Pranab’s CENVAT Googly

Businesses are generally happy with the recent budget as the tax rates (excise and service tax) have not been increased. However, on going through the fine print, it seems that the Finance Minister has pulled a few fast ones, much like Pakistani all rounder Shahid Afridi, when the batsmen — or in this case, businessmen — least expected it!

Take, for instance, the changes in Central Value Added Tax, or CENVAT Credit Rules, 2004, which allow manufacturers and service providers to claim credit on various central taxes paid on goods and services –— or inputs purchased during their business operations. This credit can be utilised to offset the output excise duty or service tax liability of the manufacturer or service provider.

Internationally, under the Goods and Services Tax, or GST, regime, companies are allowed to claim credit on taxes paid on all legitimate business expenses. In India, the credit regime has often been characterised as restrictive, ad hoc and ambiguous. In this year’s budget proposals, significant changes have been made in the credit rules for greater clarity. However, it seems the government has made these rules even more restrictive.

Consider this: credit for service tax paid on ‘input services’ will now be confined to services which have a more direct relation to the business activity of the taxpayer, with a few exceptions. Earlier, companies were entitled to claim credit for ‘any activities relating to business’, be it lease rentals, telecommunication charges or any other corporate expenses. This expression was often interpreted liberally by the courts and even by the tax authorities in some cases, but it is now proposed to be omitted.

Credit is also proposed to be denied on‘inputs’ and ‘input services’ meant for personal use of or consumption by employees. In every business, especially that of the service companies — such as BPOs, financial service providers, consulting firms and so forth — a significant portion of expenses are employee related such as cab charges, cafeteria expenses and health insurance. This amendment may lead to denial of credit with respect to such expenses.

There’s more. Trading (sale or purchase of commodities) will now be considered an‘exempt service’, apparently with retrospective effect. Many businesses were of the view that service tax paid on common expenses was fully allowed as credit. Now, they will have to write off the service tax, to the extent related to trading activities.

Another major blow for taxpayers is the withdrawal of a specific provision that allowed companies to take full credit on around 17 specified services — such as consulting services, repair services, intellectual property services — even if they were used partly for exempt activities. This means that proportionate credit will now need to be reversed even for these services.

For businesses, all the expenses in the Profit & Loss Account will have to be reviewed to segregate those on which service tax paid will be allowed as a credit. This may also require changes in IT systems, accounting and other processes. Since these rules are coming into effect from April 1, companies do not have much time in hand.

How hard Corporate India will be hit is not clear because overhead costs vary from industry to industry but it would not be inaccurate to estimate that the impact could be between two and four per cent of overhead costs. Businesses will hope that this is a temporary phase and once the GST regime comes into effect, the government will align India’s tax scheme with the best international practices.

Pratik Jain is Executive Director and Supriya Oberoi Jain is Director at KPMG. With inputs from Abhinav Srivastava, Manager, KPMG