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Economy

A High Service Tax Means Do Not Make In India, Buy From Abroad

Service Tax was hiked to 14% in this budget. The FinMin folks seem to think this is just a gradual move towards the GST rates of 20% or so, since manufacturing is charged over 24% right now (12% VAT, 12% excise).

This is ludicrous. Telling us to pay 20% on every service to the government is clinically insane. Whether we get a GST or not, we should have much lower taxes, not higher ones, and definitely not so much for services.

The Saving Grace for Physical Products: CVD

Tell us this. Why you buy something from an Indian company rather than from a foreign import? Because the Indian product is either better, or it’s cheaper, or it’s more easily available. The cost of just transporting certain things, like cement, makes it unviable for foreign producers to sell into India, as the price differential is not so much.

And then, we have excise duty. If excise is at 12%, then the cost to make something locally is higher by 12%. But if you import the same thing, the customs folks charge you a countervailing duty  (CVD) of 12%. Which means you have a level field with a foreign player. Therefore the transportation costs could hurt him more, and thus you buy from a local brand instead.

In some cases, our local manufacturers have no scale at all (like in laptops) so you prefer to import – the differential is so much that even with any duty extras, this import is cheaper.

Services, Specifically Technical Services Don’t Get This Advantage

Let’s say you have a person who does graphic design. He will charge you 14% service tax on top of his bill. This applies to all services, from accountants to software services to what not.

Now, if you got the same graphic design from a person in Russia, you will not pay the 14%. There is no “countervailing service tax” that applies on such payments. Which means the service provider located abroad gets the 14% advantage. They get to provide a service from abroad, and all else being equal, they have a 14% advantage over you.

Technically there is a “withholding tax” – where you have to pay a part of the money to the Indian tax authorities (typically 25%, reduced in 10% for technical services in this budget). But most of us startups pay using credit cards; we just pay the bills on individual cards, and the company reimburses the money. And withholding taxes are different for different countries especially with those we have a free trade agreement with.

For a service tax of 10% it really didn’t make sense to outsource our work abroad – you could pay that extra 10% locally, and for smaller amounts (like logo design or such) the extra cost was miniscule.

But at 20% it will be ridiculously expensive to buy services made in India. It’s much cheaper to get work done abroad, and to pay using things like Bitcoins or even through a credit card.

This will prompt the use of a “tax-avoidance” business model. Imagine a new startup in Singapore, which can pay into your Indian account through, say, Bitcoins. You provide services to your customers in India, but through this Singapore entity; your customers, even a company in your city, pay that Singapore entity and it pays you, for a small fee of say 5%. Since 5% is so much cheaper than 20% local service tax, it’s just easier to do the Singapore route, even for customers located in India.

Note: As a startup model, this will be very short lived, but can be lucrative. (It violates the GAAR principles, but GAAR applies only after 2017) Singapore has a free trade agreement that disallows withholding tax for technical or advisory services, so a round trip is easy to do and legal today, IMHO.

The Only Option: Keep Service Tax Low

With an increasingly free world, the concept of charging high taxes for services should be avoided. At 10% you’re pretty much at the limit, in my opinion. A high tax just forces people to look at alternatives that can be provided through the internet, from abroad. What’s the point, then, of asking us to Make in India? We would rather buy from abroad, or Make for Abroad, since service taxes don’t apply in either scenario.

From accounting services, to software design and development, to consultancy to more, there will be a “service tax arbitrage” by going abroad, that we should absolutely avoid. In general, asking service companies to pay their income taxes property is better than an over-the-top heavy tax on services.

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  • amit mundhra says:

    Service tax is payable by the service receiveer in case of import of services. Though this is the law but it can be seldomly applied in case of individual persons. So saying that there will be service arbitrate will be incorrect.

  • Durgesh says:

    I think Government is targeting those services where there is no option to get it from abroad due to a local component. Like banking, mobile, cable TV, Air Travel, hospitality. It’ll be interesting to see the data that how much service tax is coming from what type of services and what portion has a potential to be outsourced – like graphic design.

  • Chintamoney says:

    there is a small enabling provision to charge Service tax on Reimbursement amount in this budget which will close this loophole

  • kumar says:

    you might also want to think of service of the said item. while some makers sell separate global-service plans, others refuse to service items bought abroad, even if there is a warranty.

  • we are missing currency differences but still your conclusion is very right.

  • Sam says:

    Technically no! If you buy services from abroad, you have to pay Service Tax under a mechanism known as “reverse charge”. Ask a competent CA about it. So your contention that buying services from abroad attracts less tax is not true. Of course you may evade it, but then that is against the law.

    • This is a good point. Just found out about it, thanks! I guess it should apply when a company buys a service from abroad? That means all the startups buying amazon services should be paying service tax as reverse charge?

  • anon says:

    I did not follow.
    I thought currently service tax is 12.36 now something like 14% an it will be made 16%/
    Where does this 20% number come up.

  • anon says:

    20% is looks very high.
    However equation is not so bad when you look at from company perspective.
    Say total services that I have bought is 100 so I pay 120. Also total services that I sell is 200 so I charge 240.
    Ain’t I suppose to get service tax credit of 20 that I have paid so total I pay is only 40 and not 60.
    so actually for me cost of service is only 100 and not 120 as I will get service tax credit of 20 Rs.
    for a salaried individual , it will be very expensive as there is nothing like service tax credit.
    Am I missing something ?

    • That is really the problem. Companies can offset but someone’s paying the full 20% in the end and not getting credit.
      Consumers are screwed, and honestly this is way too high a tax. At 10% one can understand. 12% is a tad high. 20% is insane.

  • Vineet says:

    On TV no one is saying openly that Service Tax will be 20% with GST, when this hits there will be a political storm, unless this gets offsetted somewhere people will not vote for this govt again.

  • The rate of tax should be low and procedure to levy and collect must be simple. coverage should be high to collect more.
    These complex laws are not understood and applied properly by even the officials.Finally the ruling party governments become unpopular.