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Service tax rules leave India Inc vexed
July, 17th 2008

Many taxation issues pertaining to inter-state delivery of services are being envisaged when states are given the power to tax a set of services. Two principal questions that seem to arise are whether revenue will go to the jurisdiction of production or that of consumption; and how to identify the place of supply and that of actual use of the services in the case of inter-state delivery of services.

Tax authorities are mulling solution to the first question taking cue from the destination principle followed by most countries to tax international transactions with VAT imposed on imports and rebated on exports. The second question is much more complex, and its solution involves greater efficiency of administration. The state governments are making their demand for the power for levy of service tax more vociferous. Tax policy managers at the centre would, however, do well to put the necessary administrative systems in place before the states demand is met.

Another vexed issue in regard to taxation of services is linked to how export of services is defined. The Export of Service Rules notified by the government are ambiguous and increasingly disputatious. The matter is relevant as exports are meant to be tax-neutral while consumption of specified services locally is taxable. Let us pore over a few niceties.

Currently, only if the services rendered from India are fully used outside India, the process qualifies as exports. In the BPO industry, there are different possibilities of partial use of some composite services rendered by an Indian entity within the territory of India and while part of the services is used outside India. If you go strictly by the wording in the Export of Services Rules, it would seem that even if 99% of the services rendered by an Indian entity in a particular transaction is used outside India and the balance 1% used by local entities, the transaction cannot be treated as exports. That means the relevant entity will not be eligible for refund of input taxes. There is already a spate of litigation over this question which is fundamental.

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