Service Tax in Special Economic Zones

[Dr. Sanjiv Agarwal]

 

Special Economic Zones are specially delineated areas that are treated as foreign territories in the context of trade and tariff laws.

A Special Economic Zone (SEZ) is a specified duty free zone deemed to be a foreign territory within the country for the purpose of tariff and trade. The objectives of SEZ include promotion of goods and services leading to enhanced economic activities, investment promotion, development of infrastructure, creation of employment opportunities etc. SEZ’s could be multiple product SEZ’s, sector specific, IT sector, free trade and warehousing, gem and jewellery sector, biotechnology etc. SEZ’s enjoy a host of fiscal and tax benefits. Indirect tax exemptions include customs duty, central excise duty, service tax, central sales tax, stamp duty and other miscellaneous taxes and duties. Direct tax exemptions include income tax, dividend distribution tax, securities transaction tax, minimum alternate tax etc.

In CCE, Thane- I v Tiger Steel  Engineering (I) Pvt Ltd [2010 -TMI - 201623 - CESTAT, MUMBAI]. it was observed that SEZ Act, 2005 deems supplies from DTA to SEZ unit or developer as exports and deeming provisions are meant exclusively for the benefit of SEZ units. DTA units can not claim any complementary benefit based on deeming provision of SEZ Act or Rules by mere supply of goods to SEZ units. It was held that SEZ Act, 2005 is a special statute enacted for manufacturing units in SEZs and is intended to benefit such units only. The provisions in SEZ Act, must be considered as vehicles to convey benefit to SEZ units. Deeming fiction implies that legal fiction can not be extended beyond statutory object.

In CCE, Thane I v Tiger Steel Engineering (I) Pvt Ltd [2010 -TMI - 201623 - CESTAT, MUMBAI]. it was  held that definition of ‘export’ in Customs Act,1962 applies to Cenvat Credit Rules 2004 and that export in rule 5 of Cenvat Rules covers physical exports only. The refund of accumulated credit is not admissible to a DTA unit and such DTA unit is not entitled to refund of unutilized cenvat credit on inputs used in or in relation to goods manufactured and supplied to SEZ units.

The SEZ Act, 2005 and the SEZ Rules, 2006 envisage the demarcation of an area of land to be designated as a Special Economic Zone. For the purpose of doing business inIndia, it is to be treated as a foreign country. The main incentive of setting up a unit in an SEZ is the relaxation in normally cumbersome procedure and much convoluted tax laws.

Services have been defined in sub-section (z) of section 2 of the SEZ Act, 2005 to mean such tradeable services which:

(i) are covered under the General Agreement on Trade in Services annexed as IB to the Agreement establishing the World Trade Organization concluded at Marrakeshon 15.4.1994;

(ii) may be prescribed by the Central Government for the purposes of this Act; and

(iii) earn foreign exchange.

The Central Government has defined and prescribed what is meant by ‘services’ in clause 76 of the SEZ Rules. Accordingly, the “services” for the purposes of sub-clause (z) of section 2 shall be the following, namely, trading, warehousing, research and development services, computer software services, including information enabled services such as back-office operations, call centers, content development or animation, data processing, engineering and design, graphic information system services, human resources services, insurance claim processing, legal data bases, medical transcription, payroll, remote maintenance, revenue accounting, support centers and web-site services, off-shore banking services, professional services (excluding legal services and accounting) rental/leasing services without operators, other business services, courier services, audio-visual services, construction and related services, distribution services (excluding retail services), educational services, environmental services, financial services, hospital services, other human health services, tourism and travel related services, recreational, cultural and sporting services, entertainment services, transport services, services auxiliary to all modes of transport, pipelines transport.

Special Economic Zone Act, 2005 provides for similar exemptions. The exemption from payment of service tax on taxable services under section 65 of the Finance Act, 1994 rendered to a Developer or a Unit (including a unit under construction) by any service provider shall be available for the authorized operations in a Special Economic Zone.

Section 26(e) of SEZ Act, 2005 relates to exemption from service tax and provides that every developer and the entrepreneur shall be entitled to exemption, drawback and concessions –

“(e) exemption from service tax under Chapter V of the Finance Act, 1994 on taxable services provided to a developer, or unit to carry on authorized operations in the special economic zone.”

Similarly, Rule 31 of SEZ Rules, 2006 provides for exemption to SEZ/units in SEZ from service tax on taxable services rendered to developer or unit for carrying out authorized operations. The rules also do not stipulate consumption of taxable services within the jurisdictional limits of SEZ. Thus between the two exemptions provided for SEZ’s – one in SEZ Act/Rules and one by of notification, the one provided in Act/Rules shall prevail. It may be noted that it is a settled law that where two exemptions are available to assessee, one which is more beneficial to the assessee may be choosen. In view of section 26(e) and section 51 of the SEZ Act, so long as taxable services are meant for furtherance of authorized operations, exemption from service tax could be availed.

Use in authorized operations is a much wider term which could be direct or indirect. Consumption involves actual process of consuming some thing or utilization. Following judicial interpretations are noteworthy in understanding what consumption would mean –

The word ‘consumption’ in its primary sense means the act of consuming and in ordinary parlance means the use of an article in a way which destroys, wastes or uses up that article. But in some legal contexts, the word has a wider meaning. It is not necessary that the commodity must be destroyed or used up. Consumption consists in the act of taking such advantage of the commodities and services produced as constitutes the utilization thereof. Burmashell Co. v. Belgaum Municipality, AIR 1963 SC 906, 911; Jafarabad Municipality v. Kathrawar Industries Ltd., AIR 1969 Gujarat 344

Consumption in the true economic sense does not mean only use of goods in the production of consumer’s goods or final utilization of consumers goods by consumers involving activities like eating of food, drinking of beverages, wearing of clothes or using of an automobile by its owner for domestic purposes. A manufacturer also consumes commodities which are ordinarily called raw materials when the produces semi-finished goods which have to undergo further processes of production before they can be transformed into consumer’s goods. At every such intermediate state of production, some utility or value is added to goods which are used as raw materials and at every such stage the raw materials are consumed. State of Karnataka v. B. Raghurama Shetty, AIR 1981 SC 1206, 1208.

The word ‘consumption’ in its primary sense means the act of consuming and in ordinary parlance means the use of an article in a way which destroys, wastes or uses up that article. But in some legal contexts, the word ‘consumption’ has a wider meaning. It is not necessary that by the act of consumption the commodity must be destroyed or used up. The word ‘use’ is of wider import than ‘consumption’. Kathiawar Industries Ltd. v. Jaffrabad Municipality, AIR 1979 SC 1721. Also refer Burmah Shell, AIR 1963 SC 906.

‘Consumption’ means ‘utilisation’ of commodities and services. For some commodities, there may be even more than one kind of final consumption, e.g., grapes may be eaten as fruits or wine may be made from them. Books, articles of furniture, paintings, etc., may be consumed over a period of time – Anwar Khan Mehboob & Co. v. State of Bombay 1960 (11) STC 698 (SC).

Conversely, if a service is provided by SEZ to DTA, it shall not be construed as deemed import for the reason that SEZs are part of Indian territory and definition of ‘import’ in section 2(o) of SEZ Act, 2005 does not include supplies from SEZs to DTA as imports.

Exemption to Services provided to Developer of SEZ

 

Notification No.	Period	Area	Exemption
4/2007-STdated 31.3.2004	31.3.2004 to 18.5.2009	Within SEZ	General
9/2009-ST dated 31.3.2009	31.3.2009 to 19.5.2009	Inside or outside SEZ	Via Refund route
15/2009-ST dated 20.5.2009	w.e.f. 20.5.2009 onwards	Inside SEZ	Unconditional Exemption
15/2009-ST dated 20.5.2009	w.e.f. 20.5.2009 onwards	Outside SEZ	Via Refund route
15/2009-ST dated 20.5.2009	w.e.f. 20.5.2009 onwards	Partly inside/outside SEZ	Via Refund route
17/2010-ST dated 1.3.201	w.e.f. 1.3.2011onwards	Wholly consumed inside SEZ	Fully exempt
17/2010-ST dated 1.3.2011	w.e.f. 1.3.2011onwards	Partly inside, partly DTA	Prorata via refund route

Amendments w.e.f. 1.3.2011

Notification No 9/2009-ST dated 3.3.2009 has been superceded by Notification No 17/2011-ST dated 1.3.2011 w.e.f. 1.3.2011 to provide for the following –

Notification No. 17/2011-ST has been issued superseding notification 9/2009-ST

dated 03.03.2009. The new notification has the following unique features:

(a) Criteria for the determination of “wholly consumed” services have been laid down in the notification, borrowing from the Export of Services Rules, 2005. It has also been specified that all services received by an entity in a SEZ, which does not have any other DTA operations, will constitute “wholly consumed” services.

(b) No service tax is required to be paid ab-initio if the same are meant to be “wholly consumed” within SEZ, including services liable to tax on reverse charge basis under section 66A.

(c) Refund of the remaining services i.e. which are not wholly consumed shall be available on pro rata basis i.e. ratio of SEZ turnover to total turnover.

(d) Suitable rule has been introduced in Cenvat Credit Rules, 2004 to waive the requirements of rule 6 in case of services provided, without payment of tax, to a SEZ unit for its authorized operations.

(e) New Rule 6 A of Cenvat Credit Rules allow provision of service without payment of service tax to a SEZ developer or unit in SEZ for their authorized operations. This will not require reversal of any cenvat credit on this account and facilitate tax free receipt of services by units in SEZ or developer of SEZs. Sub rules (1), (2), (3) and (4) of Rule (6) of Cenvat Credit Rules 2004 shall not apply in such cases.

Notification No 17/2011-ST provides for a modified scheme for refund of service tax to SEZ units and developers in which wholly consumed services in SEZ have been extended outright exemption and all other services are permitted to have refund on a proportionate basis. Since provisions of sub rules (1), (2), (3) and (4) of rule 6 of Cenvat Credit Rules shall not be applicable in case taxable services are provided without payment of service tax to a unit in SEZ or developer of SEZ for their authorized operations, these services will not require maintenance of separate records or proportionate reversal or payment of amount equal to 5 percent.

Notification No 17/2011-ST dated 1.3.2011 (Refer Annexure 21.3) exempts  taxable services received by a unit located in a SEZ or developer of a SEZ for its authorized operations from whole of service tax, education cess and secondary and higher education cess. The exemption is available to taxable services chargeable to tax under section 66 or 66 A. The basic premise of this exemption scheme is that if services are wholly consumed for authorized operations within the SEZ, no service tax ought to be charged or paid by service provider or service receiver under reverse charge method. In cases where services are not wholly consumed within SEZ, exemption shall be available by way of refund.

The exemption under Notification No 17/2011-ST is subject to the following conditions -

1. Exemption shall be provided by way of refund of service tax paid on specified services

2. Specified services should be used only for the purpose of authorized operations in a SEZ.

3. In case of wholly consumed services in SEZ, service provider or service receiver under reverse charge method, has the option not to pay the service tax in the first case instead or the unit or developer claiming exemption by way of refund as per this notification.

4. For claiming refund, SEZ unit or developer shall get the list of taxable services required for authorized operations approved by the Approval Committee of the SEZ. This list must be approved at the initial state itself and in any case before seeking refund claim.

5. SEZ developer or unit in SEZ who does not carry on any business other then SEZ operations is required to furnish a declaration to this effect in ‘Form A-1’ duly verified by the specified officer of SEZ.

6. The declaration in Form A-1 contains the particulars of name, address, Permanent Account Number, import / export code number, jurisdiction and registration. It contains declaration to the effect that-

(i) maintenance of  proper account of specified services as approved by the Approval Committee, received and used authorized operations.

(ii) making available accounts and records at all reasonable times to jurisdictional officers for inspection and scrutiny.

(iii) use of specified services for authorized operations in the SEZ.

(iv) not owning or carrying out any other business activity in the domestic tariff area .

(v) particulars of service provider.

1. When specified services received by SEZ developer or unit are not wholly consumed in SEZ and are shared between authorized operations in SEZ and unit in domestic tariff area (DTA), refund will be restricted prorata  to the extent of ratio of export turnover to the total turnover in any period to which claims relates. Thus, the maximum refund in such cases shall be –

service tax paid on specified services

used for SEZ Authorized Operations         X      Export turnover of SEZ Unit

shared with DTA Unit for the period                               for the period

Maximum = ----------------------------------------------------------------------------------

refund                                                   Total turnover for the period

 

 For the purposes of condition

(1) total turnover means the sum total of the value of,-

(i) All output services and exempted services provided, including the value of services exported;

(ii) All excisable and non-excisable goods cleared, including the value of the goods exported;

(iii) Bought out goods sold, during the period to which the invoices pertain and the exporter claims the facility of refund under this notification.

(2) turnover of SEZ Unit ‘ shall mean the sum total of the value of final products and output services exported during the period of which the invoices pertain and the exporter claims the facility of refund under this notification.

1. SEZ unit or developer shall declare that specified services on which refund is claimed have been actually issued for the authorized operations in SEZ.

2. Amount of invoice and service tax should have been actually paid by SEZ unit or developer on the invoice, challan etc in question.

3. No refund or exemption in relation to taxable service other than wholly consumed services shall be taken under any other Notification. In other words, refund in such cases can be claimed only under Notification No 17/2011-ST .

4. No cenvat credit can be taken for service tax paid on specified services.

5. SEZ developer or unit in SEZ should maintain proper account of receipt and use of specified services on which exemption is claimed for authorized operations.

Procedure for Claiming Exemption under Notification No 17/2011-ST dated 1.3.2011

SEZ developer or SEZ units should follow the following procedure for claiming refund / exemption-

1. Unit in or developer of SEZ who has paid service tax on specified services should avail exemption by filing refund claim.

2. Unit in SEZ or developer of SEZ who is registered under Central Excise or service tax shall file refund claim to Assistant or Deputy Commissioner of Central Excise having jurisdiction over SEZ or registered office or head office of said developer or unit, as the case may be.

3. Refund claim should be made in ‘Form A-2’.

4. Form A-2 is used for both cases- wholly consumed services and refund for specified services giving details in Table A and Table B/C respectively.

5. Refund should be of service tax paid on specified services-

- used in the manufacture of final products exported from SEZ

- used in providing out put services exported from SEZ.

1. Amount of turnover in Table C should be verified and certified as true by the statutory auditor of SEZ unit.

2. In case of unregistered SEZ developers or units, a declaration should be filed before jurisdictional Assistant or Deputy Commissioner of Central Excise in ‘Form A-3’.

3. Based on “Form A-3, after verification a service tax code number will be allotted within seven days of the receipt of declaration.

4. The time period for filing claim is within one year from the end of month in which actual payment of service tax was made to service provider.

5. Assistant or Deputy Commissioner of Central Excise may permit extension of such period.

6. Refund claim should be accompanied by -

(i)  copy of list of approved specified services for authorized operations.

(ii) invoice / bill/ challan along with proof  of payment for such specified services and service tax paid.

(iii) declaration

1. The declaration should be to the effect that-

(i) Specified services have been actually used for authorized operation in SEZ

(ii) Proper accounts of specified services received and used for the authorized operations are maintained and shall be produce on demand.

(iii) Accounts and documents furnished are true and correct in all respect

1. After due verification of refund claims and information in Form A-2, and satisfying that payment has been made, the Assistant / Deputy Commissioner  shall refund the service tax paid.

2. For ‘wholly consumed’ services, service provider shall provide such services subject to production of documents, ie, declaration in Form 1 A or list of approved specified services.

3. Erroneously refunded amounts, if any, shall be subject to recovery as recovery of service tax.