The integration of service tax into the Cenvat chain has created a few issues, with policy being unclear. Consider a scenario where a service provider engaged in providing only taxable services to its clients also sells some imported equipment to the clients, which may or may not be related to the services provided.

The advertisements of the service provider carry details of both the taxable services and the equipment. An issue that arises here is whether the service provider can claim full Cenvat credit for the service tax paid on advertisement services, given that such services have arguably been used for promoting both taxable services and trading activities of the service provider. Similar issue could arise in the context of a manufacturer who is also engaged in trading activity.

This issue has somehow not been deliberated upon much in the past, though the amount of credit in question could be substantial in many cases.The credit rules provide for reversal of credit taken on inputs and capital goods if they are removed as such, thus, effectively disallowing credit on goods traded. However, no specific restriction has been prescribed for input services that are attributable to such trading operations. Such input services could either be used exclusively for the trading operations, or may be common for trading and services/manufacturing activity undertaken.

As regards services used exclusively for the trading operations of a dealer (such as advertisement which only promotes the products traded), credit may not be available. This is for the reason that such services have absolutely no nexus with the manufacture of goods or provision of taxable services.

However, availability of credit with respect to common input services which are used for trading and manufacturing/providing taxable services is a highly debatable issue. The credit rules do not provide any straightforward answer to the issue and, in fact, contain several provisions which only add to the confusion.

The credit rules provide for denial of partial credit if common services are used for providing exempt services (which include non-taxable services), along with manufacture of excisable goods or provision of taxable services. These provisions would also apply to trading activity if the same qualifies as a non-taxable service. The term service has not been defined under the service tax laws. In international experience, trading has been treated as a service under various legislations and guidelines, including the classification of services issued by WTO.

However, in common parlance, trading is known to be a distinct activity from manufacture and services. The Indian tax laws also appear to be recognising this distinction, as these activities are separately taxed under the excise, service tax and sales tax laws. Thus, whether trading should be regarded as a service for Cenvat credit purposes is itself a matter of debate.

If trading qualifies as a service, then, currently it being a non-taxable service, any common input services used for trading and manufacturing/providing taxable services would be subject to the credit rules that provide for partial denial or reversal of credit in case of taxable and exempt activities. Else, one can argue that full credit should be available for common input services, since the credit rules do not stipulate that an input service should be used exclusively for providing taxable services or for manufacture of excisable goods. So long as these services are being used for generating taxable output, even if a non-taxable output (trading in the instant case) that does not qualify as exempt goods or exempt service is benefited by such services, credit should not be denied.

This view is supported by various court rulings where it has been held that if common inputs are used in manufacture of excisable and non-excisable goods (these are not exempt goods, but are goods which do not figure in the tariff) then full credit would be available with respect to such inputs. These rulings are based on the premise that credit is to be denied in case of manufacture of exempt goods and non-excisable goods cannot be equated with exempt goods.

The above view may be contested by the authorities on the ground that the legislature never sought to give credit for trading activity, which attracts neither excise duty nor service tax. Therefore, till such time the matter is decided by the courts, confusion would continue to prevail.

Manufacturers or service providers engaged in trading activity should, therefore, analyse the quantum of credit involved and the facts of the case. Accordingly, they may decide as to whether to claim credit (and be prepared for litigation, if required), to forego it, or to park it in the books and wait for the matter to be resolved by the courts or through amendment to the credit rules.

SUBRAMANIAM HARISHANKER
(The author is national head, indirect tax, KPMG. Inputs from Siddharth Mehta, Manager )