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Title Constitutionality of taxing services provided and received outside India
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Article by Avneesh Arputham
Category Faculties of Law


Constitutionality of taxing services provided and received outside India


What is Section 66A?

The Finance Act, 1994 was amended by the Finance Act, 2006 with a view to replace the Explanation under Section 65(105) with the new Section 66A, which came into force on 18.4.2006. The Central Government also introduced the Taxation of Services (Provided from outside and Received in India) Rules, 2006[1] under Section 66A. This new section, along with the rules, shows the intention of the Central Government to tax services rendered by non-resident persons from outside India (i.e. outside the territorial limits of India) to a person in India.


As per these new provisions, if a taxable service is rendered by a person outside India and if the said service is received by a person in India or by a person located in India, the person in India shall be deemed to be the provider of such service, for the purposes of payment of service tax.Section 66A is based on the reverse charge method, where a legal fiction is created by which the recipient of service is made liable to pay the tax as if he alone had provided the services domestically. In such a case, the recipient of service is treated as ‘deemed service provider’.


For S.66A to be applicable, the following conditions must be met:

(a) Provider of service is based outside India – Such service is provided or to be provided by a person who has established a business or has a fixed establishment from which the service is provided or to be provided or has his permanent address or usual place of residence, in a country other than India.

(b) Recipient of service is based in India - Such service is received by a person who has his place of business, fixed establishment, permanent address or usual place of residence, in India; and thus for the purpose of determining import scenario, the location of service provider and service recipient is the key factor. Relevant terms and expressions for usual place of residence, in relation to a body corporate mean the place where it is incorporated or otherwise legally constituted.



Further under Rule 3 (iii) of the Taxation of Service (Provided from outside and Received in India) Rules, 2006 (i.e. category III services) the only requirement is that the services are received by a recipient located in India. Thus, even under the rules, it is not necessary that the services are received in India.


Thus, under S. 66A and the accompanying Rules, it is not necessary that the service must have been received in India. The service recipient in India shall be considered as the service provider, if such services are received by a recipient located in India, for use in relation to commerce or industry. The Indian recipient of such service shall be deemed to be the service provider, merely because of the fact that it is located in India. The fact that the service itself might have been rendered and received outside India is completely overlooked.


Reverse charge mechanism

Taxation of imported services is an acceptable norm in most countries. The economic rationale being that a service provider outside the country should not have an advantage over the local service provider and the tax treatment should be similar.

The most commonly used mechanism for taxing imported services is the reverse charge. The members of the EU introduced a reverse charge in the late 1970s in response to the growing level of services traded within the common market. Canada's Goods and Service Tax (GST) system incorporates the reverse charge and, more recently, Australia introduced a reverse charge as part of its GST system. There is a general acceptance among the Organisation for Economic Co-operation and Development (OECD) member countries of the appropriateness of the reverse charge mechanism to tax imported services provided in business-to-business transactions.

The reverse charge mechanism results in the taxation of services in the jurisdiction in which the services are consumed, that is, in the jurisdiction to which they are imported. The adoption of a reverse charge mechanism is, therefore, consistent with the accepted OECD framework for consumption taxes and the OECD's more recent guidelines on the appropriate place of taxation for internationally traded services. These OECD guidelines, which are endorsed by the Business and Industry Advisory Committee (BIAC), a committee of the OECD, also recommend the adoption of the reverse charge mechanism as the most viable tax collection method for cross-border business-to-business transactions.


Parliament’s legislative competence

To challenge the constitutionality of a law, the first step is to check the legislative competence behind it. However, in this case the Parliament has the legislative competence to enact the impugned provisions.


With the enactment of the Finance Act, 1994, the Central Government derived its authority from the residuary Entry 97 of the Union List for levying tax on services. The legal backup was further provided by the introduction of article 268A in the Constitution vide Constitution (Eighty-eighth Amendment) Act, 2003, which stated that taxes on services shall be charged by the Central Government and appropriated between the Union Government and the States. Simultaneously, a new Entry 92C was also introduced in the Union List for the levy of service tax.The Authority of levy of Service Tax on specified services is contained in Section 66 of the Finance Act, 1994 as amended. Time and again there have been attempts to challenge the constitutional validity of the levy of service Tax and the courts have more than once upheld the constitutional validity of such levy.


For administrative convenience, service tax is collected from the service providers under Section 68(1) of the Act. Section 68 is a machinery section, which prescribes the mechanism to collect tax. Section 68(1) provides that every person providing taxable services to any person shall pay service tax at the rate specified in Section 66 in such manner and within such period as may be prescribed. Where the Service Tax is not feasible to be collected under Section 68(1) from the person providing the service, Section 68(2) comes into play, which enunciates that notwithstanding any thing contained in Sub-section (1), in respect of any taxable service notified by the Central Government in the Official Gazette, the Service Tax thereon shall be paid by such person and in such manner as may be prescribed at the rate specified in section 66 and all the provisions of the Chapter shall apply to such person as if he is the person liable for paying the Service Tax in relation to such service.


Section 94 of the act empowers the Central Government to make rules for carrying out the provisions of this Chapter. Clause (a) of Sub-section (2) of section 94 empowers the Central Government to make rules for collection and recovery of Service Tax. Sub-clause (iv) of Clause (d) of Sub-rule (1) of Rule (2) of the Service Tax Rules, 1994 has been inserted by Notification No.12/2002-S.T., dated 01.08.2002 w.e.f. 16.08.2002. Thus, this notification notifies that the “person liable for paying Service Tax” is the person receiving taxable service in India in relation to any taxable service provided by a person who is a non-resident or is from outside India and does not have any office in India.


Therefore, the Parliament’s legislative competence in making this law can’t be questioned.


Origin versus destination based tax

It must be remembered that taxes can be categorised as origin-based i.e. if they are payable at the location where taxable activities were performed or destination-based i.e. if they are payable at the location where the product or service is sold or used. An origin-based tax is imposed on domestic production, while a destination-based tax is imposed on domestic consumption. A good example of a destination based tax is sales tax because sales are normally taxed at the location of the sale, and not at the location of production.


The Finance Ministry had issued a clarification on April 25, 2003 that Service Tax is a destination based consumption tax. In All India Federation of Tax Practitioners v Union of India[2] it was held that “Service tax is a destination based consumption tax in the sense that it is on commercial activities and is not a charge on the business but on the consumer…”


Since service tax is a destination based consumption tax, it can only be charged when the services are received in India. Logically, no service tax can be charged on those services which are received outside India, merely on the ground that the recipient on the service is located in India.  


Territorial extent of Section 66A and the Doctrine of Territorial Nexus

Further, Section 64 of the Finance Act, 1994 itself states that the provisions of Chapter V of the Act shall apply to the whole of India except to the state of Jammu & Kashmir, thereby defining the geographical boundary of the operation of the Act and leaves no doubt that the Act does not have any extra territorial operation. Later, the government extended the provisions of the Act to the Continental Shelf and Exclusive Economic Zone.[3] There is no other provision in the Act which extends the operation of the Act outside India.


In the Service Tax Instructions issues it has been clarified that “Service Tax is payable on all taxable services rendered in India, whether to an Indian or foreign client.”[4] This clarification was reiterated as answer to Question No. 3.7 in the booklet titled ‘Frequently asked Questions on Service Tax’ where it was stated that “service tax is leviable only on the taxable services supplied within India except Jammu & Kashmir.”[5]


If these provisions are permitted to levy and collect the service tax on services provided and received outside India, then it will extend the territorial jurisdiction beyond the territories of India which is against the principle of law settled by the Supreme Court. In Ishikawajma-Harima Heavy Industries Ltd. v Director of Income Tax, Bombay[6] and All India Federation of Tax Practitioners v Union of India[7] it was held that service tax would be leviable only on the services provided within the country. This was reiterated in Haridas Exports v All India Float Glass Manufacturers Association.[8]


Also, the doctrine of territorial nexus is applied to find out whether a particular law has extra territorial operation. It signifies that the object to which the law applies need not be physically located within the territorial boundaries of the State, but what is necessary is that it should have sufficient territorial connection with the State. If there is a territorial nexus between the subject matter of the act and the state making the law, then the statute isn’t regarded as having extra- territorial operation. Thus, a state may levy a tax on a person, property, object or transaction only when it has sufficient and real territorial connection with it.


There is no general formula defining what territorial connection or nexus is sufficient or necessary for the application of the law to a particular object. In Hoechst Pharmaceuticals v State of Bihar[9] it was held that “sufficiency of the territorial nexus involves consideration of two elements:

  1. the connection must be real and not illusory
  2. The liability sought to be imposed under the Act must be pertinent or relevant to that connection.”


In the light of the above, it is evident that there is no real connection between the transactions which take place outside India and the competence of the legislature to tax the parties to this transaction. Service tax is a consumption based destination tax i.e. the tax can be imposed only at the place where the service is received. If the service is received outside India, the tax should be imposed by the country where the service is received as the entire transaction has no link with India. Merely because the receiver of the service has his office in India does not mean that the transaction has any real nexus with India. Therefore, there is a clear lack of territorial nexus between such a transaction and the Parliament’s power to tax it.


Exemption to Indian company having a foreign branch

More importantly, sub-section (2) of Section 66A states that if an Indian Company has a foreign branch, and if such foreign branch is having a permanent establishment in such country, the Indian branch and the foreign branch, shall be considered as separate entities. As a result of this provision, if any service is consumed by the foreign branch of an Indian establishment, the Indian branch shall not be liable for payment of service tax, provided the foreign branch has got a permanent establishment, in such foreign country. In this context, a Circular[10] issued by the Ministry of Finance clarifies that services provided by the latter permanent establishment to the former permanent establishment shall be treated as provision of services by one person to another. The clear absence of territorial nexus in this case has been efficiently observed and intelligently provided for.


Object of taxing services

Taxation of services provided and received outside India is contrary to the object and reasons for levying Service Tax under Entry 92C of the Union List. The Parliament while amending the Constitution for the purposes of levying Service Tax in the statement of objects and reasons has clearly spelt out that the purpose of levying the Service Tax is to tax the service sector which has contributed a major portion to the country’s GDP, whereas in the present case services rendered abroad by foreign parties that is outside the territories of India by the foreign national and never received in India has been taxed through impugned provisions that is contrary to the very object of levy of Service Tax in India. 


Possibility of double taxation

There is also a possibility that under these provisions, if an Indian company hires any service, for the purpose of business or commerce, in a country other than India then service tax is payable in India notwithstanding any tax/duty that has already been paid in that country where such services are rendered/provided. Thus if service tax is levied on the services rendered outside India, it is unjustified as it will lead to double taxation and the person charged will be compelled to pay service tax in India as well as in the country where the services are availed.


Decisions on Section 66A

The constitutionality of Section 66A has been challenged in a number of cases. In M/s Orient Crafts Ltd.v. Union of India and Another[11], the Hon’ble Delhi High Court upheld the validity of Section 66A read with the rules made there under. In another similar matter in Ankit Exim Pvt. Ltd. v. Union of India[12] the Hon’ble Delhi High Court reiterated the decision laid down in the Orient Crafts case. However, it is important to note that in both these cases, the court never directly looked into the constitutionality of taxing services rendered and received abroad, merely on the ground that the service recipient is located in India.  


More importantly, in the Orient case, the learned Counsel for the petitioner argued by way of an example that if a person in India goes abroad and has a haircut, he would be liable to pay service-tax in India on the basis of Section 66A. However, the Court, negating this example, held that the rules that have been framed by the Central Government make it absolutely clear that taxable service provided from outside India and received in India is liable to service-tax. The court emphasized that in the example given by the learned Counsel for the petitioner, there is no question of the service of a haircut having been received in India. Thus the court emphasized the fact that only those services which are received in India are liable to be taxed.

This view taken by the Delhi High Court would certainly be of big assistance in not only in understanding the law but also in the implementation and enforcement thereof. The Department also seems to be holding the same view as the CBEC Circular No. B1/4/2006-TRU, dated 19-04-2006, while clarifying the Import Rules, mentions that, “only services received in India are taxable under these provisions.”


The appeal in Ankit Exim Pvt. Ltd. v. Union of India[13]is pending before the Hon’ble Supreme Court, with the main issue being the constitutional validity of S.66A. In the light of the above, it is necessary that the court should take into account the clear absence of territorial nexus and declare S.66A to be unconstitutional to the extent that it taxes services provided and received outside India merely on the ground that the service recipient is located in India. The observations made by the Hon’ble Delhi High Court in the Orient Crafts case should be kept in mind and the possibility of a person/corporation being charged service tax on the ground that he is located in India should be removed.


[1]Vide Notification No. 11/2006-Service Tax, dated 19.4.2006

[2]2007 (7) STR 625 (SC)

[3]Vide Notification No. 1/2002, dated 1.3.2002

[4]Para 7.3 of Circular F. No. B-11/3/98-TRU, dated 7.10.1998

[5]‘Frequently asked Questions on Service Tax’, October 2003

[6]AIR 2007 SC 929 : (2007) 3 SCC 481

[7]2007 (7) STR 625 (SC)

[8]2002 (145) ELT 241 (SC)

[9](1983) 4 SCC 45

[10]Circular F. No. B1/4/2006 – TRU dated 19.04.06

[11](2006) 206 CTR(Del) 262

[12]SLP (Civil) No. 21190/2009

[13]SLP (Civil) No. 21190/2009


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