New Provisions for Valuation of Services

New Provisions for Valuation of Services

Ms Puloma Dalal, Tax Consultant

Valuation Rules has been a new phenomenon in the service tax law. Valuation of Goods for the purpose of the levy of Customs Duty and Excise Duty has undergone hiccups, litigation and therefore stages of evolution. A service being intangible and often 'personalised' the valuation is going to be even more difficult. The new Rules and the concept have to undergo evolution. This feature deals with presentation of the law and the Rules as they are and some issues related thereto. The process of implementation of new valuation rules is likely to bring forth a number of issues connected with valuation of service.

Background

Section 67 of the Finance Act, 1994 (The Act) dealing with valuation of taxable services for charging service tax has been replaced by the Finance Act, 2006 and the new Section 67 effective from 18-04-2006 has conceptually changed the provisions relating to valuation of service for the levy of service tax. In addition, Service Tax (Determination of Value) Rules, 2006 (The Valuation Rules) have been notified to come into force from 19-04-2006. Prior to its substitution, Section 67 of the Act read as "For the purpose of this Chapter, the value of taxable service shall be the gross amount charged by service provider for such service provided or to be provided by him." Further, explanation to this Section provided for exclusion and inclusion of certain specific costs and payments. Between 1994 and 2005, the net of service tax widened from three services to eighty-one services and with the provisions of Finance Act, 2006, the net includes a total of about 96 services. Accordingly, complexities have increased manifold. In many cases, the consideration received by a service provider did not reflect the actual value of service. Under the erstwhile Section 67, it was not possible to attach any money value to non-money consideration. The amended Section 67 provides for "cost of service in the hands of recipient of service" and "value of similar service" as the basis for valuation, which is complete departure from the earlier' position in law that restricted itself to "gross amount charged" by the service provider. Further, the treatment of "out of pocket expenses" has undergone a reversal of the earlier stand.

The basis of valuation under amended Section 67

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When consideration for providing a service is received in money: [sub-section (i) of Section 67(1)]

The value of such service shall be the gross amount charged by the service provider for providing such service or to be provided by him. In most cases, where non-money consideration is not involved, the method of ascertaining 'value' based on the gross amount charged in a bill or an invoice will continue to be followed as the amount charged in an invoice generally represents the value of a service.

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When consideration for providing a service is not wholly or partly consisting of money: [sub-section (ii) of Section 67(1)]

In such cases, it is provided that value should be such amount in money that with the addition of service tax charged, a sum equivalent to the total consideration amount (consideration in money & equivalent money value of non-money consideration) is arrived at. For example, if money value of consideration is Rs. 80 and non-money consideration is established at Rs. 20, the amount of service tax chargeable shall be:

÷	12.24 x 100 = 10.90
	112.24

Therefore, chargeable consideration is Rs. 89.10.

This is, however, possible only in cases when the non-money consideration is known, or ascertainable or can be established.

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When consideration for providing a service is not ascertainable: [sub-section (iii) of Section 67(1)]

In such cases, the value has to be determined in accordance with the Valuation Rules.

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When gross amount charged includes service tax payable: [Section 67(2)]

In this case the status-quo continues. Service tax chargeable is to be calculated by doing backward calculation as follows:

÷	Rs. 100 x	12.24 = service tax chargeable
		112.24

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The term 'consideration' as per explanation in Section 67 is one which includes any amount that is payable for the taxable service provided or to be provided. It is to be noted that the definition is inclusive and not exhaustive.

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The term "gross amount charged" is explained as one which includes cheque payment, credit card payment, deduction from account and any form of payment by credit note, debit note and book adjustment. (It may be noted here that items written in italics may have wide implications).

Valuation Rules

Vide Notification No.12/2006, Service Tax (Determination of Value) Rules, 2006 have been issued to come into force from 19-04-2006.

Main aspects covered in the Valuation Rules

3.1.

Value of similar service:

According to Rule 3(a) of the Valuation Rules and subject to provisions of section 67, in case of a taxable service where consideration received does not consist wholly of money; then value is required to be determined, based on the gross amount charged by a service provider for similar service provided to any other person in ordinary course of trade. The word 'similar' means general similarity or likeness and, certainly, it does not indicate 'identical' service. Therefore, the term 'similar' would remain highly subjective in nature. In case of a number of professional services, each service has unique components. Therefore, when full money value is not attached to a 'particular' service, the cost of a 'similar' service may or may not be available and the issue will be open to debate and litigation. The issue as regards the word "similar" therefore has to be interpreted with great care and may have repercussions to follow. However, in case of standardised services of physical nature, this rule may help the department to plug revenue loss. For instance, free services provided by vehicle dealers or bouquet of services provided by banks, etc.

3.2

Equivalent money value of consideration:

When it is not possible to determine the value in accordance with Rule 3(a) as discussed above, Rule 3(b) provides that in such cases, the service provider himself has to determine equivalent money value of such consideration which should not be less the cost of providing such service. The Rule does not provide any methodology for calculation of cost of providing such taxable services. The term 'used' here is 'cost'. And therefore, the amount determined need not have any mark-up on the cost. Normal principle of costing may be applied here. For determining cost of captively consumed goods, certain guidelines are adopted under the Central Excise Rules. Similar guidelines may be recommended for determination of cost of providing service. However, service being intangible and often personalised or talent-based, the exercise may be difficult, subjective and not free of debate. Yet, if the transaction is proven to have taken place at arm's length, it would be difficult for the department to object to the determined cost of service.

3.3

Rejection of Value:

Rule 4 of the Valuation Rules provides that although basic responsibility is cast on the service provider to determine value of his own service, it does not restrict the Central Excise Officer to question the accuracy of such valuation. He is empowered to issue a show-cause notice. This provision proposes litigation in the valuation matter and, therefore, the assesses may have to face unhealthy interface with the administration in cases when consideration does not consist of full money value.

3.4

Reimbursable expenditure & Inclusion or exclusion of certain costs or expenditure:

Rule 5 of the Valuation Rules provides that when any expenditure or costs are incurred by a service provider in the course of providing taxable service, all such expenditure/costs will form integral part of taxable value for charging service tax irrespective of whether the same are included in the gross value charged by the service provider or otherwise. This provision is in complete contrast to the earlier stand of the department in respect of out of pocket expenses like traveling, hotel stay, boarding etc. Earlier, this was not forming part of taxable value subject to the condition of producing documentary evidence. This seems drastic ex-facie especially when the incidence of tax is as high as 12.24%. The Rules have provided four illustrations in this regard, which, in nutshell are: -

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Cost of advertisement incurred by a real estate agent for his client & claimed as reimbursement;

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Costs for traveling expenses, postage, telephone etc. incurred and shown separately in the invoice;

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An architect incurring costs like air travel tickets, hotel accommodation, telephone charges etc. while performing services & even if recovered as separately itemised expense;

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A chauffeur of a rent-a-cab service provider who is provided with a lumpsum amount towards food, night accommodation, parking fees etc. by the service provider and charged ultimately to the receiver of services.

In all the above illustrations, it is commented in the Rule that service tax is required to be paid in terms of Rule 5 as the expenses are construed to have been incurred in the course of providing services and they are not incurred in the capacity of a "pure agent".

3.5

Exception to the above rule:

However, sub-rule (2) of the Rule 5 provides that when expenditure/costs are incurred as a pure agent of the client, it will not form part of the value for charging service tax subject to certain conditions.

Who is a Pure agent?

Pure agent according to the explanation provided is a person who enters into a contract (the contract need not always be a written contract or agreement; however, in order to avoid any controversy, it is advisable to have a contract in writing) with the recipient of his service to act as pure agent to incur expense/cost while providing service; one who does not intend to or holds any title to the goods or services procured or provided by him; and one who does not use himself goods or services so procured and receives only actual amount incurred to procure such goods or services.

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Eight conditions to be fulfilled are summarised below:

÷ Service provider acts as a pure agent of the recipient of service when he makes payment to any third party;

÷ The recipient of service receives & uses the goods/services so produced;

÷ The recipient of service is liable to make payment to third party;

÷ He authorises the service provider to make payment on his behalf;

÷ He has the knowledge that goods/services for which payment is made are provided by third party;

÷ The payment made is indicated in the bill separately by the service provider;

÷ The cost is recovered on actual basis only; and

÷ The service provider procures the third party services or goods in addition to providing his own service.

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Lastly, the Explanation 2 to Rule 5 provides that all the components of a taxable service are includible in the value on which service tax is chargeable and it is immaterial even if they are separately indicated in the invoice.

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However, it is apparent from the above that the expenses incurred as an "agent" are not includible subject to the above conditions. The term "pure" agent is peculiar to only these Rules. A custom house agent, a clearing and forwarding agent or a logistics service provider under a contractual agreement where it is expressly provided that he is acting as 'an agent' & incurring costs such as customs duty, octroi, any other statutory duties/ taxes, or any other third party payments such as transport on behalf of client and charging separately for his own services would not form part of the 'value'. The provider of service is required to disclose that he is a pure agent of his principal or client as per the clarification of the department, although the Rule does not specify the same. Further, the Finance Ministry's Circular F.No.BI/4/2006-TRU dated 19-4-2006 states in Para 4:1:9 that "whether the expenditure or cost has been incurred by the service provider in his capacity as a pure agent of the client or incurred on his own account, is a question of fact and law and is to be determined carefully".

There seems inadequacy here in respect of "shared expenses". In practice, in a large number of cases, some expenses are shared by more than one entity. For instance, advertisement cost is often shared by a manufacturer and his agent or a dealer or at times even more than one dealer. Automobile manufacturers and dealers or banks and automobile dealers often share advertising cost. Similarly, cost of a business exhibition is also often shared by a principal and his agent/s. In this case, the concept of "pure agent" cannot apply. Are these cases not absolutely genuine? The issue needs to be addressed by the Board in order to avoid avoidable hardship.

3.6

Service specific inclusions/exclusions:

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In terms of Rule 6 of the Valuation Rules, the following items have to be specifically included in the value of taxable service:

÷ Commission/brokerage including brokerage paid to sub-broker by a stock-broker,

÷ Adjustments made by telegraph authority,

÷ Amount of premium charged by insurer to policy holder from deposits made by subscribers at the time of application,

÷ Commission received by air-travel agent from airlines,

÷ Commission fee etc. received by actuary, intermediary or insurance agent,

÷ Reimbursements received by authorised service stations from manufacturers,

÷ Commission/any amount received by rail travel agent,

÷ Remuneration/commission etc. received by a clearing and forwarding agent,

÷ Commission/fee etc. paid to agent by insurer in relation to insurance auxiliary services provided by insurance agent.

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Items specifically excluded are:

÷ Initial deposit made by the subscriber at the time of application for telephone, pager, facsimile/telegraph/telex/leased
circuit, etc.,

÷ Air fare collected by air travel agent,

÷ Rail fare collected by rail travel agent,

÷ Interests on loans.

It is noted here that under the erstwhile Section 67, cost of parts / material supplied during provision of services of maintenance / repair & erection/commissioning or installation, cost of unexposed films etc. were specifically excluded. This does not find place here. Nevertheless, the material supplied per se does not form part of "any service" as provided in the amended Section 67. Prima facie, there does not seem any difficulty in excluding value of material while determining value of taxable service.

3.7

Taxable services provided from outside India:

When a service is partly performed in India and partly performed outside India, the total consideration paid by the recipient for such service including the value of service paid for service partly performed outside India will form value of taxable service and service tax will be charged accordingly.

Viewing the valuation Rules in totality and in particular, the genuine out of pocket expenses like traveling expenses, hotel stay expenses etc. incurred during the course of providing service forming part of value of taxable service under the new Valuation Rules appear draconian. Attaching money value to non-money consideration for intangible benefits in a global scenario of cut-throat competition also appears extremely difficult in many situations. In addition to this, the Ministry's Circular of 19th April 2006 in para 4:1:3 has stated that for a non-money consideration, when pricing of a service is done based on a charge recovered for similar service, 'the same should be based on a normal transaction between two independent persons at an arm's length price." However, no parameters are provided for establishing arm's length pricing. Therefore, the concept is again subjective. For instance, if A provides services to B through the medium of C and A & C may be related parties but B is an outsider, whether arm's length pricing could be established will depend on facts of each case. Clubbing on account of related parties on the lines of Central Excise may not be ruled out, although the issue is not touched upon so far. In terms of various issues, therefore, litigation appears inevitable in a large number of cases.

Departmental Clarification

Ministry of Finance (DR) Circular No.F.No.B.1/4/2006-TRU of 19-04-2006 has provided clarification as regards Section 67 and Valuation Rules at paragraphs 4:1 to 4:1:13. Some noteworthy clarifications are provided below:-

"After verification of the records, if the department is of the view that the value so determined and adopted for payment of service tax warrants revision, the issue should be decided after issue of show cause notice and observing the prescribed procedures. Before issuing any show cause notice on matters relating to valuation, concurrence of Commissioner should be obtained. "

"It is not relevant that various expenditure or costs are separately indicated in the invoice or bill issued by the service provider to his client."

"If the service provider acts as an undisclosed agent i.e. acting in his own name without disclosing that he is actually acting as an agent of his client, he cannot claim the expenditure incurred by him as reimbursable expenditure."

(The above instruction strictly is not in accordance with the legal provisions. The Valuation Rules do not provide for such a condition. General law also does not stipulate such a provision).

"In view of the comprehensive provisions on value of taxable services, all the circulars issued relating to value of taxable services are withdrawn. If there are any areas where specific clarification on valuation is needed, the same may immediately be brought to the notice for consideration."

Some Issues

5.1

In view of the amended Section 67 and the new Valuation Rules, would there be presumptive valuation for "free services"? Whether the instruction provided vide CBEC&C Circular No. 62/11/2003 of 21-08-2003, that "there will be no service tax if service is provided free as value of service tax will be Zero" stands withdrawn?

5.1.A

In view of the clarification issued vide the Ministry's Circular of 19-04-2006, the instruction vide Circular dated 21-08-2003 certainly stands withdrawn. However, in case of a "gratis" service, where there is actually no consideration received, the valuation Rules cannot apply. The Rules would apply in cases when cost of a service is recovered through other than money value of consideration. For instance, when a stock broker buys or sells shares in his own account or in the accounts of his own family members and if no brokerage or a token brokerage is charged, there is actually no consideration or consideration other than money is not involved and therefore no service tax liability would arise in cases of all genuinely free services. This, however, would be by and large true but concept of 'free service' in various situations may remain open to taxability. For instance, in case of various schemes of 'free services' declared by automobile dealers, non-monetary consideration hidden under built-in costs or reimbursement from an alternative source would definitely be considered. Therefore, identification between a genuinely free service per se and an 'eye-wash' case of a free service may prove to be an exercise by itself.

5.2

Rule 6(1) of the Service Tax Rules, 1994 provides that service tax liability arises only when the value of taxable service is received. In cases when no value is actually received in money terms and the service tax liability has to be calculated based on the Valuation Rules read with provisions of 67, how & when would the tax liability be discharged if the provisions of the Rule 6(1) were made applicable?

5.2.A

There is an anomalous situation or inconsistency between the provision of Section 67 and the Service Tax Rules. The Rule 6 is required to be amended to consider the situation when value or actual cost of a service is not receivable by a provider of service. Generally, the Rules cannot override the Act. For consideration received otherwise than in cash, the payment should be deemed to be received. A suitable notification/circular should address the contradiction between the Act and the Rules.

5.3

Under the departmental Circular dated 19-4-2006, all earlier clarifications as regards out of pocket expenses incurred by a service provider and charged to the receiver of service stand withdrawn and accordingly service tax is now payable on expenditure & cost relating to provision of service. In cases when such expenditure is incurred by the service receiver himself, how would the liability of service tax arise as there is no reimbursement or out of pocket expense charge shown in any invoice?

5.3.A

In such cases, when the receiver directly pays for expenses of the service provider, then also the "cost of the service to the receiver of service" includes cost incurred directly by the receiver on his own account. In terms of sub-clause (ii) of Section 67(1), the consideration received by the provider of service is not wholly or partly in money and therefore to arrive at the total consideration value, the expenditure incurred by the receiver of service will be includible in the value of taxable service and then on such amount, liability of service tax will have to be calculated.