SERVICE TAX TO BE IMPOSED ON BOOK ADJUSTMENTS

[Dr. Sanjiv Agarwal]

Finance Act, 2008 has amended section  67 w.e.f. 10.5.2008 so as  to include any amount debited or credited in the books of account within the scope of the term, 'gross amount charged' where transaction of taxable service is with associated enterprises including transactions in suspense account.

Transactions between associated enterprises

Transactions between associated enterprises would attract service tax even when there are only entries in the books of accounts and no money is actually exchanged. With the amendment made by Finance Act, 2008,  associated enterprises will have to pay service tax on the basis of accruals instead of actual cash inflow / outflow, though there is no system of tax on accrual basis in service tax. For transactions between associated enterprises, any amounts debited or credited to books of accounts would be the basis for levy of service tax as such book entries will be included in the 'gross amount charged'. Thus, for such enterprises, book adjustments will also become basis for levy of service tax which was earlier based on actual receipts.

No service tax would be payable for such book adjustments in the following cases-

transactions are not between associated enterprises.

·  transactions does take place between associated enterprises but they do not relate to any taxable service.

·  associated enterprise does not render taxable services exceeding Rs. 10 lakh in aggregate, i.e., falling under small service provider exemption scheme.

·  Service is otherwise exempt under any rules, notifications etc.

·  Transactions between associated enterprises not involving services but relating to sale or other commercial transactions.

Book Adjustments

It is necessary to  know what is meant by books and adjustment to understand this provision.

In business, the books most frequently referred to are the books of account in which business transactions are recorded. Books of account are normally considered to be legal documents. Books of account contain various accounts (say, debtors and creditors). Such accounts mean an account or register of debt or credit in a book. A "book account" means a book containing a statement in detail of the transactions between parties, including prices, made contemporaneously with the transaction, and entered in a book.

Adjustment in finance and accounts means to correct figures or make allowances for charges, credits etc. It involves alteration in debit or credit balances by way of allowances or charges posted in an account by means of debit or credit notes. It is a process of adjusting financially the sums due or owed. Such adjustments are done by way of adjusting entries by way of journal entries without directly affecting the cash flows. Such adjustments are absolutely legal and an universally accepted accounting practice.

According to Dictionary of Accounting Terms, adjustment means -

increase or decrease to an account resulting from an adjusting journal entry. For example, the accrual of wages at year-end will cause an increase in both salary expense and salary payable.

changing an account balance because of some happening or event. For example, a customer who returns merchandise ill receive a credit adjustment to the account.

Suspense Account

According to Black's Law Dictionary, 8th edition 2004, 'suspense account' means  temporary record used in book keeping to track receipts and disbursements or an uncertain  nature until they are identified and posted in the appropriate ledgers and journals. A suspense account does not appear in a final financial statement. It is a useful tool when, for example, a lump-sum receipt or expenditure must be broken down to match several transactions before posting.

Suspense accounts are accounts of transactions which being impossible to enter in the normal books of accounts in a regular way for one reason or the other  are thus required to be held in suspense for the time being. Suspense account is a temporary account that records part of a transaction before complete analysis of that transaction, or that records sums to correct errors.

In banking, it is an expression where a person whose money is held in suspense is entitled to withdraw it any moment he likes, though he neither gets a pass book nor is entitled to draw any cheques or to be paid interest in respect of the amount. Commissioner of Income Tax v. K.R.M.T.T. Thiagaraja Chetty & Co., AIR 1952 Mad 305, 322.

In common parlance, it  means an account in which the amount is held in deposit in favour of the person who remitted it and may be refunded in future, if the same is not appropriated or utilised for the purpose for which it was remitted. (LIC v. Prassana  Devaraj, 1994 (2) KLT 541 at 545)  

The expression 'suspense account' in the common parlance, means an account in which the amount is held in deposit in favour of the person who remitted it and may be refunded in future, if the same is not appropriated or utilised for the purpose for which it was remitted. LIC of India v. Prasanna  Devraj, (1995) 82 Comp cases 611, 616 (Ker).

Suspense account is a temporary account in which entries of credits or charges are made until then proper disposition can be determined. Entries in suspense accounts are generally transitional. It is an account used temporarily to any doubtful receipts and disbursements or discrepancies pending their analysis and permanent classification.

Departmental Clarification  on Book Adjustments

CBEC has clarified as follows in respect of levy of service tax on  transactions between associated enterprises vide Circular No. 334/1/2008-TRU dated 29.2.2008

"6.1 Service tax is levied at the rate of 12% of the value of taxable services (section 66). Section 67 pertaining to valuation of taxable service for charging service tax states that value shall be the gross amount charged for the service provided or to be provided and includes book adjustment. As per rule 6 of the Service Tax Rules, 1994, service tax is required to be paid only after receipt of the payment.

6.2 It has been brought to the notice that the provision requiring payment of service tax after receipt of payment are used for tax avoidance especially when the transaction is between associated enterprises. There have been instances wherein service tax has not been paid on the ground of non-receipt of payment even though the transaction has been recognized as revenue/expenditure in the statement of profit and loss account for the purpose of determining corporate tax liability.

6.3 As an anti-avoidance measure, it is proposed to clarify that service tax is leviable on taxable services provided by the person liable to pay service tax even if the amount is not actually received, but the amount is credited or debited in the  books of account of the service provider. In other words, service tax is required to be paid after receipt of payment or crediting/debiting of the amount in the books of  accounts, whichever is earlier. However, this provision is restricted to transaction between associated enterprises. This provision shall also apply to service tax payable under reverse charge method (Section 66A) as taxable services received from associated enterprises. For this purpose section 67 and rule 6(1) are being amended.

6.4 The term 'associated enterprise' has the same meaning as assigned to it in section 92A of the Income Tax Act, 1961. It is a relative concept i.e. an enterprise is an associated enterprise when it is viewed in relation to other enterprises. This concept is used in the Income Tax Act for applying transfer pricing provisions. An enterprise which participates, directly or indirectly, or through one or more intermediaries, in the management or control or capital of the other enterprise is considered as associated enterprise. It also covers an enterprise in respect of which one or more persons who participate, directly or indirectly, or through one or more intermediaries, in the management or control or capital of the other enterprise.

6.5 Section 92A(2) of the Income Tax Act specifies various situations under which two enterprises shall be deemed to be associated enterprises. Enterprise means a person who is engaged in the provision of any services of any kind. For details, relevant provisions of Income Tax Act may be referred to."

Charge of Service Tax

Section 66 of Finance Act, 1994 is the charging section and section 68 is the collection section for the purpose of service tax. While service is levied on the basis of section 66, based upon rendering    of taxable service as stated in section 65(105) of the Finance Act, 1994, service tax is payable on the basis of service tax collected by the provider of taxable service from the recipient of service. It is the receipt of gross amount which is taxed irrespective of whether it is received before, during or after rendering of taxable service. Service tax is also payable on advance payments against which service has yet to be rendered or performed. The payment of gross amount could be in cash or by way of cheque, draft, credit card, transfer, debit or credit notes or any book adjustment. Service tax is payable for the month or quarter ,as the case may be by fifth day of the month following the end of month or quarter.

However, in respect of associated enterprise, payment of service tax shall be based on book adjustments as per amendment made by Finance Act, 2008 (to be enacted). Transactions between associated enterprises would attract service tax even when there are only entries in the books of accounts and no money is actually exchanged. With the amendment made by Finance Act, 2008, associated enterprises will have to pay service tax on the basis of accruals instead of actual cash inflow/outflow, though there is no system of tax on accrual basis in service tax. For transactions between associated enterprises, any amounts debited or credited to books of accounts would be the basis for levy of service tax as such book entries will be included in the 'gross amount charged'. Thus, for such enterprises, book adjustments will also become basis for levy of service tax which was earlier based or actual receipts.