Service tax on cross border transfer of funds-Clarity needed

Over the last six months, the Central government has time and again expressed the need and desire to provide certainty on taxation aspects. While the Finance Minister would be presenting his second budget on 28 th February 2015 laying down the policies and road map for tax reforms, it is also expected that certain clarifications must be provided on key issues being faced by the industry so that the desire or objective of tax certainty can be achieved.

One such areathat needs urgent attention is applicability of Service tax on cross border transfer of funds between overseas Branch and Head office. This issue primarily has significant implication to the Information Technology (IT) industry which operates through network of branch offices in multiple countries.

In order to provide working capital and funds to such branch offices, the Head office in India remits funds either as expenses reimbursement or as contribution to meet working capital requirements. The Branch offices may be entrusted to promote the business, marketing and client relationship including delivery of services to customers.

These funds are generally utilized by the Branch offices for meeting expenses towards salaries, rent, office administration, travelling, payments to vendors for support services etc.

The issue which needs clarity is whether such expense reimbursement or transfer of funds from the Head office in India to a branch overseas will attract service tax on account of deeming fiction created in Explanation 2 of Section 65B(44) (erstwhile Section 66A) of Finance Act, 1994 (‘Service Tax Law’). This deeming fiction provides that an establishment of a person located in taxable territory and another establishment of such person located in non-taxable territory are treated as establishments of distinct persons.

As per the Education Guide on Taxation of Services issued in July 2012 (on introduction of negative list based service taxation regime), the implications of this deeming provision is that inter-se provision of services between such persons, deemed to be separate persons, would be taxable. For example, services provided by the branch office of a multinational company to the headquarters of the multi-national company located outside India would be taxable provided other conditions relating to taxability of service are satisfied.

Considering this deeming fiction, adjudicating authorities across the country have raised demand on such expenses reimbursement or transfer of funds to the overseas branch office on the ground that the Branch office is providing services to the HO and such payments are construed to be a consideration for the service.

While the recent judicial precedents, in case of KPIT Technologies – 2014-TIOL-1529-CESTAT-MUM and Torrent Pharmaceuticals – 2014-TIOL-2647-CESTAT-AHM, provide relief to the assesseeon the ground that as per emerging international concepts on reverse charge mechanism a service provided to oneself cannot be taxed. The Tribunal has held that if the expenses incurred by the Branch have suffered the local VAT/GST in that country and such expenses are reimbursed by HO, then the same expense cannot be taxed again under reverse charge basis.

The tribunal further expressed that the purpose of Section 66A is for taxing the import of services and not for taxing monetary transactions between the branch and head office.

The counsels have argued that the purpose of deeming fiction is to ensure that the services received by the overseas Branch is not construed to be taxed under reverse charge mechanism in the hands of the Head office. However, Education Guide on Service taxation clarifies to the contrary.

Though the aforesaid decisions involve periods prior to the introduction of negative list based taxation regime, however, it is expected that the treatment should not materially alter in absence of any service being rendered by the Branch to the Head office.

As the quantum of exposure is significant and many Industry players are affected, it is expected that FM will pay heed to the representation of the IT industry and issue a suitable clarification on the real purpose of the introduction of deeming fiction to reduce unwarranted litigation and achieve certainty of tax treatment.

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