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Service Tax Credit

The Raja Chelliah Committee which initially recommended the levy of tax on service in India saw such a levy the context of the gradual movement towards unified VAT, covering both services and commodities, and eventually resulting in an indirect taxation regime which was, to the extent possible, revenue neutral. The input tax credit mechanism with respect to the levy of service tax is a step in that direction, and is expected to benefit the taxpayer and the tax administration by:

  • Ensuring greater levels of tax compliance.
  • Promoting transparency.
  • Reducing cascading effect of taxes.
  • Increasing service sector competitiveness.
  • Minimising disputes in service tax administration.

The Finance Act, 2002 has amended Section 94 of the Finance Act, 1994 to provide for credit of Service Tax paid on input services used in the output services where both the input and output services fall within the same category of taxable services. As per section 94(2)(ee) of the Finance Act, 1994, Central Government has been empowered to make rules for the credit of service tax paid on the services consumed for providing a taxable service in case where the services consumed and service provided fall in the same category of taxable service.

Section 94(2)(eee) of the Finance Act, 1994 inserted with effect from May 14, 2003 empowers Central Government to make rules for the credit of service tax paid on the services consumed or duties paid or deemed to have been paid on goods used for providing taxable service. Presently, credit may only be availed in respect of service tax paid on inputs.

The Service Tax Credit Rules, 2002 have come into force from 16th August, 2002 for availing credit of input Service tax under same category. The date of applicability for availing credit under different categories is from 14th May, 2003. The applicable dates are, thus, as follows:

  • Where input and output services fall under same category input service challan/ bill/invoice issued on or after 16.8.2002;
  • In any other case input service challan/bill/invoice issued on or after 14.5.2003.

The manner of availing credit has been prescribed under the Service Tax Credit Rules 2002 as amended by the Service Tax Credit (Second Amendment) Rules, 2003 vide Notification No. 5/2003-Service Tax dated May 14, 2003 (''Credit Rules'').

In terms of Rule 3 of the Credit Rules an output service provider shall be allowed to take credit of the Service Tax paid on input service in the following manner, namely:-

  1. Where the input service falls in the same category of taxable service as that of output service, Service Tax credit shall be allowed to be taken on such input service for which invoice or bill or challan is issued on or after the sixteenth day of August, 2002.
  2. In any case, Service Tax credit shall be allowed to be taken on such input service for which invoice or bill or challan is issued on or after the fourteenth day of May, 2003.

Provided that the output service provider shall be allowed to take such credit, on or after the day on which he makes payment of the value of input service and the Service Tax paid or payable as indicated in invoice or bill or challan referred to in sub-rule (1) of rule 5. No credit is available if the output service is exempt from service tax. In the interest of clarity it is imperative to explain the following terms in detail:

Output services - 'Output service' means any taxable service rendered by service provider to a customer, client, subscriber, policy holder or any other person. [Rule 2(b) of Credit Rules].

Input services - 'Input service' means any service received and consumed by a service provider in relation to rendering output service. [Rule 2(c) of Credit Rules].

Meaning of 'same category of taxable service' - Two services shall be deemed to be falling in the same category of taxable service, if the input service and the output service fall within the same sub-clause of clause (105) of section 65 of the Finance Act, 1994.

Illustration: The services provided by a photo studio to a customer and by a developing and processing lab to a studio fall in the same category of service i.e. 'photography service' Meaning of 'in relation to' - Service tax paid on input services is eligible for credit only when it is received and consumed in relation to taxable output service. The Supreme Court in Doypack Systems Pvt. Ltd. vs. Union of India [1988 (36) ELT 201 (SC)] held that the expression 'in relation to' is a very broad expression, which pre-supposes another subject matter. These are words of comprehensiveness, which might both have a direct significance as well as an indirect significance depending on the context. The words 'in relation to' are the same as those used in Cenvat Credit Rules in respect of eligibility of inputs for Cenvat credit. This term has been interpreted in broad terms, i.e. as long as there is reasonable nexus (direct or indirect) between input and output services, the credit will be available. However, if input service is unrelated to output services, the credit will not be available. On the other hand, input services like courier services and telephone services may be held to be 'in relation' to taxable output service.

Credit of tax on input service will be available only if service tax is payable on output services. If output services are exempt from tax or not taxable at all, credit of input service tax is not available. However, if input service is partly used for taxable service and partly for exempt or non-taxable service, credit of service tax paid on input services is available as per provisions of rules 3(4) and 3(5). [Rule 3(3) of Service tax Credit rules]. If the input and output service does not fall in same category, it may be than the input service may be used in relation to taxable output service as well as exempt service or service which is not taxable at all.

In such case, assessee is required to maintain separate records for input services used in relation to taxable output services. In such case, he can avail full credit of service tax on input services. [Rule 3(4) of the Credit Rules]. In case of common services, assessee may not be able maintain separate records of input services used in relation to taxable service and other services, the assessee will be entitled to credit of service tax upto a maximum of 35% of output services. [Rule 3(5) of Credit Rules. Service tax is payable by 25th of following month [25th of following quarter if assessee is individual, proprietary firm or a partnership firm]. However, the assessee can only avail credit of service tax as available at the end of month/quarter as applicable. [proviso to Rule 4(1) of Service tax credit Rules]. Thus, even if tax is payable by 25th of following month/quarter, credit available as at end of month/quarter alone can be utilised for payment of service tax of that month/quarter. In terms of Rule 5 of the Credit Rules, credit can be availed based on a bill, an invoice or a challan. Such a document shall contain details regarding:

  1. Name and address of the service provider.
  2. Service tax registration Number.
  3. Serial number.
  4. Date of issue.
  5. Description and value of the input service.
  6. Service tax paid/ payable.

The service provider is required to maintain records reflecting the following details

  1. Serial number and date of document on which credit is availed.
  2. Name and address of the service provider.
  3. Service Tax registration number.
  4. Description of service received.
  5. Value of service received.
  6. Amount of credit availed.
  7. Date of utilisation of credit.
  8. Amount of credit utilised and balance thereof.

Return in the prescribed form (in terms of Rule 5(4) of the Credit Rules)is required to be filed along with Form ST3.

It may be noted that the Finance Act, 1994 does not prescribe a time limit within which service tax credit should be availed and utilised. However,in CCE v. Mysore Lac & Paint Works Ltd. [1991 (52) ELT 590 (T)] it was held that MODVAT credit has to be taken within in a reasonable period. Further the Supreme Court in the case of Government of India v. Citedal Fine Pharmaceuticals [1989 (42) ELT 515 (S.C)] in the context of recoveries under Rule 12 of the Medicinal & Toilet Preparation Rules 1956 observed ''In the absence of any period of limitation it is settled that every authority is to exercise the power within a reasonable period. What would be reasonable period, would depend on the facts of each case''.

Hence credit taken by an assessee, should be within a reasonable time, and such reasonable time within which to avail credit could be one year, in view of the analogous provisions of refund under section 11B of the Central Excise Act, 1944.. In any event, as far as 'utilisation' of such credit is concerned, it can be done at any time.

In brief, the present position regarding the availing of service tax credit is as under:

  • Credit is only available if input service is in relation to output service.
  • If input and output services fall in same category, full credit is available.
  • Credit can only be availed once the service tax on the input service has been paid.
  • No credit is available if the output service is exempt from service tax.
  • No inter sectoral (i.e manufacturing and services and vice-versa) credit is allowed. The position has been clarified vide circular no. 56/5/2003 dated April 25, 2003.
  • If input and output services do not fall in same category, full input service tax credit will be available only if separate records of input services used in relation to output taxable services are maintained.
  • If separate records are not maintained, then credit of input tax will be available subject to ceiling of 35% tax payable on output services. Even here, the input services should have been used in relation to output service.
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