Service tax controversy around an Indian “intermediary”

In India the export status of sales promotion services has historically been an area prone to dispute with the Indian Revenue seeking to tax such services provided by an Indian service provider to an overseas principal/ customer, based on the location of performance of such services in India. TaxbyManish discusses how, with the proposed treatment of ‘intermediary for goods’ in the Budget, this controversy may come to the fore yet again.

The export status of sales promotion services controversy appeared to settle in favour of the taxpayer with a series of court rulings upholding export status of such services having regard to the location of the service recipient abroad. Further, introduction of the “Place of Provision of Service Rules 2012” (PPS Rules) considerably strengthened the case for non-taxation of sales promotion services provided by a commission agent to an overseas principal/ customer in connection with facilitating supply of goods into India.

Effective from 1 July 2012, under the PPS Rules the “place of provision” of “intermediary” services (basically services of a broker, commission agent etc) is to be determined as under:

• The location of the service recipient in case of an intermediary for goods (including a host of financial instruments)
• The location of the service provider in case of an intermediary for services

Under the recently announced Union Budget proposal, effective 1 October  2014, an ‘intermediary for goods’ is proposed to be treated on par with an ‘intermediary for services’.  With this alignment the controversy surrounding export status for a range of marketing and sales promotion services provided in/ from India (currently raging in the context of intermediaries facilitating supply of services) appears set to re-emerge in the context of intermediaries facilitating supply of goods.   

Under the proposed definition, an ‘Intermediary’ means "a broker, an agent or any other person, by whatever name called, who arranges or facilitates a provision of a service (hereinafter called the ‘main’ service) or a supply of goods between 2 or more persons but does not include a person who provides the main service or supplies the goods on his account."

The following key interpretative issues have arisen around the scope of an ‘intermediary’:

• Whether intermediation is confined to transactions/ efforts that result in actual supply of goods or services against payment of a commission calculated, based on the quantum or value of goods/ services whose supply was facilitated (ie classic commission agency model)
• Whether mere marketing and sales promotion activities that may indirectly translate into an actual supply of goods or services against a ‘cost-plus’ model of reimbursements of efforts employed (irrespective of whether the efforts resulted in an actual supply of goods/ services by the principal supplier), shall also constitute intermediation

An affirmative answer to bullet point 2 above, shall result in service tax of 12.36% becoming a cost on marketing support fees charged by Indian subsidiaries operating under a 'cost plus' model. This could potentially be an issue even for call centres based in India and providing marketing and sales support in relation to goods supplied by an overseas principal/ affiliate. Another sector likely to be impacted by the proposed amendment is financial intermediaries (to recap, the Indian service tax law considers a host of financial instruments/ securities to be “goods”).

Based on a literal interpretation of the provision it could be argued that an intermediary should mediate the actual provision (or arrangement/ facilitation) of a main service / supply of goods and not merely market the same vis-a-vis a 'prospective customer'. 

However, a liberal interpretation of the expressions “arranges” and “facilitates” could cover within its remit a host of marketing and sales promotion activities that are provided in relation to the arrangement and/ or facilitation of a main service/ supply of goods as there does not appear to be any requirement under law for ensuring conclusion of a contract for the actual provision of a main service/ supply of goods. While services in the nature of brand building without any direct customer interface should not qualify as intermediation, this issue is far from resolved. 

Further taking into consideration the fact that the intention of the Indian Revenue has in the past been to tax marketing and sales promotion services, it is possibly with this intention that the category of “intermediary” has been introduced (and now extended to goods), whereby tax is required to be paid based on the location of the intermediary.  

An added complication to the issue is where the Indian subsidiary also undertakes a host of post-sale activities such as installation of goods supplied, customer training, maintenance support etc. Bundling of pure marketing services such as brand building (which may not qualify as intermediation) with elements of other services that are taxable based on the location of their performance, could potentially render the entire service fee liable to service tax in India. Therefore it is important to map the range of pre and post-sale services offered with a view to identify elements of the service that could attract service tax based on the location of their performance. Unbundling these elements from other non-taxable service elements to the extent they constitute independent service offerings, could usher in tax efficiencies on the overall service offering.