Negative list of services step in right direction

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The Financial Express
by
Saloni Roy
Tax Partner, EY

The release of the concept paper on taxation of services based on a ‘negative list’ by the finance ministry, has struck quite a debate. The move from taxation by way of a ‘positive list’ is a potential game changer and will herald a new era of taxing services hitherto unseen.

A change to bring the laws in consonance with other international taxation regimes is definitely a move in the right direction, but, there is much to be done and issues to be ironed out before this shift can be given the green signal.

For starters, the proposed definition of ‘service’ is broad to mean ‘anything which does not constitute supply of goods, money or immovable property’ ends up raising several questions.
To take an example, what would be covered within the ambit of “obligation to refrain from an act”? From the definition, it appears that payments for non-compete agreements could be under the tax net. Generally, consideration paid for inaction on part of someone is typically not considered a service and may face resistance. Likewise, could penalties imposed for breach of contract or otherwise be taxed?

Another point to deliberate is the taxation of services in relation to lease or hire of goods. There is a thin line of difference, if at all, between lease of goods and service in relation to lease of goods. It has to be ensured that leasing of goods should not suffer double taxation or get mired in litigation. Similarly, the inclusion of ‘temporary transfer or permitting the use or enjoyment of any intellectual property right’ within the definition of service, could lead to double taxation, as several VAT legislations also treat the same as a ‘good’ subject to VAT. Any supply that is treated as a ‘supply of goods’ for VAT purposes, ought to be categorically excluded from the definition of ‘service’.

Litigation is also imminent, and currently ongoing, in cases of composite contracts for services and supplies. Proposing to tax such transactions based on “the dominant intent test”, a position that is already litigative, would continue to leave such transactions to interpretation and possibly, taxation twice over.

The definition also includes ‘right to enter any premises’. While charges collected to enter museums, theatres, etc would come within this ambit; would car parking charges also be included?

The definition excludes supplies by an employee to an employer in the course of employment. What would be covered within the ambit of ‘employment’ should be clearly identified. For instance, how would casual labour or part time employment be treated? Similarly, there should be clarity regarding treatment of seconded employees, especially given the current structure of multinational companies, where such secondment is a regular practice. As it is, such instances of secondment and loaning of employees attract litigation under the current service tax regime. Given this, it is vital to be mindful while drafting such exclusions.

The second aspect is the negative list of services. The negative list excludes specified healthcare services and proposes two alternatives. In the absence of a robust social security system, it would be wise to adopt Option 2, where all healthcare including preventive health checks and plastic surgery are exempt, except cosmetic surgery.

Another service that could have wide impact is the ‘right to use an immovable property’. Given that the service of renting of immovable property is highly questioned, it would be preferable to keep renting of personal dwelling entirely outside the tax net. Rentals vary across cities, urban and rural areas, thus throwing a challenge to identify an appropriate threshold above which tax would be attracted. As the proposed law will include within its sphere an entire gamut of service providers, it would be fundamental that an appropriate threshold is defined, so that tax compliance and administration is not onerous.

The Ministry also needs to be watchful that corresponding changes in the existing rules are drafted in a crisp, easily implementable and not open to interpretational issues. Under the current regime, with specific service categories, it is relatively easy to frame rules for import and export. Nonetheless, despite this, there is ongoing litigation on qualification of a service as an import or export. Under the proposed regime, with the lack of taxable categories, this task would be that much more difficult.

The industry still faces difficulties in interpretation of the credit rules. This has been further augmented with the amendments in Budget 2011 which, in effect, reduced the credit availability to industry. With the move towards taxation of services based on a negative list, the industry hopes for a strong credit mechanism with little exclusion, so that cascading is kept to a minimum.

As we stride towards a GST regime, taxation of services based on a negative list is clearly a positive development. For this change to be a success, it is fundamental that the government considers views of its citizens and develops a model law that is easy to implement, does not lead to double taxation and is not couched in a dilemma of interpretational concerns.

The writer’s views expressed are personal.