The Hindu Business Line : Spare shared services from tax

THE Common Minimum Programme (CMP) has laid out an ambitious spending programme over a five-year period and the Finance Minister, Mr P. Chidambaram, has the onerous job of having to raise the resources and, at the same time, keep all the stakeholders happy.

India's tax-GDP ratio is one of the lowest. The total Central and State tax-GDP ratio is about 16 per cent compared to about 27 per cent in South Korea, 37 per cent in the UK and 30 per cent in the US.

As per a CRISIL `Infrastructure Advisory', the investment in infrastructure has been historically around 5.5 per cent of GDP while in growing economies such as Taiwan and South Korea it is 10 per cent. Considering that most of the investment in infrastructure in India is in the public sector, the need for more resources is imperative.

The resources have to necessarily come from increased tax receipts. The ratio of Central taxes to GDP has declined to about 9.3 per cent of the GDP from about 10.5 per cent, mainly due to rationalisation of Excise and Customs tariff. Considering the limited scope to raise additional resources from income-tax, Excise and Customs, taxation of services is the untapped resource available to the Finance Minister.

While the service sector contributes to more than 50 per cent of GDP, the tax receipts from this sector is a mere 3 per cent of the total revenue.

According to reports, the Vijay Kelkar task force on the Fiscal Responsibility and Budget Management (FRBM) Act expects the collections from service tax to grow ten-fold to Rs 80,000 crore in the next four years from about Rs 8,000 crore at present.

So the picture is clear. A broad-based levy on all service activity with just a negative list of services exempt from tax can be expected. But such a levy with a basic threshold limit, or integration of the tax on service with that on goods may not happen in this Budget. All these may have to wait till a comprehensive service tax legislation is formulated.

In this Budget, the levy of service tax is likely to be extended to more services under the present dispensation.

Shared services

To achieve optimum use of the resources, the tendency of many corporate groups is to centralise either in the holding company or in one of the group companies a number of functions such as advertising, human resources, security services, internal audit, banking, financial and insurance services, and so on. Employees of one company are often deputed to a group company. The cost of such services is often shared on actuals without any profit element.

The levy of service tax on such services has been a contentious issue as there is no specific exemption. With the extension of the levy to more services, the need for specific exemption for shared services merits greater attention.

It would be pertinent to refer to the international practice of levy of VAT on shared services between group companies.

In the UK VAT, there is a provision for group registration. This is an arrangement that allows two or more corporate bodies to account for VAT as a single taxable person. A VAT group is treated in the same way as a single company registered for VAT on its own.

To be eligible for assessment as a group;

one of the group members controls each of the others; or

someone outside the group, be it another corporate body, an individual or a partnership controls each of the proposed members.

Control takes its meaning from Section 736 of the UK Companies Act 1985. Sale or supply of goods or services between group companies is disregarded for levy of VAT but certain specified services are subject to a charge known as the intra-group reverse charge. The reverse charge applies only when a member of a UK VAT group buys in a specified service from an overseas company outside the VAT group and receives these supplies at an overseas establishment. This member (`the supplier') then uses these supplies in making an intra-group supply to another member of the UK VAT group. Consequently, VAT will be due on the intra-group supply from the representative member.

Even in respect of these specified services, VAT is not attracted when the service is rendered by a member of the group to other members, from its own resources.

The services specified for the reverse charge are listed in Schedule 5 to the VAT Act 1994. The justification for allowing group registration is that a company may carry on a variety of activities in separate divisions. Transfer of goods/ services between divisions is not liable to VAT since the taxable entity is the company and credit of input tax credit and liability to VAT is reckoned for the company as a whole.

It may happen that the same business instead of being organised as divisions may be operated as individually registered companies. It may happen that one of the companies in the group may be VAT exempt or be unable to recover its VAT in full. Such a contingency would not have arisen if the activity had been organised in divisions.

Realising that where resources are optimised by organising the activity as different companies instead of as divisions of a single company, the group registration facility for VAT purposes has been recognised. Such group registration is allowed in several other countries.

While the issue of group registration under VAT and its relevance in the Indian context may be taken up for consideration at a later point of time, the pertinent point is that there is a need for exemption for supply of service between group companies.

Quite often there is a need to establish a different company because of the collaborator or product being different. By providing shared services to group companies the resources are optimised and wasteful expenditure is avoided. These activities relate to the operations undertaken for reduction of cost and not with the intention to earn income out of such activities.

There is, therefore, an immediate need to specifically exempt supply of taxable service between group companies, at least those services that are rendered from own resources and are not outsourced. The exemption may be allowed only when rendered on a cost-sharing basis subject to submission of documentary proof.

Two rates of tax

Another issue that merits attention is the high burden of tax on small service providers and consequent low level of voluntary compliance.

One of the reasons stated in the 2003-04 Budget for the steep increase of 60 per cent in the rate of tax from 5 per cent to 8 per cent was that the facility of input tax credit has been made available. Since there is no basic threshold limit there are several small taxpayers for whom there may not be any appreciable input tax credit.

The record keeping for small assessees would be cumbersome and there is a possibility of denial of credit due to technical lapses.

Till a basic threshold limit is introduced, the assessee should be given the option to pay tax at 5 per cent without input tax credit or pay tax at 8 per cent with input tax credit. The lower rate will ensure better tax compliance by smaller assessees.

Reimbursement

It is common knowledge that reimbursement of expense incurred in the rendering of services does not result in any economic benefit to the service provider. These are expenses that the service receiver could have also incurred directly. There is no justification for levy of service tax when incurred by the service provider and claimed from the service receiver.

At present, exemption to reimbursement of expenses is provided selectively to certain services by circulars. The exemption for reimbursement of expenses should be made available for all services, by specifying in the legislation/Rules, subject, of course, to submission of documentary proof.

(The author is a Madurai-based chartered accountant.)