Dummies guide to service tax

After a wonderful evening with your friends at the cool new joint, you wonder how your bill has added up to a different amount. On reading the fine print, you see various components like VAT, Service Tax that amount to double digits and if your bill is in the four figures then it is an additional couple of hundreds. Haven’t you wondered what this service tax is, who pays it, and most importantly why you should be paying it?

Dummies Guide to Service Tax - Frustated Man

What is Service Tax?

According to the information guide on the government website, “Service tax is a tax levied on the transaction of certain services specified by the Central Government under the Finance Act, 1994. It is an indirect tax (akin to Excise Duty or Sales Tax), which means that normally, the service provider pays the tax and recovers it from the recipient of the service.”

It was introduced in 1994 by the then finance minister Mr. Manmohan Singh to reduce the intensity of taxation on the manufacturing sector and to tap the rapidly growing services sector, and its vast contribution to the GDP.

Why are services taxed?

Service tax is a source of revenue generation for the government just like others sources of taxes such as Income tax, wealth tax, excise, and custom and is collected at the central level by the Central Board of Excise and Customs (CBEC).

Initially, the services that were taxable were only three and gradually this list started increasing every year to include more and more services. As India started moving from an agricultural economy to industrialized and then to a service led economy just like other nations before her, the income generated from the service sector steadily increased. Thus in 2012 the government decided to do away with the list and include all services in order to introduce a comprehensive taxation system and eliminate loopholes and avoid administration issues regarding classification of services. As of date, the services sector comprises 56.9% of the GDP and thus service tax has far exceeded all other sources of taxation today.

The definition of what constitutes a service is given by the government in the Finance Act of 2012 and provided in the law under section 65b.


Negative list and Exemptions

There are some services that are not taxable and are clearly mentioned in a list called as the negative list. These include services provided by the Reserve Bank of India, the foreign commission, services related to agriculture, etc. among others. In addition to this negative list, there is also an exemptions list for services that have been exempted temporarily from paying tax. The difference between the negative list and exemptions is that exemptions are of a temporary nature and services in this list are exempted only for a limited period of time and can be removed from this list by the government of the day for various reasons but to add or remove services from the negative list requires approval from the Parliament.

Service Tax Rate

The effective rate of Service Tax is 12.3% on the value of the taxable service. The above effective rate comprises of Service Tax @12% payable on the “gross value of taxable service”, Education Cess @ 2% on the service tax amount, and Secondary and Higher Education Cess @ 1% on the service tax amount.

Example: Suppose the value of taxable service is 100 INR, service tax @12% will be 12 INR and Education Cess @2% of the Service Tax will be 0.24 INR and Secondary & Higher Education Cess @1% of the service tax will be 0.12 INR. So the total invoice generated will be 112.36 INR

A good thing to know is that service tax is to be applied on the amount charged and not the declared tariff. So for example, if you have booked a room in a hotel which charges 1100 INR and then avail a discount for 300 INR, then the service tax needs to be applied on the actual amount charged now which is 800 INR and not on the declared tariff of 1100 INR.

Coming back to our restaurant bill, we see typically the following heads under which we have been charged:

  • Total Food Amount – This is the net amount of the food consumed. E.g. 1200 INR
  • Service Charges – This is the amount charged by the restaurant for the services like serving food, music, hospitality, etc. E.g. 300 INR
  • VAT (Value Added Tax) – This is a state levied tax on the sale of food and liquor and differs from state to state. The rate of VAT is different for food and liquor, so a good idea would be to ask the restaurant separate bills for each. VAT is applied on the sum of the above two heads. So in our bill it would be 217.5 INR @ 14.50% VAT.
  • Service Tax – 12.36% tax is levied on all air-conditioned restaurants and only on the services rendered and not on the food. Hence you need to check that it is not calculated on the food amount. As per Rule 2C, Service Tax should be charged only on 40% of the Food amount (incl Service Charge) and not on the Total Bill. This is an abatement provided by the government to restaurants in order to bifurcate the amount taxed on food and services. Thus 40% of 12.36% becomes 4.94% and this rate is applied on the tab of 1500 which comes to 74.16 INR

Thus we end up with a total amount of 1791.66 INR (1200 + 300 + 217.5 + 74.16) and the next time you turn up at a restaurant, please check the bill and ask questions if you think you have been overcharged.

The service provider

On the other side of the table if you are the service provider, then is your service eligible for paying service tax and thus recovering it from your customer?

A service provider is required to apply for service tax registration if the value of the services provided exceeds 9 lakh INR during that financial year, but the service tax itself needs to be paid only if the value exceeds 10 lakh INR.  It has to be deposited by the service provider with the government every quarter in case of individuals/partnership and monthly in all other cases.

All about service tax

Reverse Service Charge

As mentioned before the service provider usually pays service tax. However an exception has been made to this rule in section 68(2) of the Finance Act, which shifts the liability of payment to the service receiver either fully or partially. This is known as the reverse charge mechanism. The rate of tax remains the same and the services that come under this mechanism are listed clearly. E.g. if you have availed legal services from an advocate for your business, then reverse service charge is applicable and you have to pay the tax.

Under this mechanism, the service receiver have to be registered irrespective of the value of the service received and also cannot avail of the 10 lakh limit. They are also required to file half yearly returns even if the return is Nil. This mechanism was deliberately introduced to include small service providers and receivers under the tax umbrella and widen the tax base to include the unorganized sector.

A partial reverse service charge mechanism is applied when both the service receiver and service provider have to pay tax as per the specified %. E.g. tax distribution on renting of motor vehicles is 60% / 40% by service provider and receiver respectively.

The service receiver can avail CENVAT credit for the service tax actually paid. This means they can minus this amount from the central excise duty for manufacturing of final products or payment of service tax on output services i.e. services provided by them. This is done to avoid the cascading effect of tax on tax for the receiver at the end of the chain.

Special Considerations

Service tax is applicable to the whole of India except the state of Jammu and Kashmir. This measure had to be taken to help the State’s economy recover from the aftermath of terrorism. However sine 2012 as the political climate in the state is continuing to stabilize, some services are being taxed at the state level to increase its revenue generation and pumped back into the state economy.

Future Possibilities

With the intention of establishing a comprehensive taxation system on manufacture, sale and consumption of goods and services at a national level, the Goods and Services Tax GST is being considered in the roadmap for the future. Currently, a manufacturer needs to pay excise for finished goods that are again taxed at the retail outlet when sold thus burdening the consumer at the end of the supply chain. It is estimated that by judicious application of GST, the taxation burden will be divided equitably between manufacturing and services, through a lower tax rate and by widening the tax base.

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