Service Tax: Guidance Note 2 – What is Service?.

Guidance Note 2 – What is Service?

In the existing system, only the services specified in clause (105) of section 65 of the Finance Act, 1994 are taxed under the charging section 66. In the new system, all services, other than services specified in the negative list, provided or agreed to be provided in the taxable territory by a person to another would be taxed under section 66B. This Note explains the various ingredients and aspects of the definition of service. Service’ has been defined in clause (44) of the new section 65B and means –

•  any activity
•  for consideration
•  carried out by a person for another
•  and includes a declared service.

The said definition further provides that ‘Service’ does not include –

•  any activity that constitutes only a transfer in title of (i) goods or (ii) immovable property by way of sale, gift or in any other manner
•  a transaction only in (iii) money or (iv) actionable claim
•  any service provided by an employee to an employer in the course of the employment.
•  fees payable to a court or a tribunal set up under a law for the time being in force

There are three explanations appended to the definition of ‘service’ which are dealt with in later part of this Guidance Note. Each of the ingredients bulleted above have been explained in the points below.

2.1 Activity

2.1.1 What does the word ‘activity’ signify?

‘Activity’ has not been defined in the Act. In terms of the common understanding of the word activity would include an act done, a work done, a deed done, an operation carried out, execution of an act, provision of a facility etc. It is a term with very wide connotation.

Activity could be active or passive and would also include forbearance to act. Agreeing to the obligation to refrain from an act or to tolerate an act or a situation has also been specified as a declared service under section 66E of the Act.

2.2 Consideration

2.2.1 The phrase ‘consideration’ has not been defined in the Act. What is, therefore, the meaning of ‘consideration’?

Yes. ‘Consideration’ has not been defined in the Act. The definition of ‘consideration’ as given in the Indian Contract Act, 1872 can safely be adopted to understand the concept of consideration. When so applied to the Act, ‘consideration’ for a service provided or agreed to be provided by service provider would mean anything which the service receiver or any other person has done or abstained from doing, or does or abstain from doing, or promises to do or to abstain from doing for receiving the service.

In simple term, ‘consideration’ means everything received in return for a provision of service which includes monetary payment and any consideration of non- monetary nature as well as deferred consideration.

2.2.2 What are the implications of the condition that activity should be carried out for a ‘consideration’?

•  To be taxable an activity should be carried out by a person for another for a ‘consideration’
•  Activity carried out without any consideration like donations, gifts or free charities are therefore outside the ambit of service. For example grants given for a research where the researcher is under no obligation to carry out a particular research would not be a consideration for such research.
•  An act by a charity for consideration would be a service and taxable unless otherwise exempted. ( for exemptions to charities please see Guidance Note 6)
•  Conditions in a grant stipulating merely proper usage of funds and furnishing of account also will not result in making it a provision of service.
•  Donations to a charitable organization are not consideration unless charity is obligated to provide something in return e.g. display or advertise the name of the donor in a specified manner or such that it gives a business advantage to the donor.

2.2.3 What is the meaning of monetary consideration?

Monetary consideration means any consideration received in the form of money. ‘Money’ includes not only cash but also cheque, promissory note, bill of exchange, letter of credit, draft, pay order, traveler’s cheque, money order, postal or electronic remittance or any such similar instrument when used as consideration to settle an obligation.

2.2.4 What is non-monetary consideration?

• Non-monetary consideration could be in the form of following:
•  Supply of goods and services in return for provision of service
•  Refraining or forbearing to do an act in return for provision of service
•  Tolerating an act or a situation in return for provision of a service
•  Doing or agreeing to do an act in return for provision of service

Illustrations

If……	And in return…
A agrees to dry clean B’s clothes	B agrees to click A’s photograph
A agrees not to open dry clean shop in B’s neighborhood	B agrees not to open photography shop in A’s neighborhood
A agrees to design B’s house	B agrees not to object to construction of A’s house in his neighborhood
A agrees to construct 3 flats for B on land owned by B	B agrees to provide one flat to A without any monetary consideration

Then

For the services provided by A to B, the acts of B specified in 2nd column are non- monetary consideration provided by B to A. Conversely, for services provided by B to A, similar reasoning will be adopted.

2.2.5 Is the value of non-monetary consideration important?

Yes. The non-monetary consideration also needs to be valued for determining the tax payable on the taxable service since service tax is levied on the value of consideration received which includes both monetary consideration and money value of non-monetary consideration.

2.2.6 How is the money value on non-monetary consideration determined?

The value of non-monetary consideration is determined as per section 67 of the Act and the Service Tax (Determination of Value) Rules 2006, which is equivalent money value of such consideration and if not ascertainable, then as follows:-

•  On the basis of gross amount charged for similar service provided to other person in the ordinary course of trade;
•  Where value cannot be so determined, the equivalent money value of such consideration, not less than the cost of provision of service.

2.2.7 Are research grant with counter obligation on researcher to provide IPR rights on outcome of a research a consideration?

In case research grant is given with counter obligation on the researcher to provide IPR rights on the outcome of research or activity undertaken with the help of such grants then the grant is a consideration for the provision of service of research. General grants for researches will not amount to a consideration.

2.2.8 Would the payments in the nature as explained in column A of the table below constitute a consideration for provision of service?

S. No.	A	B
	Nature of payment	Whether consideration for service?
1.	Amount received in settlement of dispute.	Would depend on the nature of dispute. Per se such amounts are not consideration unless it represents a consideration. If the dispute itself pertains to consideration relating to service then it would be a part of consideration. For example the amount may represent payments for an executed works contract in dispute.
2.	Amount received as advances for performance of service.	Such advances are consideration for the agreement to perform a service.
3.	Deposits returned on cancellation of an agreement to provide a service.	Returned deposits are in the nature of a returned consideration. If tax has already been paid the tax payer would be entitled to refund subject to provisions in this regard.
4.	Advances forfeited for cancellation of an agreement to provide a service.	Since service becomes taxable on an agreement to provide a service such forfeited deposits would represent consideration for the agreement that was entered into for provision of service.
5.	Security deposit that is returnable on completion of provision of service.	Returnable deposit is in the nature of security and hence do not represent consideration for service.
6.	Security deposits forfeited for damages done by service receiver in the course of receiving a service	If the forfeited deposits relate to accidental damages due to unforeseen actions not relatable to provision of service then such forfeited deposits would not be a consideration in terms a clause proposed to be inserted in rule 6 of the Valuation Rules.
7.	Fines and penalties paid for violation of provisions of law.	These are not considerations as no service is received in lieu of payment of such fines and penalties.
8.	Excess payment made as a result of a mistake	If returned it is not consideration. If not returned and retained by the service provider it becomes a part of the taxable value.
9.	Demurrages payable for use of services beyond the period initially agreed upon e.g. use of containers beyond the normal period.	This will be consideration and is being so provided in the amendments made to Rule 6 of the Valuation Rules.

2.2.9 Can a consideration for service be paid by person other than the person receiving the benefit of the service?

Yes. The consideration for a service may be provided by a person other than the person receiving the benefit of service as long as there is a link between the provision of service and the consideration. For example, holding company may pay for works contract service or architect services that are provided to its associated companies.

2.3 By a person for another

2.3.1 What is the significance of the phrase ‘carried out by a person for another’?

The phrase ‘provided by one person to another’ signifies that services provided by a person to self are outside the ambit of taxable service. Example of such service would include a service provided by one branch of a company to another or to its head office or vice-versa.

2.3.2 Are there any exceptions wherein services provided by person to the same person are taxable?

Yes. Two exceptions have been carved out to the general rule that only services provided by a person to another are taxable. These exceptions, contained in Explanation 2 of clause (44) of section 65B, are:

•  an establishment of a person located in taxable territory and another establishment of such person located in non-taxable territory are treated as establishments of distinct persons. [Similar provision exists presently in section 66A(2)].
•  an unincorporated association or body of persons and members thereof are also treated as distinct persons. [Also exists presently in the explanation to section 65].

Implications of these deeming provisions are that inter-se provision of services between such persons, deemed to be separate persons, would be taxable. For example, services provided by a club to its members and services provided by the branch office of a multi-national company to the headquarters of the multi-national company located outside India would be taxable provided other conditions relating to taxability of service are satisfied.

2.3.3 Who is a ‘person’? Is it only a natural person or includes an artificial or a juridical person?

‘Person’ is not restricted to natural person. ‘Person’ has been defined Section 65 B of the Act. The following shall be considered as persons for the purposes of the Act:

•  an individual
•  a Hindu undivided family
•  a company
•  a society
•  a limited liability partnership
•  a firm
•  an association or body of individuals, whether incorporated or not
•  Government (Central and State Governments, will be separate persons)
•  a local authority, or
•  every artificial juridical person, not falling within any of the preceding sub-clauses.

2.3.4 Are Government and local authorities also liable to pay tax?

Yes. However, most of the services provided by the Government or local authorities are in the negative list.

2.3.5 What is the rationale behind taxing certain activities of the Government or local authorities?

Only those activities of Government or local authorities are taxed where they compete with private entities. The rationale is as follows-

 to provide a level playing field to private entities in these areas as exemption to Government in such activities would lead to competitive inequities; and

 to avoid break in Cenvat chain as the support services provided by Government are normally in the nature of intermediary services.

2.3.6 Would taxable services provided by Government or local authorities still be taxable if they are covered under any other head of the negative list or are otherwise exempted?

No. For example, transport services provided by Government to passengers by way of a stage carriage would not be taxable as transport of passengers by stage carriage has separately been specified in the negative list of services. The specified services provided by the Government or local authorities are taxable only to the extent they are not covered elsewhere i.e. either in the negative list or in the exemptions.

2.4 Activities specified in the declared list are services.

Declared Services are activities that have been specified in Section 66 E of the Act. When such activities are carried out by one person for another in the taxable territory for a consideration then such activities are taxable services. For guidance on the declared services please refer to Guidance Note 5.

2.5 Activity to be taxable should not constitute only a transfer in title of goods or immovable property by way of sale, gift or in any other manner

•  Mere transfer of title in goods or immovable property by way of sale, gift or in any other manner for a consideration does not constitute service.
•  Goods has been defined in section 65B of the Act as ‘every kind of moveable property other than actionable claims and money; and includes securities, growing crops, grass and things attached to or forming part of the land which are agreed to be severed before sale or under contract of sale’.
•  Immovable property has not been defined in the Act. Therefore the definition of immovable property in the General Clauses Act, 1897 will be applicable which defines immovable property to include land, benefits to arise out of land, and things attached to the earth, or permanently fastened to anything attached to the earth.

2.5.1 What is the significance of the phrase ‘transfer of title’?

‘Transfer of title’ means change in ownership. Mere transfer of custody or possession over goods or immovable property where ownership is not transferred does not amount to transfer of title. For example giving the property on rent or goods for use on hire would not involve a transfer of title.

2.5.2 What is the significance of the word ‘only’ in the said exclusion clause in the definition of ‘service’?

The word ‘only’ signifies the transactions which involve only transfer of title in goods or immovable property is not included as service. A transaction which in addition to a transfer of title in goods or immovable property involves an element of another activity carried out or to be carried out by the person transferring the title would not be excluded from the definition of service.

2.5.3 Would the answer to 2.5.2 mean that all composite transactions which in addition to a transfer of title in goods involve an element of provision of service be considered as a ‘service’ and taxable as such?

No. The manner of treatment of such composite transactions for the purpose of taxation, i.e. are they to be treated as sale of goods or provision of service, has been laid down by the Honorable Supreme Court in the case of Bharat Sanchar Nigam Limited vs Union of India [2006(2)STR161(SC)]. The relevant paras 42 and 43 of the said judgment are reproduced below -

“42. Of all the different kinds of composite transactions the drafters of the 46th Amendment chose three specific situations, a works contract, a hire purchase contract and a catering contract to bring within the fiction of a deemed sale. Of these three, the first and third involve a kind of service and sale at the same time. Apart from these two cases where splitting of the service and supply has been Constitutionally permitted in Clauses (b) and (g) of Clause 29A of Art. 366, there is no other service which has been permitted to be so split. For example the clauses of Art. 366(29A) do not cover hospital services. Therefore, if during the treatment of a patient in a hospital, he or she is given a pill, can the sales tax authorities tax the transaction as a sale? Doctors, lawyers and other professionals render service in the course of which can it be said that there is a sale of goods when a doctor writes out and hands over a prescription or a lawyer drafts a document and delivers it to his/her client? Strictly speaking with the payment of fees, consideration does pass from the patient or client to the doctor or lawyer for the documents in both cases.

43. The reason why these services do not involve a sale for the purposes of Entry 54 of List II is, as we see it, for reasons ultimately attributable to the principles enunciated in Gannon Dunkerley’s case, namely, if there is an instrument of contract which may be composite in form in any case other than the exceptions in Article 366(29-A), unless the transaction in truth represents two distinct and separate contracts and is discernible as such, then the State would not have the power to separate the agreement to sell from the agreement to render service, and impose tax on the sale. The test therefore for composite contracts other than those mentioned in Article 366 (29A) continues to be - did the parties have in mind or intend separate rights arising out of the sale of goods. If there was no such intention there is no sale even if the contract could be disintegrated. The test for deciding whether a contract falls into one category or the other is to as what is the substance of the contract. We will, for the want of a better phrase, call this the dominant nature test.”

The following principles emerge from the said judgment for ascertaining the taxability of composite transactions-

•  Except in cases of works contracts or catering contracts [exact words in article 366(29A) being – ‘service wherein goods, being food or any other article of human consumption or any drink (whether or not intoxicating) is supplied in any manner as part of the service’] composite transactions cannot be split into contracts of sale and contracts of service.
•  The test whether a transaction is a ‘composite transaction’ is that did the parties intend or have in mind that separate rights arise out of the constituent contract of sale and contract of service. If no then such transaction is a composite transaction even if the contracts could be disintegrated.
•  The nature of a composite transaction, except in case of two exceptions carved out by the Constitution, would be determined by the element which determines the ‘dominant nature’ of the transaction.
•  If the dominant nature of such a transaction is sale of goods or immovable property then such transaction would be treated as such.
•  If the dominant nature of such a transaction is provision of a service then such transaction would be treated as a service and taxed as such even if the transaction involves an element of sale of goods.

 In case of works contracts and ‘service wherein goods, being food or any other article of human consumption or any drink (whether or not intoxicating) is supplied in any manner as part of the service’ the ‘dominant nature test’ does not apply and service portion is taxable as a ‘service’ This has also been declared as a service under section 66E of the Act. For guidance on these two types of composite transactions and the manner of determining the value portion of service portion of such composite transactions please refer to point nos. 5.8 and 5.9 of this Guidance Paper.

•  If the transaction represents two distinct and separate contracts and is discernible as such then contract of service in such transaction would be segregated and chargeable to service tax if other elements of taxability are present. This would apply even if a single invoice is issued.

The principles explained above would, mutatis mutandis, apply to composite transactions involving an element of transfer of title in immovable property.

2.5.4 Why is notification 12/2003-ST proposed for deletion?

Notification 12/2003 – ST exempted so much of the value of all taxable services as was equal to the value of goods and materials sold by the service provider to the service recipient subject to condition that there is documentary proof of such value of goods and materials. Under the negative list scheme, transactions that involve transfer of title in goods are excluded. Therefore if goods are being sold by a service provider under a distinct and a separate contract then sale of such goods is excluded from the definition of service. If it is a ‘composite contract’ and dominant nature of the contract is that of provision of service then value of goods cannot be excluded and if the dominant nature is sale of goods then the contract is not taxable as service. In view of the above notification 12/2003-ST has been proposed to be deleted.

2.5.5 “Securities” has been included as goods. What are securities?

• Securities has been defined in section 65B of the Act as having the same meaning assigned to it in clause (h) of section 2 of the Securities Contract (Regulation) Act, 1956 (42 0f 1956) in terms of which ‘securities’ includes –
•  Shares, scrips, stocks, bonds, debentures, debenture stock or other marketable securities of a like nature in or of any incorporated company or other body corporate.
•  Derivative.
•  Security receipt as defined in clause (zg) of section 2 of the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002.
•  Units or any other such instrument issued to the investors under any mutual fund scheme.
•  Government securities;
•  Such other instruments as may be declared by the Central Government to be securities.
•  Rights or interest in securities.

2.5.6 What are the implications of inclusion of ‘securities’ as ‘goods’?

The definition of ‘goods’ has essentially been borrowed from the Sale of Goods Act, 1930 with the only variation that in the inclusion clause of the said definition the phrase ‘stocks and shares’ been replaced with ‘securities’. In effect, therefore, activities that are in the nature of only transfer of title by way of sale, redemption, purchase or acquisition of securities on principal-to-principal basis, excluding services of dealers, brokers or agents in relation to such transactions, are outside the ambit of ‘services. However activities which are not in the nature of transfer of title in securities (for example a person agreeing not to exercise his right in a security for a given period of time for a consideration) would not be included in this exclusion clause to the definition of ‘service.

2.5.7 Are ‘deemed sales’ defined in article 366(29A) of the Constitution also included in the ambit of ‘sale’?

Yes. The six categories of deemed sales as defined in article 366(29A) of the Constitution are also included in the term sale since these transactions have been deemed to be a ‘sale’ in the Constitution itself. These are –

•  transfer, otherwise than in pursuance of a contract, of property in any goods for cash, deferred payment or other valuable consideration
•  transfer of property in goods (whether as goods or in some other form) involved in the execution of a works contract
•  delivery of goods on hire-purchase or any system of payment by installments
•  transfer of the right to use any goods for any purpose (whether or not for a specified period) for cash, deferred payment or other valuable consideration
•  supply of goods by any unincorporated association or body of persons to a member thereof for cash, deferred payment or other valuable consideration
•  supply, by way of or as part of any service or in any other manner whatsoever, of goods, being food or any other article for human consumption or any drink (whether or not intoxicating), where such supply or service, is for cash, deferred payment or other valuable consideration.

2.5.8 What is the meaning of ‘transfer of the right to use any goods’?

Transfer of right to use goods is a well recognized constitutional and legal concept. Every transfer of goods on lease, license or hiring basis does not result in transfer of right to use goods. ‘Transfer of right of goods’ involves transfer of possession and effective control over such goods. Transfer of goods without transfer of possession and effective control over goods would not be a sale but a service (such transfer has also been declared as a service under section 66F of the Act)

For guidance on ‘transfer of right to use’ please see Point no 5.6 of this Guidance Note.

2.5.9 What is the scope of the phrase ‘delivery of goods on hire-purchase or any system of payment by installments’?

Section 2 of the Hire Purchase Act, 1972 defines a “hire purchase agreement’ as ‘an agreement under which goods are let out on hire and under which the hirer has the option to purchase them in accordance with the terms of the agreement and includes an agreement under which-

(i) possession of goods is delivered by the owner thereof to a person on condition that such person pays the agreed amount in periodical installments, and

(ii) the property in the goods is to pass to such person on the payment of the last of such installments, and

(iii) such person has a right to terminate the agreement at any time before the property so passes.’

As per the Sales of Goods Act by Mulla (Seventh Edition. Page 14) delivery is ‘voluntary dispossession in favour of another’ and that ‘in all cases the essence of delivery is that the deliveror, by some apt and manifest act, puts the deliveree in the same position of control over thing, either directly or through a custodian, which he held himself immediately before the act’.

The nature of such arrangements has been explained by the Supreme Court in the case of Association Of Leasing & Financial Service Companies Vs Union Of India [2010 (20) S.T.R. 417 (S.C.)]. The relevant extract in para 20 of the said judgement is reproduced below:

“20. According to Sale of Goods Act by Mulla [6th Edition] a common method of selling goods is by means of an agreement commonly known as a hire-purchase agreement which is more aptly described as a hiring agreement coupled with an option to purchase, i.e., to say that the owner lets out the chattel on hire and undertakes to sell it to the hirer on his making certain number of payments.”

Key ingredients of the deemed sale category of ‘delivery of goods on hire-purchase or any system of payment by installments’, therefore are-

•  Transfer of possession (and not just of custody)
•  The hirer has the option or obligation to purchase the goods in accordance with the terms of the agreement.

2.5.10 What is the difference between a normal hiring agreement and a hire-purchase agreement?

In a mere hiring agreement the hirer has no option to purchase the goods hired and the risks and rewards incidental to ownership of goods remain with the owner and are not transferred to the hirer. In a hire-purchase agreement the hirer has an option or an obligation to purchase goods.

2.5.11 If ‘delivery of goods on hire-purchase or any system of payment by installments’ then what is scope of the declared service entry ‘activities relating to delivery of goods on hire-purchase or any system of payment by installments’?

For answers to this query please refer to point no. 5.5 of this Guidance Paper.

2.5.12 Are ‘financial leases’, ‘operating leases’ and ‘equipment leases’ covered as ‘delivery of goods on hire purchase or any system of payment of installments’?

Such leases would be covered only if the terms and conditions of such leases have the ingredients as explained in point no. 2.5.9 above.

2.6 Transactions only in money or actionable claims do not constitute service

2.6.1 What kind of activities would come under ‘transaction only in money’?

•  Deposits in or withdrawals from a bank account.
•  Advancement or repayment of principal sum on loan to someone.
•  Conversion of Rs 1,000 currency note into one rupee coins to the extent amount is received in money form.

2.6.2 Would a business chit fund come under ‘transaction only in money’?

In business chit fund since certain commission received from members is retained by the promoters as consideration for providing services in relation to the chit fund it is not a transaction only in money. The consideration received for such services is therefore chargeable to service tax.

2.6.3 Would the making of a draft or a pay order by a bank be a transaction only in money?

No. Since the bank charges a commission for preparation of a bank draft or a pay order it is not a transaction only in money. However, for a draft or a pay order made by bank the service provided would be only to the extent of commission charged for the bank draft or pay order. The money received for the face value of such instrument would not be consideration for a service since to the extent of face value of the instrument it is only a transaction in money.

2.6.4 Would debt collection services or credit control services be considered to be transaction only in money?

No. Such services provided for consideration are taxable.

2.6.5 What are actionable claims?

As per section 3 of the Transfer of Property Act, 1893 actionable claims means a claim to any debt, other than a debt secured by mortgage of immovable property or by hypothecation or pledge of movable property or to any beneficial interest in movable property not in the possession, either actual or constructive, of the claimant, which the Civil Courts recognize as affording grounds for relief, whether such debt or beneficial interest be existent, accruing, conditional or contingent.

Illustrations of actionable claims are -

•  Unsecured debts
•  Right to participate in the draw to be held in a lottery.

2.6.6 If an unsecured debt is transferred to a third person for a consideration would this activity be treated as service?

No. Since unsecured debt is an actionable claim, a transaction only in such actionable claim is outside the ambit of service.

2.7 Provision of services by an employee to the employer is outside the ambit of services

2.7.1 Are all services provided by an employer to the employee outside the ambit of services?

No. Only services that are provided by the employee to the employer in the course of employment are outside the ambit of services. Services provided outside ambit of employment for a consideration would be a service. For example, if an employee provides his services on contract basis to an associate company of the employer, then this would be treated as provision of service. Likewise a person engaged by the employer in private capacity and beyond the demands of employment will be taxable.

2.7.2 Would services provided on contract basis by a person to another be treated as services in the course of employment?

No. Services provided on contract basis i.e. principal-to-principal basis are not services provided in the course of employment.

2.7.3 What is the status of services provided by casual workers or contract labour?

If…….	Then……
Services provided by casual worker to employer who gives wages on daily basis to the worker	These are services provided by the worker in the course of employment
Casual workers are employed by a contractor, like a building contractor or a security services agency, who deploys them for execution of a contract or for provision of security services to a client	Services provided by the workers to the contractor are services in the course of employment and hence not taxable. However, services provided by the contractor to his client by deploying such workers would not be a service provided by the workers to the client in the course of employment. The consideration received by the contractor would therefore be taxable if other conditions of taxability are present.

2.8 Exclusions from the definition of ‘service’

•  Explanation 1 clarifies that ‘service’ does not cover functions or duties performed by Members of Parliament, State Legislatures, Panchayat, Municipalities or any other local authority, any person who holds any post in pursuance of the provisions of the Constitution or any person as a Chairperson or a Member or a Director in a body established by the Central or State Governments or local authority and who is not deemed as an employee.
•  Explanation 2 creates two exceptions, by way of a deeming provision, to the general rule that only services provided by a person to another are taxable. As per these deeming provisions establishment of a person located in taxable territory and establishment of such person located in non-taxable territory are deemed to be establishments of distinct persons. Further an unincorporated association or body of persons and members thereof are also deemed as separate persons. For implications please see point no 2.3.2 of this Guidance Paper.
•  Explanation 3 explains that a branch or an agency of a person through which the person carries out business is also an establishment of such person.