5 April 2016 EY Tax Alert CESTAT rules that Service tax is not leviable under reverse charge mechanism on salary and other costs reimbursed by the Indian head office to its foreign branch Executive summary Tax Alerts cover significant tax news, developments and changes in legislation that affect Indian businesses. They act as technical summaries to keep you on top of the latest tax issues. For more information, please contact your EY advisor. This Tax Alert gives an update on the decision 1 of the CESTAT, Mumbai which deals with the issue on applicability of Service tax under reverse charge mechanism on the salary and other expenses reimbursed to the overseas branch by its Indian head office ( HO ). Section 66A of the Finance Act, 1994 provides for discharge of Service tax liability on reverse charge mechanism. It further provides that establishments of a person in India and outside India, shall be treated as separate persons. CESTAT held that Service tax is not leviable on salary and other expenses (in relation to its employees), remitted to overseas branch on the following grounds: The legal fiction of branches being distinct from HO is not applicable to exporters who operate through branches. Taxing such transactions would mean collecting taxes merely for refunding it subsequently. Existence as a branch for the overall promotion of the objectives of HO in India does not render the transaction taxable under section 66A. When a service to be rendered in India by HO is deliberately routed through an overseas branch, only then the legal fiction under section 66A will come into play. The transfer of funds by gross or net outflow are nothing but reimbursements and taxing of such reimbursements would amount to taxing of transfer of funds which is not contemplated by the Finance Act, 1994 whether before 2012 or after. 1 2016-TIOL-709-CESTAT-MUM
Background Appellant is engaged in the business of developing software for overseas customers particularly mobile operators. Such services were taxable as per section 65(105)(zzzze) of the Finance Act, 1994 ( Act ) as information technology services. However, the appellant being an exporter, they were exempt from payment of Service tax. Appellant rendered services through onsite and offshore operations and for the former, engineers were deputed from India. For this purpose, a network of branches and subsidiary companies at different locations outside the country were established by the appellant. The branches of the appellant acted as salary disbursers of the staff deputed from India to client locations and carried out other assigned activities. The salaries so disbursed, as well as other expenses of running the branch, were met from the coffers of the appellant. Payments made by customers were also received in branches and transmitted to HO after netting the expenses incurred by the branch. On the value of services carried out by subsidiaries to the parent company, appellant had discharged Service tax under the reverse charge mechanism prescribed in section 66A of the Act. However, HO had not discharged Service tax on reimbursements made towards employees salary and other expenses to its branches. Section 66A of the Act, levies Service tax on all taxable services received by a person who has his fixed / permanent establishment in India from a person who has a fixed / permanent establishment (from which the service is provided or to be provided) in a country outside India. As per section 66A(2) where a person is carrying on a business through a permanent establishment in India and through another permanent establishment outside India, such permanent establishments shall be treated as separate persons. Commissioner issued an order confirming demand on such reimbursements for the period 16 May 2008 to 31 July 2013 on the following grounds: Appellant and its branches are different persons. The purpose and activities of the branches are for rendering service to the HO in India. Payments made to the branches are not reimbursements but consideration for taxable service. Penalty was also levied on the appellant and its principal officers. Aggrieved by this order, appellant filed an appeal before the CESTAT. The issue before the CESTAT was : What is the status of overseas branches vis-à-vis the HO and the limitation thereof? What is the jurisdiction to classify the services under section 65(105) of the Act? Whether reimbursable expenses are to be included for computation of gross receipts under section 67 of the Act? Appellant s contentions Branches and HO are not independent entities. HO is not a permanent establishment and section 66A(2) of the Act, which is intended to tax service rendered by a permanent establishment to another permanent establishment, has been incorrectly invoked.
Tax liability arises only for services received in India which is not established. Therefore, any service rendered to the HO by branch would not be within the scope of section 66A. In absence of client relationship, business auxiliary service cannot be said to have been rendered. Reimbursements cannot be regarded as consideration and overseas branches did not charge any consideration for any service. Amount paid to the employees is in pursuit of employment contract. Appellant relied on Tribunal decision in the case of Torrent Pharmaceuticals Ltd. 2 wherein it was held that branches are not service providers within the meaning of section 66A of the Act. Salaries, sub-contracting costs and expenditure on services that were rendered outside the country cannot be taxed under section 66A of the Act. Activities taxed overseas cannot be taxed under Finance Act, 1994. Entire demand is revenue neutral as CENVAT credit could be taken and refund could be claimed. Revenue contentions Revenue contended that payments made to the branches were in the nature of consideration for taxable services rendered by the branch to HO and that the appellant was liable to pay Service tax on reverse charge basis for being a recipient of business auxiliary service. CESTAT ruling CESTAT observed that, section 66A(2) is limited to being a charging section in a specific context. It is not elastic enough to govern the corporate intercourse and commercial indivisibility of headquarters and its branches. 2 2014-TIOL-2647-CESTAT-AHM Merely because there is a branch and that branch has, in some way, contributed to the activities of the appellant in discharging its contractual obligations, the definition of business auxiliary service' in section 65(19) of the Act may not apply. That is where the impugned order has erred in not reading section 65(105) along with section 66A and Rules framed for the purpose of charging tax on services received from abroad. Unless both are applied together, the jurisdiction to tax would be in question. As per the two Rules 3, it is apparent that mere identification of a service and the legal fiction of separate establishment is not sufficient to tax the activities of the branch. The very existence of a branch presupposes allocation of financial resources by the primary establishment in India to enable undertaking of the prescribed activity. The application of Act, to such a business structure within India does not provide for a deemed segregation. It noticed that Taxation of Services (Provided from Outside India and Received in India) Rules, 2006 also mirrors the Export of Services Rules, 2005. That, however, cannot be taken as intent to tax the inflow of service merely because of a corresponding exemption accorded to the outflow of services. CESTAT relied on few judicial precedents 4 which support the proposition that a service is taxable 3 Taxation of Services (Provided from Outside India and Received in India) Rules, 2006 and Place of Provision of Services Rules, 2012 4 2014-TIOL-979-CESTAT-DEL, 2014-TIOL-2647-CESTAT-AHM, 2014-TIOL-409-CESTAT-BANG
under section 66A only when such service is rendered in India. A service is taxable under section 66A of Finance Act, 1994 only when such service is rendered in India. A forced disaggregation merely for the purpose of tax when similar domestic structures are not taxed and when commercial soundness calls for establishment of branches would be clearly inequitable. Section 66A requires taxing of taxable services rendered by an overseas branch to its HO and the two sets of Rules 3 limit tax demand only to the extent that these services are received in India in relation to business or commerce. A plain reading would make it apparent that the services referred to must be for pursuit of business or commerce in India. Also, there is no dispute that the activities of the branch are in connection with the export activity of the appellant. The transaction of the appellant and the branches which is under dispute, being related to exports, is unambiguously not intended to be taxed as it has nothing to do with business or commerce in India. A branch, by its very nature, cannot survive without resources assigned by the HO. The business of the appellant is such that credibility in the eyes of its overseas clients lies in the name and style of the appellant. It cannot be substituted by any other entity. The activity of the HO and branch are thus inextricably enmeshed. Employees of the branch are the employees of the organization itself. There is no independent existence of the overseas branch as a business. The economic survival of the branch is entirely contingent upon the will and pleasure of the HO. The legislature would not prescribe the collection of a tax merely for the purpose of refunding it subsequently. An exporter who operates through branches is clearly not the target of the legal fiction of branches being distinct from HO. The intent of section 66A in taxing the activity rendered by an overseas branch to its HO in India is limited to the local commercial or business activities of the HO is thereby confirmed. Consequently, mere existence as a branch for the overall promotion of the objectives of the primary establishment in India which is essentially an exporter of services does not render the transfer of financial resources to the branch taxable under section 66A. When a service to be rendered in India by the primary establishment is deliberately routed through an overseas branch or when a service that would otherwise be contracted from an overseas entity is, instead, sourced through an overseas branch, this legal fiction will come into play. The transfer of funds by gross outflow or by netted flow are nothing but reimbursements and taxing of such reimbursement would amount to taxing of transfer of funds which is not contemplated by the Act whether before 2012 or after. In view of above, the demand of tax and the penalties imposed on the appellant and the principal officers were set aside. Comments This is yet another ruling providing clarity on non-taxability of cost reimbursements by HO to its branch, though under the earlier regime of Service tax. The implication of such reimbursements will need to be examined based on facts of each case, particularly in view of the amended provision of section 67.
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