Employ people to cut cost, burden of service tax contingencies and litigation with revenue.

[C.A. DEV KUMAR KOTHARI]

Also consideration of few recent judgments in the context of subject matter of article.

 Ever increasing rate and scope of service tax:

We have seen that within short span of time tax rate on taxable services including education cess has gone up from 5% to 12.36%. Furthermore, as per the Finance Minister the rates ware increased from 10% to 12% as a step towards 'national level of goods and service tax'. One should not be surprised if in the next budget rate is again increased to reach near or the level of 16% for uniform GST.

The present rate of 12.36% is high and it has contributed to inflation also. The impact of higher rate becomes more pressing when credit is not available for service tax paid if the user of taxable service is unable to avail credit for the tax element due to any reason like the user is not rendering taxable service or is not manufacturing excisable goods against which he can avail credit for service tax paid on various services or when services availed are not qualified for credit.

 Factors of high cost in our economy:

Our economy is already a high cost economy, and contribution of public sector and higher and varied taxes are major reasons for high cost.  The high cost of tax administration for the tax payer is also well known. This is mainly due to certain wrong practices of always believing businessmen as dishonest, unnecessary litigation by the revenue, and policy of first collect and then refund of allow credit etc.  

 Public sector seems profitable only because of monopolistic conditions. Wherever public sector is competing with private sector ( for examples telecommunication, petroleum products and fertilizers), the private sector is also high priced due to higher prices charged by public sector due to inefficiencies and revenue leakages in operations in the public sector.

 If we look from another angle-16% rate for GST is highly exorbitant. It seems a clear warning that rate of service tax is likely to be increased further in near future.

 Service vs. sales:

The 12.36% rate is really very high, and it is a cause of concern. Now where sales tax rates are lower one may think to attempt to shift certain services from service to sales category to reduce tax rates.

 Ever expanding list of taxable services:

Every year more and more services are being brought into taxable category. The rate is same for all services, in spite of the fact that many services are very essential, and few services may only be called as luxury if at all. About 20 years ago telephones were considered somewhat luxury (thanks to slow and inefficient telecom department riddled with red tape) and a dream even by well to do officers. However, now even clerical people consider it as necessity and people engaged as peons in stable service are having telephones at their homes, mobile phones in their pockets and or are also using telephones through PCO.  

Why outside services are availed by outsourcing?:

Outsourcing of service is some times preferred in many cases due to economy in operation and less administrative burden. In case of employment of persons, a fixed cost element is added and that goes on increasing the breakeven level of any organization whereas in case of outsourcing of service, fixed costs are controlled and payments are based on productivity and efficiency and also as and when required. In case of outsourcing, element of fixed costs can be reduced or controlled. Furthermore outsourcing is based on requirement, whereas in case of in house there will be fixed expenditure irrespective of requirement.

 Labor related problems:

Acute Trade Union related problems were also a cause of concern and it was preferred to avail services by out sourcing through contractors. Now-a- days, trade union related problems have also declined considerably and the workers have also understood that salary and wages are for work done and not for employment enjoyed.

 Another problem was relating to provident funds and other funds. However, now these contributions are also taken in to account as package of salary and perquisites, and total package is fixed. Now-a-days even in case of out sourcing of services the element of such costs is considered when service charges are fixed on cost plus basis or even otherwise. Therefore, an organization, which is already having system of these contributions, need not be worried about associated work, and problems. And one cannot also expect savings on these scores by out sourcing because service provider may also have these elements of costs. 

 Hire and fire is becoming easy in open economy.

 Therefore, now it is easy to think of in-house activity in lieu of outsourcing in comparison to the situation, which prevailed about 20 years ago due to trade union related acute problems.

 In house service through employees:

With reduced union problems, many employers will prefer to have employees instead of outsiders. Even in employment relationship, part time work, 3-4 days week, reduced working hours, flexible working hours, work from home are being considered and tested successfully. Thus, in changed scenario, in house activity that is work through employees can be preferred in place of out sourcing. 

 Analysis of major services ABC analysis:

In any organization an analysis of major services which are being outsourced is required to be made. The same may be arranged in ABC category. First of all for A category of services, Comparative charts of in-house and out sourced services can be made. If it is possible to have in house service, and it is cost advantageous, a policy decision can be taken in favour of in house service.

 Compulsory Outsourcing and savings:

Some services are required to be performed by outsiders- independent professional. For example statutory audit, tax audit, cost audit, etc. In such cases one has no option but to avail service from outsiders and have to pay service tax. However, by having better systems of internal check, internal control, internal audit, and full preparation through in hose people the work of outsiders can be made easy and less time consuming and therefore, the fees payable to them can be reduced by strengthening organizational capacity. This will also reduce cost on account of outsourcing attracting service tax. 

 Benefits of in house service

 Besides better control one can also have better teamwork oriented towards overall better performance of the organization. In case of in-house set-up, advantages of using the departmental people for other work can also be availed. In house service shall also obviate need of establishing credentials of outsiders for the purpose of credit of service tax, allowability of expenditure etc.

 Mergers of service receiver and service providers:

 Service tax is basically based on concept of service provided by one person to other person. Just like concept that one cannot trade with him, it is true that one cannot render service to himself in commercial sense. Secondly for service, service charges should be levied by one person who renders service and payable by other person, who receives service. Therefore, any service captively availed will not be subject to service tax. For example, where the services are carried through own employees for own use that is captive use there will be saving of service tax.

 In some cases it may be found convenient and economically suitable to merge the service provider entity with the service receiver entity so that outsourced service becomes in-house service and service tax is saved. 

Besides mergers will enhance enterprise valuation.

 Saving of service tax - a major cost reduction:

The policy of outsourcing definitely requires reconsideration in view of 12.36% tax and ever increasing services in tax fold. Services, which are not, eligible for credit against excise duty and / or service tax payable, there can be definite saving by in house service. Therefore, wherever possible, the business may choose to employ people as salaried person instead of outsourcing similar services. For example few service are discussed below:

The function of internal audit, physical verification of inventory and fixed assets, management audit may be performed by employees appointed for that purpose instead of through practicing accountants or management consultants.

Commercial Civil construction for new construction as well as for repairs and maintenance matters may be undertaken through Engineers and workmen appointed as employees for that purpose   instead of through contractors and consultants.

 (c) Major work of designing of buildings, interiors decoration etc. may be completed through employees and only for availing expertise senior Architects, decorator's services may be availed.

For purchase and sales of goods, fixed assets, air tickets, etc. commission agents may be substituted with employees.

Transportation of goods by road may be undertaken by purchasing / hiring vehicles and employing drivers, and helpers wherever possible and economically viable on the basis of quantity to be transported. This can be undertaken by having a transport division.

 In house service as a means of expansion and diversification:

Another advantage of adoption of in house service can be a means of expansion - resulting in to deployment of idle funds, cost reduction, and profit improvement. In case of service intensive  business using services as input for a substantial cost of product or services, it would be just like  to have own resources of raw material. By in house service one can achieve a diversification related with the existing business.

A chart for analysis:

A chart can be prepared in following manner taking net cost on account of service tax (after available credit ) in descending manner, in respect to services which can be arranged in house:

                                                                       Rs. in lakh

Nature of service availed	Total amount spent/ budgeted	Service tax payable	Service tax available for credit	Service tax not available for credit	Possibility of  in house to the extent	Possible cost reduction by in house (15%) + service  ST Saving
Road transport	8000	989	200	689	70%	840 +
Cleaning, repair and maintenance	500	61.20	61.20	-	95%	71.25 + 0
Security	100	12.36	12.36	10.00	90%	13.5+ 0
Internal audit	40	4.94	-	4.94	100%	6+4.94

 Cost saving assumed @ 15% on in house arrangement.

Service tax saving considered only for services on which CENVAT is not allowed.

After analysis of possible savings one can consider other aspects for making in house arrangements including capital budgeting, changes in fixed costs, impact on break-even point, improvement in margins etc. for taking final decision as to having in house services.

 Reduction of formalities and disputes:

In case of in house services there will be less dispute with excise and service tax departments for eligibility of CENVAT credit, documents for  CENVAT, amount and period of CENVAT etc.

A learning from recent case: In RPG Enterprises Ltd Versus Commissioner of Central Excise, Mumbai 2008 -TMI - 30816 - CESTAT MUMBAI RPG Enterprises rendered certain services to its associates concerns on no profit no  loss basis and claimed that services were not rendered to client but group concerns. The Tribunal held that the service provider and service receiver are separate entities, there is no case of agency and therefore RPG Enterprise is liable to pay service tax and confirmed huge demand of service tax based on services rendered as management consultants and also equal amount of penalty.

Without going into intricacies involved and considering the merits of the case, as it is not required for the purpose of this article, the author feels that In this case it is seen that RPG Enterprise required very minimal services of its employees for own use and major benefit of employees was availed by service receivers who were few group concerns. Therefore, it was not a case of utilizing fully human resources by allowing others to avail some working hours or days of employees to reduce cost of idle human resources but it was a case of rendering services for which people were employed by RPG and not by CEAT or other user companies. There was no relationship of agency between RPG and other companies. Principal of mutuality also did not apply because each company was an independent body corporate having separate identity. The RPG was considered as management consultant in several documents and proceedings before other authorities. In these circumstances the CESTAT held that RPG is service provider and other group companies like CEAT was service receiver so service tax is payable. In view of facts, it would have been better strategy to employ people in service user companies who mainly required service of employees of RPG say CEAT Ltd and pay salary from CEAT Ltd instead of from RPG Enterprise. In case CEAT had used mainly employees for  its own business and shared services of some of  employees or for  some time, on pat time or flexible time basis  with other group concerns, then those companies could reimburse or bear a part of  salary to employees who also devoted time for them.  In that case major part of service would not attract service tax.   

 On other hand we find that in M/s Sara Services & Engineers Pvt. Limited Versus CCE, Meerut 2008 -TMI - 30858 - CESTAT NEW DELHI  time of  employees of appellant and certain facilities  were  used by a sister concern and the sister concern born proportionate expenses for time devoted or facilities used  for their work. In this case appellant did not really render any service but the time of employees or facilities of telephones, office etc were shared and proportionate expenses were born by sister concern. Therefore, in this case the CESTAT held that it was not a case of rendering service as management consultant and service tax was not payable.

In other words it can be said that the same employees were employed by two concerns, in their internal arrangement salary might have been paid by one and the other made reimbursement of proportionate costs on account of salary, travelling, telephone, office expenses etc. Thus it can be said that both the companies were having in house arrangement of engaging people and doing work at their own and it was not a case of appellant rendering service to other sister concern.

To avoid this dispute also it could have been better arrangement if both companies had engaged employees who rendered service to both companies on part time basis or in one case as full time employee and in other case as part time basis and paid salary individually to avoid dispute of service tax.

Therefore it can be said that by employing people instead of outsourcing services, costs can be reduced, contingencies about allowabilty of expenses against taxable business income, allowabilty of CENVAT credit etc can be reduced.