India's service tax collection for the Financial Year 2010-11 was estimated at Rs 69,400 crore and for 2011-12, it is expected to increase to Rs 82,000 crore as per the Union Budget projections. While this may seem to be a substantial figure considering the fact that service tax, in its present all-encompassing form, is less than a decade old, the tax authorities appear to want more.
The service tax authorities appear to be of the view that the collections are not commensurate considering the fact that the services sector contributes to over 55 per cent of the country's GDP. It is understood that the service tax collection was only 1.1 per cent of the GDP even though the services sector contributed over 50 per cent in the GDP. The figure of service tax collection seems low even after considering the fact that service tax is eventually paid on the final value addition due to the Cenvat scheme, that the unorganized sector services are not taxed and that several sectors such are medical, education, essential services etc. are only partially taxed etc. Interestingly, the annual performance report for service tax for 2009-10 indicates increase in the number of assessees by 8.53 per cent, thereby indicating the increased penetration of service tax. The Cenvat Credit Scheme has also ensured that service recipients do not have any resistance to payment of service tax since credit of the tax so paid is available.
DGST letter This situation appears to have led to an inference that the service tax so paid by the recipients to the providers for onward deposit to the Government is either not being deposited or is being delayed. The recent letter from DGST to various stakeholders seeking their views on the introduction of Tax Deduction at Source (TDS) provisions in service tax requires to be evaluated in this context.
In the case of income tax, TDS was introduced largely with the objective of ensuring regular flow of funds (since advance tax payments are quarterly, while TDS payments are monthly), widening tax base, reporting correct income and controlling tax evasion. Considering the fundamental differences between income tax and service tax, some of the reasons for TDS introduction in income tax may clearly not be applicable in case of service tax. For instance, the introduction of TDS in service tax may not result in early collection of revenue by the Government since service tax is in any case payable by most assessees on a monthly basis.
In case of income tax, the introduction of the TDS mechanism has played a key role in reducing evasion and increasing the assessee base. These purposes can be achieved in case of service tax as well, considering,
the fact that the service recipient is generally eligible to avail credit of the service tax as soon as receives the invoice of the service provider, and not when the service provider makes a payment to the Government, and
the ability of the service provider to offset such receipts against his credits and make a payment to the Government only if his credits are insufficient to meet his obligation, together with the fact that the return filings are once in six months (and therefore the service tax authorities know only after six months) may expose the service tax collections to the risk of evasion, thereby strengthening the case for tax deduction at source.
This may, however, lead to several unforeseen consequences such as accumulation of credit pool, inability to utilise the credits leading to refund applications etc. for several assesses, thereby blocking working capital. In addition, it would add to the compliance requirements for assessees who are already overburdened with multiple compliance requirements under various legislations.
In case of income tax, the TDS provisions operate only on specified incomes such as salary, interest, dividend, interest on securities, commission and brokerage, rent, fees for professional and technical services, payments to non-residents etc. Similarly, in service tax, certain taxable services may be specified for the purposes of service tax TDS applicability. For instance, as per the CBEC, between 2008-09 and 2009-10, telecom and construction services have shown a decline in terms of service tax collections. This appears to be perplexing considering the speed with which these two sectors are expanding notwithstanding reasons such as expansion of Cenvat Credit, increased capital expenditure etc. A sectoral view on the introduction of TDS on service tax, if at all introduced, appears to be warranted.
Reverse charge Interestingly, the reverse charge mechanism, which has some elements of a TDS system has been operating for a while now and does not suffer some of the disadvantages that at TDS system would entail. While the reverse charge system mandates that the service recipient will make the tax payment, it ensures that the credit of the tax so paid is generally available without any working capital blockages or additional compliances. This system appears to have been largely introduced with the twin objectives of administrative ease (not having to deal with large number of tax payers) and ease of collections (not wanting to track overseas entities providing services in India). An expansion of the reverse charge mechanism to cover a few more sectors could also be considered instead of TDS introduction on service tax with its attendant issues.
Accordingly, if TDS is sought to be introduced in service tax, it must take into consideration the differences between a direct and indirect tax, credit availability in the hands of the recipient, services prone to evasion, etc. Considering the success on account of strict implementation of TDS provisions in Income Tax, one can safely say that its introduction in service tax would certainly enhance collections, although it would lead to working capital blockages and additional compliance requirements.
(The authors are Senior Director and Senior Manager, respectively, at Deloitte Touche Tohmatsu India Pvt Ltd.)