Service Tax – Reverse Charge Made Easy!

Change is for good – if you believe it, good enough; but if you do not, well – it will change! That is the only piece of advice that can be rendered to people who are confused owing to some of the amendments in the service tax law. A big chunk of the law was amended last year; and even as of today, there are a number of practical difficulties that are being experienced as a result of it. Here, we touch upon one of these sensitive matters and try to have a 360⁰ view of the issue – Reverse Charge.

The background

The fundamental concept of service tax must be understood. It is a type of tax on value addition. Therefore, the primary liability of payment of this tax is on the person who adds value – that is the person who provides the service. When someone provides a service, value is added. For example, if some technical engineer has supervised the production process, the value of goods has increased because now the goods are likely to be better in quality. Thus, value is generated and tax is payable by the service provider. However, the incidence of tax can be passed on to the service receiver. Have you ever wondered why? This is because it is a tax on the service, not the service provider. Therefore, whosoever takes the benefit of service will have to incur the tax ultimately.

The meaning of reverse charge

As discussed above, the liability of payment of tax rests on the service provider by default. However, there are certain circumstances where the liability is on the receiver of service. These situations are together called the “reverse charge” mechanism. Some people also call it “tax shift”. The primary thing to understand is that the liability itself rests on the service receiver and the service provider is not at all liable. In order to appreciate this, kindly go through the next section.

Is it similar to tax deduction in income-tax?

In income tax, there is a concept of TDS. Therein, the income-tax law says that the person who is making the payment to another person should deduct tax before making such payment. The question arises – is the concept of reverse charge similar to this TDS concept? In order to understand this, let us consider an example.

Suppose that A is giving a service to B. Let us assume that this transaction is covered both under TDS as well as reverse charge. Then let us discuss how the provisions operate and the underlying concepts behind the same. A is providing a service to B; therefore B will make payment to A. In this regard, the following facts are important to consider.

As per service tax law	As per income-tax law
A is the service provider	A is earning income
B is the service receiver	B is incurring an expense
B must pay service tax	B must deduct income-tax and pay it.

Income tax act says that the primary responsibility of paying income-tax is on A since he is the one who is earning income. Nevertheless, since TDS provisions are applicable, B is also responsible for the tax. If B does not pay, then A remains liable to pay income-tax.

However, service tax law says that the primary responsibility of paying service tax is on B. The service is provided by A, but since reverse charge is applicable, B is responsible for paying service tax. If B does not pay, then A is not liable to pay service tax.

Thus, this is the basic difference between TDS and reverse charge which should be appreciated. Therefore, the point to capture is – if reverse charge is applicable, then the liability to pay the tax also shifts completely. Service provider will not be liable to that extent.

Why reverse charge?

Fundamentally speaking, it does not make a very big difference. Even if service provider is liable, ultimate burden of tax always rests on the service receiver. Therefore, introduction of reverse charge does not actually entail any extra encumbrance to the service receiver. Nevertheless, he is now responsible for all the procedural burdens like getting registered, filing returns etc.

The question that still haunts our minds is – why reverse charge? What substantial difference does it make? Why only some of the services are covered in this mechanism?

The underlying concept is only a policy matter. We cannot actually comment upon it. Nevertheless, there are some inferences that can be made looking at the way these provisions are designed. Generally, reverse charge mechanism is applicable in cases where it becomes difficult to trace the service provider. More interestingly, reverse charge mechanism is made applicable where there is a substantial loss of revenue in question. Following paragraph will illustrate this –

We shall begin with an example. Reverse charge is made applicable in case of service provided by an insurance agent to any insurance company. In this case, the service is provided by an insurance agent. And the service receiver is the insurance company. Generally, it is the service provider [viz. insurance agent] who is liable. But there are two problems that the government faces –

1.       The insurance agents work on a very small scale. Probably none of the insurance agents would provide service of a value exceeding Rs. 10 lakhs. As a result of this, all of them would be covered under threshold exemption. So there would be no tax! Remember that threshold exemption is not applicable when the tax is payable in the capacity of a service receiver. Therefore by doing this, the government has actually saved a lot of revenue.

2.       Secondly, it is very difficult to trace so many service providers. Every insurance company would have thousands of insurance agents. Instead of approaching so many insurance agents, it is better to approach only one insurance company and recover the full tax. Therefore, reverse charge system is a very smart and innovative method of taxation.

The reasons pointed out above are not exhaustive and definitely do not have any legal recognition. At this platform, these reasons are discussed only to understand the basic crux behind the reverse charge mechanism.

Partial Reverse Charge

The most important and exciting amendment made about by the Finance Act, 2012 was the introduction of partial reverse charge. This is totally a new and different concept which should also be understood very carefully. Generally, the reverse charge mechanism says that service receiver would be liable to pay service tax. However, the partial reverse charge mechanism says that the service receiver would be liable to pay only a certain portion of service tax, and the remaining portion shall be payable by the service receiver. This is written in the proviso to section 68(2) of the Finance Act, 1994.

We can understand this with the help of an example. Suppose a service is valued at Rs. 1000, and for the sake of simplicity, let us assume that the amount of service tax is Rs. 100. Let us further assume that partial reverse charge rate is 25%. This means that 25% of the tax shall be payable by the service receiver and 75% of the tax shall be payable by the service provider.

Why Partial Reverse Charge?

Now this is an even more important question. The basic crux behind reverse charge has been explained earlier. It is easy to digest that reverse charge mechanism was introduced for administrative convenience because recovering tax from one person is better than recovering from several other small persons. However, the partial reverse charge system has, on the contrary, increased the administrative burden.

This is because after the introduction of this system – it becomes necessary that both the service provider and the service receiver get registered with the department, both of them file returns, both pay taxes, both of them have to be administered. So obviously the administration costs would rise.

So the question is – WHY partial reverse charge? What difference does it make?

There is, unfortunately, no logical answer to this question. Some people argue that partial reverse charge mechanism can help to cover cases where there is likely to be evasion of tax by way of valuation or abatement adjustments. For example, in case of a works contract, it is possible that the value adopted may not conform to the proper statutory principles. Similarly, it is also possible that the service provider may not disclose the value fully. In this regard, therefore, it is a convenient option to confirm with the service receiver whether the value adopted was proper or not.

When the same thing is confirmed from the service provider and the service receiver both, there is likely to be lesser chance of tax evasion. This is the only possible logical reason why the partial reverse charge mechanism could add value to the already existing system of tax administration. Nevertheless, this is no declared reason and there is no definite reason why only some of the services should be covered in this system and not the others. We are, therefore, unable to comment upon this at the moment.

The Reverse Charge Provisions

Section 68 talks about person liable to pay service tax. The sub-section (2) talks about reverse charge and the proviso thereof talks about the cases of partial reverse charge. There is a notification issued under this section and the proviso according to which the extent of service tax that is to be borne by the service provider and the service receiver is disclosed. The important details of the notification are presented below in a very simple manner. The relevant notification number is 30/2012 – ST dated 20.06.2012; as amended by notification number 45/2012 – ST dated 07.08.2012. The relevant extracts are:

	Service	Share of Service Provider	Share of Service Receiver
01	Insurance Agent	Nil	100%
02	Sponsorship Service	Nil (only if receiver is a body corporate or partnership)	100% (If receiver is NOT a body corporate or partnership then Nil)
03	Legal Services / Advocate	Nil	100% (only if receiver is a “business entity”, and turnover exceeds Rs. 10 lakhs)
04	Arbitral Tribunal	Nil	100% (only if receiver is a “business entity”)
05	Service by director to company	Nil	100% (receiver is a company)
06	Support services given by government	Nil	100% (only if receiver is a “business entity”)
07	Supply of Manpower (if provider is individual, HUF, partnership or AOP)	25%	75% (only if receiver is a “business entity” and a body corporate)
08	Security Service (if provider is individual, HUF, partnership or AOP)	25%	75% (only if receiver is a “business entity” and a body corporate)
09	Works Contract (if provider is individual, HUF, partnership or AOP)	50%	50% (only if receiver is a “business entity” and a body corporate)
10	Goods Transport Agent (Tax is payable only on 25% of the value)	Nil (But if both the consignor and consignee are NOT specified persons – 100%)	100% (Only in case the consignor or consignee is a specified person; and the receiver is paying freight to the GTA)
11	Renting of Motor Vehicle (There is an optional abatement of 60%)	60% (If abatement is exercised, then no tax is to be paid by the provider)	40% (If abatement is exercised, then 100% tax is to be paid by the receiver)

General Points

1.       Reverse charge will operate only if the service receiver is located in the taxable territory. For example, if a person is providing a service of GTA and the service receiver is in Jammu and Kashmir, then service receiver will not be liable to tax since he is NOT in the taxable territory (remember that service tax does not apply to Jammu and Kashmir)

2.       Apart from the above provisions, there is a general clause in respect of ALL the services: if the service provider is located outside the taxable territory and the service receiver is located in the taxable territory, then, regardless of the nature of service, the liability will always be on the service receiver. For example, if an engineer from the US is giving services to a company in India and the engineer is located outside India, then the service tax will be payable by the company.

3.       “Business Entity” means any person who ordinarily carries out any activity relating to industry, commerce or any other business or profession. It is important to note that at several places, the reverse charge will operate only if the service receiver is a business entity. For example, if any service is provided to a company registered under section 25 of the Companies Act, 1956 will not be treated as a service provided to a “business entity”.

4.       The conditions given in the bracket are VERY IMPORTANT and will surely form a basis for endless interpretations and litigations. Therefore, it is very important to go through them.

Reverse Charge and Cenvat Credit

Now this is a very interesting concept that must be understood. Generally, whenever any service tax is paid on any input service, it can be used as a credit against the liability to pay tax on the output service. However, can Cenvat credit be used against the liability to pay tax under reverse charge? And from the other angle, can the tax paid under reverse charge be used as Cenvat credit?

In order to understand the problem, consider these facts. Suppose there is a company Caterers Ltd. which is providing a taxable service of, say, outdoor catering. It engages a manpower supply company for want of labour. In such circumstances, Caterers Ltd. shall be liable for 75% of the service tax liability on the service of manpower supply. This is covered under reverse charge. Also, it shall be liable for service tax on catering service, but this is not under reverse charge. Let us also assume that they have another input service of a chartered accountant. They are not liable for service tax on the services provided to them by a chartered accountant. Nevertheless, the chartered accountant collects service tax from them.

Please notice, in the above case, there are three services and the position is as follows.

Catering Service	Output service	liable to pay to the government as a service provider
Manpower supply	Input service	liable to pay to the government as a service receiver
CA’s service	Input service	not liable to pay to government, but payment made to the CA.

In this regard, the position of Cenvat credit must be understood. Remember that Cenvat credit on “input service” is available. But, Cenvat credit can be utilised only against “output service”.

As a result, the following conditions must be kept in mind:

1.       The tax payable on manpower supply (under reverse charge) has to be in cash and Cenvat credit cannot be utilised since it is not an “output service”.

2.       The tax paid under manpower supply can be used as a credit against the tax payable under the catering service.

Therefore, the net position is that reverse charge payment can be used as Cenvat credit, but Cenvat credit cannot be used against reverse charge payment. This is a clear and express provision in the Cenvat Credit Rules.

Some FAQs related to reverse charge

1.       What is the point of taxation in case of reverse charge?

The point of taxation in case of reverse charge is the date when the payment is made to the service provider. However, if no payment has been made till 6 months, then the date of the invoice shall become the point of taxation.

2.       Is the small service provider exemption available?

No, it is not available if the person is liable to pay tax as a service receiver.

3.       How to present partial reverse charge in the invoice?

According to the CBEC circulars, in such cases, the service provider should disclose only so much of the tax on his invoice as he is liable to pay. However, he must also disclose that the remaining tax is to be paid by the service

4.       What if service provider has actually paid the tax?

In this case, if the tax has been paid by the service provider, then the receiver may not pay it again. In such cases, the judicial view is that it will be assumed that he has recovered the same from the service receiver, and therefore it is not proper to charge double tax on the same service. Nevertheless, the interest of revenue should not be jeopardised.

5.       How to value the service?

The method of valuation adopted by the service provider and the service receiver may be different. They are independent.

Concluding Note

Although all the major aspects of reverse charge have been clarified over here, it is bound to lead to confusions which will be resolved in the years to come by way of litigation, judicial pronouncements, departmental circulars and consequential amendments. This is a part of the overall process of tax that India has gone through all these years.

Nevertheless, the administrative inconvenience brought about by the partial reverse charge method is really worth considering. It is important to see that there is no clear logic for introducing and sustaining these provisions. It is sad to see that in a situation when the tax system had to be easier and comfortable, these provisions have been brought into the picture which makes things tougher. One should always remember that a big reason for evasion is the burden of compliance.