Service Tax under reverse charge- A happy hunting ground for Revenue Audit

Provision of service is the taxable event for service tax although Point of Taxation Rules (POTR) governs the timing of tax. Usually the provider of service is liable to discharge service tax liability unless it is otherwise earmarked for recipient of service. It is comparatively easy to keep a track on service tax liability arises on income but to detect service tax liability under reverse charge basis one needs to give a deep dive in the expenditure statement of a business entity.

Position up to June 30, 2012

Import of any service and limited number of specified services such as insurance auxiliary service, sponsorship service, services pertaining to transportation of goods by road, service of distribution of mutualfundbymutualfund distributor or agent etc. were covered under recipient based service tax, popularly known as service tax paid under reverse charge basis. A close look of the then position revealed that apart from importation of service and Goods Transport Service (GTA) all other services covered under reverse charge basis have limited impact on the routine transactions of the business entities.Moreover,methods of computation of tax were also simple since limited conditions were attached to such computation.

Position from July 1, 2012 on wards

Services that are used by almost all the business entities on a regular basis, such as works contract, security service, car rental service, work force supply service etc are now under the coverage of reverse charge mechanism.

Top of it for some of the services such as Insurance Auxiliary, sponsorship service, services rendered by advocate etc. recipient is liable to pay full service tax and for other services such as car rental, supply of work force, works contract etc. recipient is liable to pay a portion of the tax.

Moreover  partial tax liability is also varies from service to service, e.g. car rental without abatement liability under reverse charge is 40% and with abatement liability is 100%, works contract liability under reverse charge is 50% whereas the same for supply of work force is 75%.

Not only that, one should, need to verify the status of the service provider and the service recipient, in other words, one need to enquirewhether the service provider is a corporate entity or not, whether service recipient is an individual or business entity or corporate entity before apply the rule of reverse tax mechanism to discharge the tax liability.

Manifolds challenges:

  • Tracking of payments that are liable to tax under reverse charge basis.

Manual tracking of payments, which will trigger service tax exposure, is not possible for any sizable business operation. Accounting software is required to be upgraded by putting relevant patches that will help business entity to arrest the payments, vulnerable to service tax.

  • Obtaining registration and compliance of law.

Business entities, which are purely in manufacturing/trading operation and were never before under the service tax net, may require to take fresh registration under service tax and require to comply the relevant provisions of the law, such as payment of tax, filing of return, facing service tax audit etc. Moreover, for appropriate discharge of service tax liability many factors such as nature of service, whether service vendor is availing abatement or whether service vendor is availing cenvat credit needs to be verified. Any short payment of tax will lead to payment of interest and penalty apart from litigation.

  • Payment of tax in cash

Unique feature of service tax, paid under reverse charge mechanism is that the payment has to be made in cash. Business entity cannot touch the accumulated cenvatcredit to discharge the service tax liability. It will definitely have an impact on the cash flow specifically for that entity that does not have any (or less) service tax/excise duty appetite. It will certainly hit bottom line of the pure trading company since trading company does not have any service tax liability to set off the credit.

  • No threshold limit

There is no shelter available to escape the service tax liability under reverse charge basis. Even for a payment of a   single rupee, business entity is required to discharge its service tax liability under reverse charge. It will cause immense hardship for small business entities that were enjoying tax shelter under the threshold limit regime.

  • Eligibility of cenvat credit

In view of the amended definition of input service, eligibility of cenvat credit on service tax paid under reverse charge basis is required to be assessed case-to-case basis.

  • Vendor classification

Applicability of service tax under reverse charge depends on the status of the vendor as well. Most of the cases if the provider of service is a corporate entity, payment of service tax under reverse charge mechanism will not be applicable. Master record of vendors is required to be configured accordingly to avoid compliance lapses.

  • Handling of service tax audit.

Last but not the least is handling of service tax audit under the new tax regime.  Business entities are prone to commit error to comply such complex procedures. The department is also knows this and thus they will focus more on this area, which will eventually become breeding grounds for litigations.

 

Way forward:

  • Review  of expenditure statement to identify payments, which will be liable to service tax under reverse charge basis.
  • Analyse the impact of such payment on additional cash out flow, cenvat credit and profitability of the company.
  • Explore solutions if any to minimise the impact.
  • Upgrade accounting software to make it compatible to new changes.
  • Closely monitor  Vendor  master file
  • Conduct periodic internal review to ensure that the business entity is not in the wrong side of the law.
  • Educate in house people who are dealing with payments.

Curtsy:  Ca. Subhasis Banerjee (subhasis@mukeshraj.com)