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Digital signature: Next step on indirect tax
April, 29th 2013

The Information Technology Act (IT Act) was enacted in India in the year 2000. Its primary objective was to provide legal recognition and an enabling framework for transactions carried by electronic means, referred to as 'e-commerce'.

The IT Act gives legal recognition to electronic means of record keeping, execution and transmission of financial and legal documents and also confers legal recognition to a document authenticated by means of digital signatures. The IT Act also emphasised the usage and acceptance of electronic records and digital signatures as legal medium of corporate governance by the government and its agencies.

The gradual signs of adaptation by government agencies are apparent in its acceptance of online returns, e-forms, accepting e-mails as valid mode of communication, etc. However, digital signatures need to be embraced much more thoroughly than currently being done.

The legal position under the IT Act on invoicing is that if a commercial document such as an invoice is signed by way of a digital signature, it is a legally validly executed document. As readers will know very well, the main use of an invoice under both VAT law as well as under CENVAT is to pass credit on to the buyer of the goods or services. Section 5 of the IT Act provides that any reference to a physical signature under any other law shall be assumed satisfied if a digital signature is affixed in place of a physical signature. This applies notwithstanding anything contained in the other law. Therefore, any reference to a physical signature in the VAT or CENVAT laws should be treated as a reference to a digital signature by virtue of the provisions of the IT Act.

This should imply that all businesses are entitled to use digital signatures for all the invoicing that they do, and their customers entitled to take credit. However, this is true only in a patchwork fashion. Most VAT and CENVAT authorities have no training with digital signatures. Therefore, they are neither familiar with the legal basis of these innovations nor do they have resources to refer back to for the technological basis. As a result, they insist on physical signatures on documents as a guarantee against a buyer taking credit fraudulently. However, as mentioned earlier, the picture is a patchwork one. Depending on the individual revenue official's familiarity with digital signatures, some jurisdictions do allow use of digitally signed invoices.

In addition, there's been a slow beginning in terms of states explicitly recognising digital signatures in the VAT law. West Bengal and Karnataka have brought in provisions that explicitly say that all references to signatures shall be construed as references to digital signatures as well as physical signatures.

However, this is something that could be speeded along considerably. The central government should take the lead here and explicitly clarify that invoices with digital signatures would be permissible for taking CENVAT credit. In modern business, it is very difficult for businesses to provide invoices that are physically signed for the thousands of shipments that are made across the country every week. From a perspective of fraud, it is far from difficult to have a fraudulently prepared physically signed invoice. Therefore, the view that physically signed invoices provide greater security against fraud is simply a product of unfamiliarity with digital invoicing systems rather than with any basis in fact.

Finally, there are an increasing number of cases where the accounting for a company is done by another company. This occurs in two scenarios. One, where a company has several group companies that carry out business. In such a case it is frequently viable for the accounting resources to be located in one of the companies, which serves all the other companies in the group. In this fact pattern, the accounting is carried by one company for all business carried out by the other companies. The other situation where this occurs is where a company hands over the responsibility of accounting to an outsourced service provider. This is not as common as yet in India, but will catch on over time.

Clearly, it would hamper the process of outsourcing the accounting in both types of situations if the invoicing cannot be digitised, but has to be printed out and then signed physically by an employee of the company in question.

Therefore, digital invoicing is the next step that the government should now undertake concrete steps in facilitating. It would not only result in India catching up to many European jurisdictions, but leaving some behind as well, on this aspect.

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