The recent decision by the Bangalore Tribunal in the case of KBace Tech Pvt Ltd and Others has initiated the new battle between the tax administration authorities and judicial organs over legislative intentions behind the grant of refund of Cenvat credit on input services to the service exporter.

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The wrangle reminds one of the never ending chases and battle of the cartoon characters Tom and Jerry. Like Tom, the finance minister keeps on simplifying the refund procedures and like Jerry, the field formations keep on exploring new hurdles by adding the new version in the entire episode. The latest entrant in this saga is the Bangalore Tribunal, whose decision has given a morale booster to Jerry in its endeavour to block the service tax refunds.

This is evident from the fact that, to relax the controversies revolving around the eligibility of refund claim to the service exporters, the Central Board of Excise and Customs came out with a Circular on January 19 this year, clarifying the position in favour of the various service exporters. Further, in order to support the Board’s view, the Union Budget 2010 brought retrospective amendments vide Notification No. 5/2006 (‘the Notification’) to rules governing the procedural aspects of claiming refund of unutilised Cenvat credit. However, soon after the issue of much-awaited clarifications and proposed amendments in the Notification, Bangalore CESTAT in the case of KBace Tech has shaken the very foundation of the Cenvat credit scheme that governs the eligibility of the input services for Cenvat credit.

Introduction of the levy of service tax in 1994 was the first initiative towards the unified value added tax (covering goods as well as services). The service tax being a consumption tax, input tax credit mechanism was introduced to avoid the cascading effect. Cenvat credit has been evolving and has undergone many changes over time.

In brief, earlier, Rule 5 of the Cenvat Rules allowed the refund of Cenvat credit availed on the inputs or input services only to manufacturer exporters.

Though delayed, government amended the Rule 5 and the Notification to cover service exporters under the refund scheme.However, the amendment of the Cenvat Rules and issuance of the Notification could not ensure the smooth and hassle-free function of the Input Credit Mechanism and sanction of the refund claims for service exporters. In fact, it began the new era of the fresh litigations with regard to determination of the eligibility of refund of credit availed on input services used in relation to the exported output services.

The refund claims filed by the applicants were mostly rejected or delayed on account of the confusion pertaining to the establishment of the nexus between the input services procured and output services provided by the service exporter. The confusion was on account of the contradictory languages used in the Cenvat Rules and in the Notification. The Cenvat Rules defining the term ‘input services’ permits the availment of Cenvat credit on the input services that are ‘used for’ providing output services, whereas, the Notification while permitting the refund of Cenvat credit termed that refund on input services ‘used in’ provision of output services exported is available.

This created room for interpretation by the authorities that refund is eligible only with respect to input services, which have direct nexus with the output services as the Notification states that the input services should be ‘used in’ provision of export of services. In order to clarify the correct position, the CBEC issued the Circular dated January 19, 2010, which clarified that there cannot be different yard sticks to determine the nexus between the input and output services under the different provisions of the service tax legislations. The different phrases used in the various provisions of service tax legislations should be construed in a harmonious manner to understand that Cenvat credit on the input services are eligible in case its absence adversely impacts the efficiency and quality of the output services.

The above Circular and the amendment in the Notification in the Union Budget were welcomed by service exporters with a hope that the long-awaited refund would now start flowing.However, this hope has been drastically shaken by the Bangalore Tribunal in the case of KBace Tech. The Tribunal while remanding back the matters observed that:

  • Section 94 of the Finance Act, 1994 (‘Act’) which empowers government to provide for rules to take Cenvat credit of only those input services that are ‘consumed’ for providing the output services;
  • The provisions of Cenvat Rules (definition of input service) and the Notification widening the scope of the eligibility of Cenvat credit on input services used in provision of the output services are beyond the provisions of Section 94, which restricts the eligibility of Cenvat credit to the input services ‘consumed’ in providing the output services;
  • Cenvat Rules cannot provide for credit of Service tax in respect of the services which are not consumed for providing the output services;
  • Binding nature of the Board’s Circular is doubtful;
  • As the recent Budget amends only the Notification and not the Statute or the Rules, hence Section 94 still prevails.

Thus, the Tribunal’s decision has provided new grounds to the field formations to continue their arguments against eligibility of refund on certain input services. This would start a new round of discussions and representations from the affected industries. Apparently, the Tribunal did not appreciate certain key aspects of the entire Cenvat mechanism. These include:Concept of consumption based tax: Service tax is a consumption based tax and to avoid the cascading effect, Cenvat Rules were introduced. The interpretation adopted in the above decision defeats the very purpose of the Cenvat Rules and the service tax legislation resulting in export of taxes.

The definition of the term ‘consumed’: The term ‘consumed’ has not been defined anywhere in the service tax legislation. The terms ‘consumption of goods’ can be easily and logically understood. However, service being intangible in nature, the term ‘consumption of service’ cannot be substantiated. The concept of ‘consumption’ does not seem to be very different from the concept of ‘usage’ in the context of services and the term ‘consumed’ may not necessarily mean narrower than ‘usage’.

No contradiction with Section 94: Section 94 of the Act authorises the Central Government to frame Cenvat Credit Rules with respect to “services consumed for” providing taxable services and not “services consumed in” providing the taxable services. The input services are always consumed by the recipient directly (i.e. consumed in) or indirectly (i.e. consumed for). The Tribunal has failed to appreciate the fact that such consumption need not be direct as much that the Act used the word “for providing the services” instead of “in providing the services”. It may be noted that if the Tribunal can consider the above harmonious interpretation, then nothing in the amended Rule/ Notification would be contradicting the provisions in the Act.

Taking a fresh look at the entire matter, it can be said that the Input Credit Mechanism, right from its introduction, has undergone the variety of changes over a period of time. It has been almost six years since introduction of the Cenvat Rules, which govern the refund of the unutilised Cenvat credit to the service exporter. However, the position as regards eligibility is not yet settled. The only victims of such legal system are the industries and ultimately the final consumers.

When elephants fight, the grass on the ground gets cleaned up. Here, it is the claimant who is at the receiving end. The writers are with KPMG. Views are personal.