To Service, or Not?

It’s a volcano that will not stay dormant for long. And when it does cut
loose, it will spew lava that will incinerate part of the one industry that’s
changed the way the world perceives India. Take a gander at this: the new rules
on service tax are in force. They have created concerns about whether service
tax would be applicable to India’s growing BPO industry, in particular
companies that don’t do either software or call center work, but others like
document processing and back-end work.

Changes in service tax regime
The new rules have created a category called ‘business auxiliary services’.
These services relate to promotion and customer relations activity, and accounts
and billing services. Soon after this sank in, there was apprehension that this
would impose a service tax obligation on the IT industry. The definition of
business auxiliary services makes it clear that IT services (SW development and
maintenance) wouldn’t be covered.

In the explanation to the Finance Act, the government clarified that the
category wasn’t intended to apply to SW and BPO companies. However, BPO and
call center companies were apprehensive because the actual wording of business
auxiliary services appeared to include services typically performed by them. In
June 2003, the government issued a notification exempting call centers and
medical transcription companies from service tax.

Exemption for forex-earners
What went unnoticed was a 1999 notification exempting companies earning in
foreign exchange from service tax. Since most Indian BPO companies service
overseas customers and earn in forex, it was this that actually exempted them
from payment of service tax. But for this, BPO firms could have been liable for
service tax under other categories as well, such as support activity for banking
and finance, marketing, credit rating and database retrieval, among others. The
debate on the meaning of the term ‘business auxiliary services’ overlooked
the significance of this issue–the fact that regardless of what was included
in the term, a BPO company may still need to pay service tax under other
categories, since the earlier exemption available to forex earners was

Current position
The government has now exempted call centers and MT from service tax in
general, not just from inclusion within the meaning of business auxiliary
services. The effect is that even if these activities fall within the scope of
other categories, they would be exempt from service tax. That leaves the
remaining BPO companies doing back-office work, other than call center activity.
This activity has huge potential. After all, pretty much any kind of service
activity that can be performed remotely is an activity that can be outsourced to
India. The banking and finance sector may be affected.

The government has also clarified that the mere use of IT in the performance
of services wouldn’t necessarily bring such activity within the ambit of
exemption to IT companies. There appears to be a contradiction here as the
definition of IT services includes, on the one hand, development and maintenance
of software or operation of a computer system, and on the other, computerized
data processing. The latter would typically cover services performed through the
use of IT, referred to as ITeS. Under this, there appears to be some confusion
over whether BPO activity would be exempt from sales tax.

One could argue that BPO involves input of information. Would review of a
loan application and input of relevant information into the customer’s systems
be treated as computerized data processing services, even though it has a
document review aspect or doesn’t relate to SW development or maintenance or
operation of a computer system?

Finally, call center activity is that involving the use of a telephone. Many
call centers are integrated facilities providing support through different means
of communication–telephone, chat and e-mail. It would appear that only
voice-based support would be covered by the exemption and not other services.
Given this scenario, there’s clearly need for the government to address this
issue further and come up with a solution that implements what appears to be its
original intention–to exempt all BPO and IT companies from service tax.

Stephen Mathias
The author co-chairs the Technology Law Practice of Kochhar & Co, a
leading law firm.

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