Remove inconsistencies before moving to GST regime

The implementation of the Goods and Services Tax (GST) may have been deferred for all the wrong reasons, but those responsible may also have unwittingly done the nation a favour.

Budget 2016 provides an excellent opportunity for Finance Minister Arun Jaitley to remove inconsistencies in the existing laws before transitioning to the GST.

As regards Central Excise (save for the perennial and ever contentious Cenvat Credit claims) and Customs laws, they are fairly stable although the usual tweaking of tariffs and rates will occur in this Budget.

The purpose behind shifting from a pick-and-choose positive list of services to a negative list was to ensure that most service providers, other than those listed in the negative list, pay service tax. This theory assu-mes that the negative list of services is kept to the minimum. Canada, for instance, has only five essential items in the negative list.

The ‘negative list’ commenced with Notification No.25/2012 which was christened a “Mega” Notification — a whole lot of services were listed in the notification.

However, the government could not control its itch every year thereafter to keep fiddling with this list, leaving us with a negative list as lengthy as the positive list. This is because of the fact that the initial mega notification was not well thought out — a trait not uncommon to many laws in India.

In Budget 2016, the finance minister can make a start by not inserting any new items in the negative list of services, while removing a few entries there and making them taxable. Refraining from adding services to the negative list and removing unnecessary and trivial items from it will send a strong signal that the government is keen on a good GST law.

Thanks to an insertion in the negative list, employees do not pay services on the salaries they receive from their employers. Recently, however, the service tax department sought to tax “recovery of notice period pay” from the employer.

The contract of employment between an employer and employee typically specifies a notice period of two or three months. However, once an employee decides to leave an organisation, both the parties are keen to move on even if the specified notice period is not served.

In these situations, the salary for the period not served is recovered from his full and final settlement. It is this recovery that the service tax department is seeking to tax from the employer assuming that he is providing a service to the employee.

To prove that this is taxable, the Department reproduces an extremely vague insertion in the list of Deemed Services under Section 66E — “agreeing to the obligation to refrain from an act, or to tolerate an act or a situation, or to do an act”— a definition that suited non-compete fees very well.

The controversial line reads “agreeing to the obligation to refrain from an act, or to tolerate an act or a situation, or to do an act”. The focus is on doing or refraining from doing an act. As there can be more than one act in any given situation, it is appropriate to conclude that what matters would be the primary act. If we apply this to notice period recovery, the following questions emerge: What is the primary Act? Who is doing the primary Act?

Pre-joining services

The primary act is not serving the entire notice period which is being done by the employee, and employees are exempt. In reality, the new employer agrees to compensate the employee for the notice period that has been recovered. Should service tax be charged on this? This is akin to a joining bonus and should be considered a part of the pre-joining services rendered by an employee to a future employer. The amount recovered by the former employer is a consideration received but no service has been rendered. Hence, no charge of service tax is attracted.

In Budget 2016, the finance minister can help solve this by stating that reco-
very of notice period pay is not a taxable service. He should also not fall into the trap of inserting this into the list of services which are taxable on the reverse charge mechanism.

An ideal GST law is the one where tax is paid only on the value addition at every stage of manufacture or service. This assumes that credit of input taxes will be allowed to be set off without any restrictions.

Till date, the experience of service tax payers has been exactly the opposite. There has been plenty of litigation on whether input tax credit can be claimed for taxes paid on catering services and employees’ health insurance. 

A draft GST law made the rounds recently and the provisions of Cenvat Credit were exactly the same as in the current law. Budget 2016 provides an opportunity for Jaitley to completely overhaul the system of Cenvat Credit-he should provide a reasonable list of inputs/services on which credit cannot be claimed. On the rest, no questions will be asked on the amounts claimed.

In summary, Budget 2016 can take a great leap towards GST by making three essential changes:

a) Making the negative list watertight;

b) Clarifying that notice period recovery is not chargeable to service tax and rephrasing the line agreeing to the obligation to refrain from an act, or to tolerate an act or a situation, or to do an act; and

c) Making the Cenvat Credit Rules easier to read, understand and apply.
If not done, one can expect the same amount of confusion and litigation
irrespective of whether GST makes it as a law or not.

(The writer is a Bengaluru-based tax expert)