Software exporters not to be denied credit for service tax on inputs in SEZs

NEW DELHI: The IT industry stands to gain hundreds of crores as the finance ministry has decided not to deny software exporters credit for service tax on inputs because they had operations both inside and outside special economic zones.

So far, the tax department has held that it could not determine if the input service was used in SEZ or not and denied them credit.

The Central Board Excise and Customs had issued a circular clarifying the issue on March 1.

The department has prescribed a new mechanism for claiming exemption on taxable services consumed in authorised operations within SEZs.

Service wholly consumed in a SEZ will be totally exempt from tax. Experts say the clarification is consistent with the SEZ laws.

"In an ideal situation, service supplies to SEZ should be treated as export and the principles determining exports should apply in this case," said Bipin Sapra, partner, Ernst & Young.

The SEZ Act exempts from tax services that are used in producing services or goods that are exported. Service tax is levied at the rate of 10% on over 100 services.

Services 'not wholly consumed' within the SEZ will be segregated into two categories i.e. services 'shared' between the SEZ and the regular operations, or technically domestic tariff area units, and services 'exclusively used' by the SEZ.

In these cases, there will not be any exemption but the units will be allowed to claim refund. If it is exclusively used for SEZ operation then full refund will be available.

On some services, the units located outside SEZs are not eligible for refunds. In these cases, SEZ unit will only be allowed refund on a proportionate basis depending on turnover.

The service tax refund rules were first notified in 2009 but have gone through many changes.

After providing for a blanket exemption to input services, the finance ministry switched to a refund mechanism for tax paid on services consumed in SEZs.

But subsequently it buckled under pressure from commerce department and spared units in SEZs from paying tax on services consumed inside the zones.

However, IT units located outside SEZs still had to claim tax refunds on services exported from the units located outside the zone.

Since most big software exporters have SEZ and non-SEZ operations, it created problem of identifying where an input service such as a software purchased by the company was being used.