But revenue officials say that companies seldom furnish details on their TCAs. So they have to take recourse to the best judgement available under law.
Some tax experts say that the department can only challenge the valuation made by the tax payer. A spilt on best judgement may not be sustainable in a single contract.
There are bound to be differences in the interpretation of law between revenue officials and tax experts. But the fact remains that the dividing line is thin, when it comes to classification of services such as IP. The confusion is compounded by varying interpretations of the legislation in different zones. The Central Board of Excise and Customs (CBEC) could perhaps look at the best practices and send out guidelines to assessing officers to ensure uniformity in the interpretation of law.
The ultimate goal is to minimise disputes, improve compliance and shore up revenues. Die hard optimists say that the service tax legislation was introduced only 13 years ago and would take a while to settle down.
Disputes of this nature could well continue as long as individual services are taxed. A shift from selective to comprehensive taxation of all services barring a few in the negative list is surely a way out. If the government keeps up with the promise of ushering in a goods and services tax by 2009-10, taxpayers will only have to wait for just three more years for a dispute-free regime.
That service tax is a relatively new impost is no excuse for the plethora of disputes over presence and valuation of services for taxation purpose. The latest example is the confusion over whether certain services received by Indian companies from foreign patents pertain to intellectual property (IP) or consulting engineering. The onus is heavier on some firms which face tax demands for services received prior to introduction of the tax on IP services.