Budget 2008 - Changes in Indirect Taxes 

V S Datey

Finance Act, 2008 has received assent of President on 10-5-2008. Service tax on new services has been made effective from 16-5-2008.

Some important issues arising out of budget charges are discussed in this Article. Obviously, most of the changes relate to service tax.

A. Service tax

A1. Highlights of changes

A2. Information Technology Software Service

Honeymoon of IT sector with tax authorities is over. IT software service is comprehensively covered under service tax net w.e.f. 16-5-2008. Following services will get covered [section 65(105)(zzzze)] -

(i)                 development of information technology software

(ii)               study, analysis, design and programming of information technology software

(iii)             adaptation, upgradation, enhancement, implementation and other similar services related to information technology software

(iv)             providing advice, consultancy and assistance on matters related to information technology software, including conducting feasibility studies on implementation of a system, specifications for a database design, guidance and assistance during the startup phase of a new system, specifications to secure a database, advice on proprietary information technology software

(v)               acquiring the right to use information technology software for commercial exploitation including right to reproduce, distribute and sell information technology software and right to use software components for the creation of and inclusion in other information technology software products

(vi)             acquiring the right to use information technology software supplied electronically, is a taxable service

A2.1 IT services covered under other service heads

In addition, other IT related services will get covered under other heads as follows -

A2.2 Definition of IT Software

“Information technology software” means any representation of instructions, data, sound or image, including source code and object code, recorded in a machine readable form, and capable of being manipulated or providing interactivity to a user, by means of a computer or an automatic data processing machine or any other device or equipment  [section 65(53a) inserted vide Finance Act, 2008 w.e.f. 16-5-2008]

Software can be broadly classified as packaged (canned or. branded) and tailor made.

Both canned as well as tailor made software are ‘goods’ - In Tata Consultancy Services v. State of Andhra Pradesh (2005) 1 SCC 308 = 141 Taxman 132 = 271 ITR 401 = AIR 2005 SC 371 = 2004 AIR SCW 6583 = 137 STC 620 = 178 ELT 22 (SC 5 member Constitution bench), it was held that canned software is goods. View was also expressed that unbranded software can be goods - view confirmed in Bharat Sanchar Nigam Ltd. v. UOI (2006) 3 SCC 1 = 152 Taxman 135 = AIR 2006 SC 1383 = 3 STT 245 = 145 STC 91 = 282 ITR 273 (SC 3 member bench).

Software is excisable goods - Information Technology Software (branded as well as tailor made) is ‘excisable goods’ under headings 8523 80 20 [earlier 8524 91 11, 8524 91 12 and 8524 91 13]. The tariff rate of duty is 12% w.e.f. 1-3-2008 (earlier it was 8%). However, all software, except canned software i.e. software that can be sold off the shelf, is ‘exempt’ under Sr. No. 27 of notification No. 6/2006-CE dated 1-3-2006. Excise duty on packaged software is 12%.

 ‘Packaged software or canned software’ means a software developed to meet the needs of variety of users, and which is intended for sale or capable of being sold, off the shelf [Explanation to Sr No. 27 of notification No. 6/2006-CE dated 1-3-2006].

Customs Duty on software - Information Technology Software falls under heading 8524 40 11 of Customs Tariff. Duty is ‘free’. Thus, on import of software (branded or tailor made) there is no customs duty. However, excise duty of 12% is payable on branded (packaged or canned) software. Hence, CVD will be payable if packaged or canned software is imported.

Paper license of software - Documents of title conveying the right to use Information Technology Software (popularly termed as paper license of software) falls under 4907 00 30 of Customs Tariff with duty rate of 12.5%. However, it is exempt vide Sr No. 157 of Notification No. 21/2002-Cus dated 1-3-2002. It is also covered under Central Excise Tariff under same heading i.e. 4907 00 30 and excise duty rate is Nil. Thus, on paper licence, basic customs duty or CVD is not applicable.

A2.3 Can service tax be imposed on development of IT software?

Many States are imposing Vat on sale of branded as well as unbranded software as both are ‘goods’. Issue is whether unbranded i.e. tailor made software is also a ‘service’?

In Imagic Creative Pvt. Ltd v. CCT (2008) 12 STT 392 = 12 VST 371  (SC), it has been held that service tax and Vat (sales tax) are mutually exclusive.

Service tax is imposed under entry 97 of List I which is a residual entry. Thus, if a transaction is covered in list II, it cannot get covered in entry 97 of List I. Since sales tax is covered in list II, it is doubtful if service tax can be imposed on a transaction which is entirely getting covered under List II.

A2.4 When the IT service will be treated as ‘export of service’ or ‘import of service’?

The service will be ‘export of service’ if recipient is located outside India, service is provided from India and used outside India and payment for such service is received by service provider in convertible foreign exchange. If recipient has commercial establishment or office relating thereto in India, order for provision of such service should be made from outside India.

The service will be ‘service provided from outside India and received in India’, (usually termed as ‘import of service’) if service is received by a recipient located in India for use in relation to business or commerce.

A2.5 Service tax if software downloaded from internet

If software is downloaded from internet, it will be ‘import of service’ and service tax will be payable by recipient under reverse charge method, except in cases where recipient is an individual and he can establish that the downloaded software is not for business and commerce - confirmed in para 4.1.5 of CBE&C TRU letter F. No.334/1/2008-TRU dated 29-2-2008.

A2.6 Providing service through internet means service performed outside India in case of some services

In respect of some services, the service will be treated as ‘export of service’ if the service is provided through internet or electronic network or any other means. The services are – (a) Maintenance or repair (zzg) (b) Technical testing and analysis (zzh) (b) Technical inspection and certification (zzi). Providing through internet or computer network will be treated as ‘performed outside India’ [second proviso to rule 3(1)(ii) of Export of Service Rules, inserted w.e.f. 1-3-2008].

A2.7 Providing service through internet means service performed in India in case of some services

In respect of some services, the service will be treated as ‘import of service’ if the service is provided through internet or electronic network or any other means. The services are – (a) Maintenance or repair (zzg) (b) Technical testing and analysis (zzh) (b) Technical inspection and certification (zzi). Providing through internet or computer network will be treated as ‘performed outside India’ [second proviso to rule 3(1)(ii) of Services (Provided from Outside India and Received in India) Rules, inserted w.e.f. 1-3-2008].

In such case, person receiving the service in India will be liable under ‘reverse charge’ method.

A3 Supply of tangible goods for use (hire) service

The service is popularly known as ‘hire service’ and taxable w.e.f. 16-5-2008.

As per section 65(105)(zzzzj), any service provided or to be provided to any person, by any other person in relation to supply of tangible goods including machinery, equipment and appliances for use, without transferring right of possession and effective control of such machinery, equipment and appliances, is a ‘taxable service’ .

‘Transfer of right to use goods’ is subject to State Vat. The service of ‘supply of tangible goods for use’ will be taxable when Vat is not payable on the transaction - see para 4.4.1 of CBE&C TRU letter F. No.334/1/2008-TRU dated 29-2-2008.

A3.1 Transfer of right to use (like leasing and hire)

Article 366 (29A) of Constitution has been amended in 1983 to include ‘transfer of right to use’ in definition of ‘sale’.  This is ‘deemed sale’ and is taxable under Vat even if actually, there is no transfer of property. Most of State Governments have provisions in their State Vat laws to cover leasing/hire for taxation.

Sometimes, goods [e.g. furniture, utensils, machinery, mattresses etc.] are given on hire. These are returned after prescribed period and hire charges are paid. This is ‘transfer of right to use for consideration’ and can be treated as ‘sale’ within extended definition of ‘sale’ under Vat laws or CST Act.

The transaction is taxable only when exclusive possession of  goods and right to enjoy them freely for contracted period is given. If owner retains effective control with him, there is no ‘transfer of right to use goods’.

‘Transfer’ implies exclusive possession to transferee - What is taxable is ‘transfer of right to use’ and not ‘right to use’.

In Bharat Sanchar Nigam Ltd. v. UOI (2006) 3 SCC 1 = 152 Taxman 135 = 3 STT 245 = 146 STC 91 = 3 VST 95 = 282 ITR 273 = AIR 2006 SC 1383 (SC 3 member bench), in concurring judgment (para 97 of SCC, para 87 of STT and Taxman, para 98 of STC), it was observed, ‘To constitute a transaction for the transfer of the right to use the goods, the transaction must have following attributes - (a) there must be goods available for delivery (b) there must be a consensus ad idem as to the identity of goods (c) the transferee should have a legal right to use the goods - consequently all legal consequences of such use including any permissions or licences required therefor should be available to transferee (d) for the period during which the transferee has such legal right, it has to be the exclusion to the transferor - this is the necessary concomitant of the plain language of the statute viz. A ‘transfer of the right to use’ and not merely a licence to use the goods.

The transaction is taxable only when exclusive possession of  goods and right to enjoy them freely for contracted period is given. If owner retains effective control with him, there is no ‘transfer of right to use goods’.

‘Transfer’ is different from ‘allowed to use’ or ‘permitted to use’ or ‘right to access’- ‘Transfer’ implies some exclusiveness to the transferee. For example, if a person boards a bus, can it be said that the bus owner has ‘transferred’ right to use bus to the passenger? The bus owner has only ‘allowed’ or ‘permits’ or ‘allows access to’ the use of bus to the passenger on non-exclusive basis.

Regarding taxability of ‘Hire of goods’, it has been consistently held that hire is taxable only when exclusive possession is transferred to the hirer, as per case law below.

Full possession and control should be transferred - In Rashtriya Ispat Nigam v. CTO (1990) 77 STC 182 (AP HC DB), it was held that hire charges are taxable only when full possession and control is given to the hirer. If the owner (person giving equipment) retains effective control over the equipment, it is not ‘transfer of right to use’.  In this case, assessee had given sophisticated machinery to contractors for execution of work entrusted to them. However, machinery continued to be in possession of assessee. Contractor was not free to use the machinery for other work, and hence there is no ‘transfer of right to use’. – view confirmed in State of AP v. Rashtriya Ispat Nigam (2002) 3 SCC 314 = 126 STC 114 = 2002 AIR SCW 1118 (SC).

In Great Eastern Shipping v. State of Karnataka (2004) 136 STC 519 (Karn HC DB) also, it was held that handing over possession and control of goods to hirer is ‘transfer of right to use goods’  and hence taxable.

In Rungtha Projects v. State of Bihar (1998) 108 STC 234 (Pat HC DB), it was observed that in case of hiring, there must be delivery of goods from one person to another on payment of hire charges. Hire is bailment of goods. – followed in Saumya Mining P Ltd v. Commissioner of Taxes (2006) 146 STC 343 (Gau HC), where it was held that when contract is for providing of crane services and control, custody and possession of crane remains with contractor, it is not a case of transfer of right to use goods and tax is not leviable.

Hiring of video cassette - In Rohini Panicker v. ASTO (1997) 104 STC 498 (Ker HC), it was held that hire charges for video cassettes from video library are taxable.

In Industrial Oxygen Co. v. State of AP (1992) 86 STC 539 (AP HC DB), it was held that giving empty gas cylinders on rent is taxable.

Rental charges for gas cylinders - In Industrial Oxygen v. State of AP (1992) 86 STC 539 (AP HC), it was held that sales tax can be levied on hire charges for cylinders (as it is ‘transfer of right to use goods’) – view confirmed in State of Orissa v. Asiatic Gases (2007) 7 VST 531 (SC) [reversing decision in Asiatic Gases v. State of Orissa (2001) 121 STC 405 (Ori HC)].

In North East Gases v. State of Assam (2004) 134 STC 249 (Gau HC), rent was payable if cylinders were kept beyond a period of 15 days. Hence, it was held that it is transfer of right to use goods and hence taxable.

A3.3  When the hire service will be treated as ‘export of service’ or ‘import of service’?

Export of service - The service will be ‘export of service’ if recipient is located outside India, service is provided from India and used outside India and payment for such service is received by service provider in convertible foreign exchange. If recipient has commercial establishment or office relating thereto in India, order for provision of such service should be made from outside India.

When service is provided to a recipient located outside India, service will be ‘export’ only if the tangible goods are located outside India [second proviso to rule 3(iii) of Export of Service Rules, inserted w.e.f. 16-5-2008].

Import of service - The service will be ‘service provided from outside India and received in India’, (usually termed as ‘import of service’) if service is received by a recipient located in India for use in relation to business or commerce.

When service is provided to a recipient located in India, service will be ‘import’ only if the tangible goods are located in India [second proviso to rule 3(iii) of Import of Service Rules, inserted w.e.f. 16-5-2008].

A4. Sale of lottery tickets

An Explanation has been added to section 65(19)(ii), vide Finance Act, 2008 w.e.f. 16-5-2008, clarifying and declaring that for the purposes of section 65(19)(ii), “service in relation to promotion or marketing of service provided by the client” includes any service provided in relation to promotion or marketing of games of chance, organised, conducted or promoted by the client, in whatever form or by whatever name called, whether or not conducted online, including lottery, lotto, bingo.

This is covered under ‘Business Auxiliary Service’.

Is sale of lottery ticket a service? - In lottery business, normal practice is that the Agent purchases lottery ticket from Government at discounted rate e.g. lottery ticket of face value of Rs 10 is purchased by him at Rs 7 and sold at Rs 10. Sometimes, the sub-agent may purchase through main agent.

Lottery ticket has been held as ‘actionable claim’. It is ‘goods’, though not taxable in view of specific exclusion in the definition of ‘goods’. Thus, basically, it is buying goods in wholesale and selling them in retail. Service, if any, is only incidental. That way, any trader in goods will try to promote the goods which he is selling. This is incidental to the main activity which is selling of goods. An activity has to be predominantly a taxable service for taxation purposes.

Valuation - Even assuming that it is ‘service’, value can only be the commission of agent and not entire value of ticket.

Constitutional issues - Tax on sale or purchase of goods other than newspapers is a State subject [Entry 54 of List II].

Lottery ticket is actionable claim. It is goods - Sunrise Associates v. Government of NCT of Delhi (2006) 5 SCC 603 = 4 STT 105 = 145 STC 576 (SC 5 member Constitution Bench). Thus, tax on sale of lottery ticket (which has been held as ‘goods’) can be imposed only by State Government (though not imposed since ‘actionable claim’ has been excluded from definition of ‘goods’ by most of States).

Further, ‘betting and gambling’ is also a State subject [Entry 34 of List II]. Imposing tax on lottery ticket seems to be encroachment on an area reserved for both taxation and control by State Government.

It may be noted that a case of evasion of service tax of about Rs 2,200 crores has been booked by department against a dealer in lotteries.

A5. Bus owners operating point to point transport of passengers

Transport operators/bus owners operate regular point to point transport of passengers between different towns under contract carriage permit. So far, they had escaped the service tax liability on the ground that the vehicle they are plying is not a ‘tourist vehicle’.  Hence, the scope of ‘tour operator’ service has been further expanded vide Finance Act, 2008 w.e.f. 16-5-2008 to cover tours conducted in ‘contract carriage’. Now, they may be asked to pay service tax.

Really, whether the service comes within definition of ‘tour operator’ itself is doubtful.

‘Tour’ does not mean just any travel between two places - As per Compact Oxford Reference Dictionary, ‘tour’  means 1. a journey for pleasure in which several different places are visited. 2. a short trip to view or inspect something. ‘Tour operator’ means a travel agent specialising in package holidays.

As per section 65(113) of Finance Act, 1994, ‘Tour’ means a journey from one place to another irrespective of the distance between such places.

Though the definition is too wide, in Usha Breco Ltd. v. CCE (2007) 8 STT 191 = 4 STR 88 (CESTAT), it was held that statutory definition of ‘tour’ does not confer an entirely artificial meaning on the commonly understood word of ‘tour’. The word ‘irrespective of distance’ in the definition of tour only means there could be no argument that tour should be to a distant place. The law seeks only to remove such ambiguity. It does not give such artificial meaning to the word ‘tour’ as to make any movement in a tourist bus a ‘tour’.

Thus, any journey from one place to another, even in contract carriage, will not be ‘tour’.

Tax on passengers is a State subject - Entry 56 of List II of seventh schedule reads ‘tax on goods and passengers carried by road or on inland waterway’. Thus, tax on passengers carried by road is a State subject. The service tax, in pith and substance, is tax on passengers. It is doubtful if such tax can be levied by Union Government under entry 97 of List I.

A6 Exemption to hotel booking services provided by person abroad

A person who does not have place of business in India may provide services relating to booking of accommodation of hotel in India, to a customer outside India. This service is exempt – Notification No. 14/2008-ST dated 1-3-2008. Thus, hotel in India is not required to pay service tax under reverse charge method.

A7 Sale and purchase of foreign exchange services

Sale and purchase of foreign exchange has been made taxable vide Finance Act, 2008 w.e.f. 16-5-2008. the service provider has the option to pay service tax calculated at the rate of 0.25% of the gross amount of currency exchanged.

An argument is made that sale and purchase of foreign exchange is sale and purchase of commodity. No service is involved and hence the transaction cannot be taxed. It is also argued that the tax will encourage gray market and official transactions will be discouraged.

As regards first argument, even assuming that it is not a service, Union has powers to impose any tax so long as it is not covered in List II and List III of seventh schedule to Constitution. As regards second argument, if the argument is accepted, really no tax or duty can be imposed on any commodity or transaction at all, since any tax is bound to encourage parallel market.

B. Cenvat Credit

B1. Cenvat Credit on exempted final products/output services

Cenvat credit of inputs and input services is not available if final product/output service is exempt from excise duty/service tax. In case of manufacturer manufacturing both exempt and dutiable goods (or service provider providing taxable as well as exempt services), it may happen that same inputs/input services are used partly for manufacture of dutiable goods/taxable services and partly for exempted goods/services.

In such cases, the manufacturer/service provider has following three options (w.e.f. 1-4-2008) –

(a)   Maintain separate inventory and accounts of receipt and use of inputs and input services used for exempted goods/exempted output services – Rule 6(2) of Cenvat Credit Rules.

(b)   Pay amount equal to 10% of value of exempted goods (if he is ‘manufacturer) and/or 8% of value of exempted services (if he is service provider) if he does not maintain separate inventory and records  – Rule 6(3)(i) w.e.f. 1-4-2008.

(c)   Pay an ‘amount’ equal to proportionate Cenvat credit attributable to  exempted final product/ exempted output services – Rule 6(3)(ii) w.e.f. 1-4-2008.

Double whammy if assessee follows rule 6(3) - Assessee cannot utilise Cenvat credit of inputs/input services utilised exclusively for manufacture or exempted final product or exempted output services, as is clarified in Explanation II to rule 6(3) inserted w.e.f. 1-4-2008 - reiterated in para 1 of CBE&C Circular No. 868/6/2008-CX dated 9-5-2008.

Thus, he cannot utilise Cenvat credit in respect of inputs/input services utilised exclusively for manufacture of exempted final products or exempted taxable services. In addition, he has to pay 10%/8% amount or reverse proportionate Cenvat credit, if he uses some common inputs/input services! This is double whammy.

Departmental clarifications - As per para 7 of CBE&C Circular No. 868/6/2008-CX dated 9-5-2008, calculation of Cenvat credit attributable to inputs used in relation to manufacture of exempted final products shall be made on basis of stores/production records maintained by the manufacturer. A certificate from Cost/Chartered Accountant giving details of quantity of inputs used in the manufacture of exempted goods, value thereof and Cenvat credit taken on these inputs may be submitted at the end of the year.

Para 6 of CBE&C Circular No. 868/6/2008-CX dated 9-5-2008 clarifies that export of service will not be treated as exempted service -

Para 5 of CBE&C Circular No. 868/6/2008-CX dated 9-5-2008 clarifies that an Input Service Distributor (ISD) does not provide any service, and is like a trader, the question of availing of option (i) or (ii) would not arise.

Many issues unanswered - There is no clarity about various issues like treatment of opening balance and treatment of input services utilised for traded goods, treatment of supplies to SEZ/EOU. It is not clear whether rule 6(2) and 6(3) are to be treated as complimentary to each other or mutually exclusive. Explanation II to rule 6(3) and its interpretation by department is highly unjust and unfair.

B2. Input Service does not cover outward freight?

Rule 2(l)(ii) of Cenvat Credit Rules, which defines ‘input service’ is amended w.e.f. 1-4-2008 as follows, Input service” means any service –  (i) used by a provider of taxable service for providing an output service; or  (ii) used by the manufacturer, whether directly or indirectly, in or in relation to the manufacture of final products and clearance of final products, upto the place of removal (The words ‘from the place of removal’ have been replaced by ‘, upto the place of removal’ w.e.f. 1-4-2008).

The amendment is made with intention that outward freight should not be ‘input service’. In my view, the outward freight is in relation to business and in view of the words ‘such as’, it is certainly covered in inclusive part of the definition. The words ‘from the place of removal’ in main part of the definition only support this view.  Even if the words ‘from the place of removal’ have been changed to ‘upto the place of removal’ w.e.f. 1-4-2008, it will not make any difference, since the outward freight will nay way get covered under ‘inclusive’ part of the definition.

In any case, outward freight upto place of removal is any way allowable even after 1-4-2008. Thus, expenses upto depot and port (in case of exports) should be allowable as ‘input services’.

C. Central Excise

C1. Highlights of changes

C2. ‘Goods’  to include any article capable of being bought and sold

Section 2(d) of Central Excise Act defines Excisable Goods as ‘Goods specified in the Schedule to Central Excise Tariff Act, 1985 as being subject to a duty of excise and includes salt’. An explanation has been added w.e.f. 16-5-2008 as follows - For the purposes of this clause, “goods” includes any article, material or substance which is capable of being bought and sold for a consideration and such goods shall be deemed to be marketable.’

As per Notes on clauses to Finance Bill, 2008 (clause No. 73), the amendment has been made to remove the ambiguity occurred due to the judgments in certain cases regarding the marketability of goods and it will be applicable prospectively.

In UOI v. Delhi Cloth Mills - AIR 1963 SC 791 = 1963 (Suppl.) (1) SCR 586 = 1977 (1) ELT (J 177) (SC 5 member Constitution bench), it has been held that the item must be such that it is capable of being bought or sold. This is the test of ‘Marketability’. The goods must be known in the market. Unless this test of marketability is satisfied, duty cannot be levied as these will not be goods. 

It appears that the amendment is made to get over this judgment.

Some main areas where immediate problems are envisaged are - (a) Intermediate products when final product is exempt (b) Waste and scrap (c) Construction industry where girders, columns are fabricated elsewhere and brought to site.

Capable - having the ability or quality necessary to do (Compact Oxford Dictionary), having or showing general efficiency and ability (Merriam-Webster Online Dictionary).

If we take these definitions, there does not seem to be difference between ‘marketable’ and ‘capable of being sold’.

There should be commercial capability of sale - Issue is - what is the distinction between ‘capable of being sold’ and ‘marketable’? There should be commercial capability of being bought or sold or mere theoretical possibility of being sold is sufficient?

In my view, the goods should be commercially capable of being sold.  Mere theoretical possibility is not sufficient. That way even moon is capable of being sold! .

‘Manufacture’ still required - Luckily, ‘manufacture’ is still required.  The article may be ‘deemed marketable’, but it is not ‘deemed manufactured’. Thus, if some waste is capable of being sold, it will be ‘goods’, but even there issue of ‘manufacture’ is still relevant.

Prospective effect - Luckily, it is clarified that amendment is prospective.

D. Customs

D1. Highlights of changes

Anti-dumping duty if goods are cleared by EOU in DTA - If the articles imported (on which anti-dumping duty was payable) are cleared by EOU as such in DTA or used in the manufacture of goods that are cleared in DTA, anti-dumping duty shall be leviable on that portion of the article, as was leviable when the article was imported into India - section 9A(2A)(ii) of Customs Tariff Act inserted w.e.f. 10th May, 2008.

E. Central Sales Tax

It was announced that CST rate will be reduced to 2% w.e.f. 1-4-2008. However, necessary notification is not yet issued, since States and Union have not agreed about compensation to States for losses to States due to reduction in CST. It is reported that some understanding has been reached between Centre and States on 6th May 2008. However, till any notification is issued, CST rate will have to be charged @ 3%.

Budget 2008 – Changes in Indirect Taxes