Service Tax Exemption to SEZ – Absence of Control mechanism

SEZ Act provides exemption of duties of customs, central excise and service tax for operations within SEZs subject to certain conditions. In this article we have discussed issues in Compliance by SEZs of Service Tax Related provisions and problems in monitoring of misuse of such exemptions :-

1. Absence of mechanism for accounting of Service tax exemption

Rule 12(1) of SEZ Rules stipulates that the Developer may import or procure goods and services from the DTA, without payment of duty, taxes and cess for the authorized operations, subject to the provisions contained in Sub-rule (2) to (8). Duty free procurement of services was inserted from June 2010.

Sub rule 5 states that the Developer shall execute a Bond-Cum-Legal Undertaking (BLUT) in Form-D, jointly with the Development Commissioner and Specified Officer, with regard to proper accounting and utilization of goods for authorised operations within a period of one year or such period, as may be extended by the specified officer.

We observed that even though duty free services were being allowed to Developers, there was no mechanism in place to capture the duty forgone on account of Service Tax availed by the Developers. Monitoring is done without this vital information even though the eligibility for availing exemption viz., list of authorised services and Form A-1 is given by DC/specified officer only. Consequently, Service Tax exemptions availed by the Developers cannot be considered while calculating the total indirect tax exemptions availed by the Developers. Further, duty free procurement of services by the developer was inserted under Rule 12 wherein requirement of Bond cum Legal Undertaking (BLUT) was also stipulated. Hence, duty free service components should also factor in while quantifying the value of BLUT to monitor the total duty forgone.

In this milieu, our analysis of ST exemption availed by the Developers obtained through concerned DCs indicated that 46 Developers/Co-developers in Andhra Pradesh, Gujarat, Maharashtra, Tamilnadu, Kerala and Odisha had availed ST exemption to the tune of 1,559.43 crore as on March 2013, but the same could not be verified, monitored and accounted for by the DC while calculating the Indirect Tax Benefits extended as there was no mechanism in place to facilitate this. The interest of Government would have been protected even if the exemption was quantified and covered by Bond-cum­Legal Undertaking (BLUT).

We believe that this is a serious risk which facilitates revenue leakage which unfortunately was not being monitored either at the level of DC or the jurisdictional Commissionerates. This loophole assumes significance as de-notification request of Developer is approved by BoA based on the recommendations of DCs wherein the details of recovery of total exemptions availed by the developer is given. In the absence of a mechanism for accounting of Service Tax exemptions, the computation of the total dues to be recovered by the DC is flawed, facilitating undue benefit to the Developers. Two such cases are highlighted in Box-1.

Box-1: De-notification allowed without recovering Service Tax dueBoA approved de-notification relying on the certificate furnished by the DC without taking cognizance of Service Tax Exemption of 33.01 lakh availed by two Developers/units in Tamilnadu (M/s Aspocomp Electronics and Estra IT Park). BoA in their meeting held in August 2009, 64 approved de-notification in M/s Maytas, Gundlapochampally, Andhra Pradesh subject to payment of ST exemption of 31.46 lakh which was not paid till date (August 2013). The cited instances occurred as the Department did not have a system of monitoring and accounting the exemption allowed on account of Service Tax.

DoC in their reply (June 2014) stated that this aspect has already been taken care of and as per notification dated 01 July 2013 issued by DoR, the mechanism for monitoring of availment of Service Tax has been incorporated and developers/units are required to submit quarterly report to the jurisdictional ST Authority.

The conditions of the BLUT in para 2 provides for refund of service tax exemption availed by the developer.

Reply is not acceptable as all the duty free benefits availed by the Developers were being monitored by Specified Officers (Customs) through BLUT and hence the value of duty free service availed by the Developers should also be monitored through BLUT. Further, the issue raised in the audit observation was availment of ST exemption by Developers/units and accounting thereof by DC for calculating the Indirect Tax benefits availed by Developers/units and covered under BLUT. DoC’s reply is silent about the mechanism that they have with ST Commissionerates to safeguard the revenue in such cases.

Recommendation: MOC&I may review the arrangements in place for Service Tax administration as there was no mechanism for capturing, accounting, and monitoring of ST forgone by DC or the jurisdictional ST Commissionerates.

2.  Incorrect exemption of service tax

Export of Services Rules, 2005 introduced exemption of service tax on export of taxable services subject to two conditions i.e such service is provided from India and used outside India and the payment for such service provided outside India is received by the service provider in convertible foreign exchange.

In Andhra Pradesh, M/s Satyam BPO Ltd., an SEZ Unit in Satyam Computer Services Ltd. IT/ITES SEZ, Madhapur, Hyderabad were engaged in providing information technology software services (ITSS) and other related services to various clients in India as well as abroad which also included services provided to its parent company M/s Tech Mahindra and M/s Satyam Computers Ltd. The assessee paid Service Tax on services rendered in DTA and claimed exemption for other services under Export of Service Rules 2005. However, we noted from the scrutiny of the services claimed to have been exported that a few services were rendered to its parent companies which were billed to the locations in India and the money received was in Indian currency which is in contravention to the rules stated supra.

As per the Annual Performance Report for the year 2011-12, the Unit has done deemed exports worth 43.81 crore to its parent companies and claimed exemption under Export of Service Rules 2005 which was incorrect and hence Service Tax is leviable @ 10.3 per cent which works out to 4.51 crore which needs to be recovered along with interest.

We also noted that the assessee was paying Service tax on similar transactions (Deemed Exports) from July 2012 onwards, which corroborates the audit observation. However, the assessee had not paid any Service Tax for the prior period in question.

Similarly, in Karnataka, in the case of M/s Syngene International Ltd.(Unit I to VI) in Biocon SEZ, services amounting to 47.94 crore claimed to be exported were actually rendered to its group companies billed in India and money was also received in Indian currency. Service tax liability of 5.13 crore on the services rendered needs to be recovered along with Interest.

DoC in their reply (June 2014) stated that Satyam Services rendered services within SEZ and whole amount realized in FE. The only issue was to verify whether double IT exemption was taken. Even though M/s. Satyam BPO did not receive foreign currency directly for the services rendered by them to overseas clients, the transaction should be treated as export of service by M/s. Satyam BPO. The money for the services rendered by M/s. Satyam BPO was received in foreign currency by M/s. Satyam, who in turn paid them in Indian currency. Commissioner (Appeals) and CESTAT have upheld this contention and as it stand now, such transactions have to be treated as export of services. They have started paying Service Tax after the enactment of the “Place of Provision of Services Rules, 2012”.

CESTAT vide order No. 1382 to 1386/2008 dated 4.11.2008, allowed the Unit to obtain refund for the Service Tax paid on the services provided to the client located abroad.

Reply is not tenable as the basic condition of receiving proceeds in foreign currency for treating a service to be exported is not satisfied by M/s Satyam BPO. The unit was rendering service to its parent company (Satyam and Tech Mahindra) in India and classifying it in the APRs as deemed exports which is not envisaged in the Export of Service Rules 2005 and hence the benefit of exemption cannot be granted. Further, possibility of double claim under export of service by both Satyam BPO and its parent company cannot be ruled out.

3. Failure to pay Service Tax under Reverse charge Mechanism

Rule 2(1) (d)(iv) of Service Tax Rules, 1994 specifies that the service receiver as the Person liable for paying service tax in relation to any taxable service provided or to be provided by any person from a country other than India and received by any person in India under section 66A of Finance Act 1994. Benefit of exemption of Service Tax under section 66A for SEZ Units has been introduced from March 2011 and no such exemption was in effect for the prior period.

We noted 33 instances of incorrect availment, ab-initio, of exemption of Service tax in Andhra Pradesh, Karnataka, Madhya Pradesh and Tamilnadu amounting to 287.52 crore under 66A for the period prior to March 2011 which need to be recovered along with interest.

Further, for the subsequent period the units were required to get approval of the services as specified services for availing ab-initio exemption of service tax liability under reverse charge mechanism u/s 66A.

We noted in 23 cases involving incorrect exemption of 128.28 crore in Andhra Pradesh, Tamilnadu, Karnataka and Rajasthan, which did not comply with the conditions stipulated for claiming ab-initio exemptions which needs to be recovered along with interest.

DoC in their reply (June 2014) stated that audit tried to point out that Service Tax exemption was not available for services availed by SEZ units from abroad for the period March, 2009 to February, 2011. Services provided by Indian suppliers is covered under section 66 of Service Tax Act and services provided by supplier from abroad are covered under section 66(A) of Service Tax Act.

By virtue of notification dated 03.03.2009, the Government introduced exemption from Service Tax for the services used by SEZ Unit / Developer by way of refund which hitherto was unconditionally exempted. In other words, before 03.03.2009, Service Providers were not required to pay Service Tax for the services rendered by them to a SEZ Unit / Developer. The above modus operandi of granting exemption by way of refund was limited to Service Tax paid under Section 66 of the Finance Act. Thus, Service Tax payable under Reverse Charge Mechanism in terms of Section 66A of Finance Act, 1994 continues to be unconditionally exempted.

Notification dated 20.05.2009 was issued amending the notification dated 03.03.2009 to exclude exemption by way of refund in respect of such services which are wholly consumed within SEZ. Thus, in respect of services which are consumed within SEZ again become unconditionally exempted.

In view of the above statutory provisions, the issue raised by audit that RIL SEZ Unit was liable for Service Tax in respect of Service Providers located outside India in terms of Section 66A for the period from March, 2009 to February, 2011 is not legally tenable.

The reply is not acceptable to audit as SEZs are deemed to be foreign territory under SEZ Act, but not under Finance Act 1994 and hence liable for levy of service tax unless specifically exempted. Benefit of exemption of service tax under 66A was allowed from March 2011 vide notification No.17/2011 and hence, exemption benefit is to be allowed for the subsequent period provided the conditions stipulated in the notification was adhered to. Further, benefit of exemption is given at DC level by issuing Form A1 and also declaring the nature of specified services. Hence, in our opinion the action for non-compliance needs to be initiated by DC only.

4. Non-payment of Service Tax

In terms of notification dated 3 March 2009, taxable services specified in Clause (105) of Section 65 of the Finance Act, 1994, chargeable to service tax under Section 66 of the said Act, received by a Unit located in a Special Economic Zone or Developer of SEZ for authorized operation, are exempt from the whole of service tax, education cess and secondary and higher education cess leviable thereon. It therefore follows that such an exemption is not available if the Developer/unit is engaged in operations not connected with the Zone.

In terms of Section 65(30a) of the Finance Act, 1994, construction of residential buildings, townships, row-house complex, etc. would attract service tax with effect from 16 June 2005. We noted in the following two instances Service Tax due from the concerned units was not recovered.

(a) M/s. New Chennai Township Private Limited, Cheyyur, a SEZ developer, owners of land measuring 612 acres, had obtained approval from the BoA (January 2008) for promoting two SEZs viz. Light Engineering Sector (312 acres) and Multi-Sector service (300 acres). Further scrutiny revealed that though nine units who had obtained approval for manufacturing and service activities in the said Zones commenced operations only during 2011- 12, the Developer had started constructing residential apartments in each Sector in the Non-Processing Area and received advances from prospective customers, as early as in 2007-08 onwards. In the two phases of construction completed, 580 residential apartments were leased out to individuals unconnected with the authorised operations of the Zone.

Despite carrying out activities not connected with the authorised operations of the Zone, the Developer did not discharge the service tax obligation to the tune of 16.42 crore, computed on the total income from operations amounting to 150.76 crore received from the prospective buyers during the period from 2007-08 to 2012-13 towards construction of these residential buildings.

(b) Taxable services of transportation of goods by vessel are liable to Service Tax with effect from 1 September 2009 subject to exemption granted to transportation of specified goods listed out in the Table annexed to the Notification No.25/2012 – ST dated 20 June 2012. Further, Notification 26/2012-ST dated 20 June 2012 permitted abatement of 50 per cent of the gross amount charged for determining the value of taxable service of transport of goods in a vessel from one part to another part in India.

M/s. Larsen and Toubro Limited, Modular Fabrication Facility, Kattupalli, an SEZ unit in Tamilnadu had transported their finished product viz., “Process­cum-living quarters platform” meant for Deendayal Field Development Project of M/s. Gujarat State Petroleum Corporation Limited, Kakinada Coast, Andhra Pradesh by Barge-Posh Giant-I with Tug-Martime Mesra during 2012-13 for a value of  Rs. 184.27 crore and incurred transportation charges of Rs. 37.27 crore. Inasmuch as the goods were not covered in the Notification first cited supra, the unit is liable to pay Service Tax amounting to 2.30 crore (@12.36 per cent of 50 per cent of 37.27 crore), calculated on the abated value of the goods, which is recoverable along with applicable interest.

(c) In term of sub-rule 3 of rule 27of SEZ Rules, Import of duty-free material shall not be permitted for operational and maintenance activity in the non-processing area. It, therefore, follows that exemption from duties/taxes is not admissible for such activity.

Further, as per clause (90a) of section 65 of the Finance Act, 1994 “renting of immovable property” includes renting, letting, leasing, licensing or other similar arrangement of immovable property for use in the course of furtherance of business or commerce. Explanation 2, thereunder, provides “renting of immovable property” also includes allowing or permitting the use of space in an immovable property, irrespective of the transfer of possession or control of the said immovable property. The activity of renting of immovable properties for commercial use is liable to Service Tax with effect from 1 June 2007 under the service of “Renting of Immovable Property”.

M/s. L&T Shipbuilding Limited, Kattupalli, awarded ‘Operation and Maintenance of the container port terminal’ at Kattupalli Village, to a Contractor viz. M/s International Container Terminal Service (India) Private Limited on receipt of Contract Licence Fee of . 85.45 crore during the year 2011-12. However, the unit did not discharge its service tax liability amounting to 10.20 crore despite the fact that receipt of operation and maintenance charges was not exempt from Service tax in terms of rules cited above.

DoC in their reply (June 2014) stated that in case of specific demand, SCN will be issued for recovery of the Service Tax wrongly availed. Further, in the case of M/s New Chennai Township Pvt Ltd, Cheyyur, during the period 2007-08 to 2012-13 amounting to 16.42 crore, action has been initiated against the Developer and the case of M/s L&T Shipbuilding Ltd. regarding payment of Service Tax amounting to 2.30 crore along with interest is being referred to Service Tax Department.

DoC may intimate the final outcome to audit.