The Customs, Excise and Service Tax Appellate Tribunal (CESTAT), Chennai, has held that the commercial mark-up earned by a freight forwarder on ocean and air freight cannot be subjected to service tax as “support service of business or commerce” when the underlying transportation activity itself remained outside the service tax net.
The Bench of Ajayan T.V. (Judicial Member) and Vasa Seshagiri Rao (Technical Member), set aside the service tax demand, interest and equivalent penalty imposed on assessee and Company Limited for the period from April 2010 to March 2015.
The Tribunal observed that valuation provisions cannot independently create a tax liability or convert a non-taxable transaction into a taxable service merely because the person recovering the freight does not qualify as a “pure agent”.
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“Where the principal activity is non-taxable by legislative design, the profit or margin earned in the course of that very activity cannot be severed and taxed as if it were consideration for a distinct service,” the Bench stated.
The appellant/assessee is a Government of India enterprise engaged in logistics and Custom House Agent activities, providing services including customs house agency, business support, business auxiliary, renting of immovable property and transportation of goods by road under the reverse-charge mechanism.
The company’s invoices included ocean or air freight as well as charges relating to documentation, less-than-container load cargo, terminal handling, delivery orders and other associated activities. Service tax was paid on the ancillary charges but not on the ocean and air freight component.
According to the department, the assessee paid freight directly to shipping companies and other agencies and recovered a higher amount from its customers by adding a commercial mark-up. It treated this activity as distribution, management and logistics falling within “support service of business or commerce”.
A show-cause notice dated October 7, 2015, was consequently issued for the period from 2010-11 to March 2015. The department alleged that the company could not be regarded as a pure agent under Rule 5(2) of the Service Tax (Determination of Value) Rules, 2006.
The authorities also invoked the extended limitation period, alleging that the company had failed to disclose the actual nature of the service and the income earned from the freight transactions in its service tax returns.
The adjudicating authority, through an order dated March 1, 2017, confirmed the service tax demand along with applicable interest. An equivalent penalty was also imposed under Section 78(1) of the Finance Act, 1994.
The Tribunal examined the dispute separately under the two service tax regimes applicable during the period in question.
Up to June 30, 2012, service tax was governed by the positive-list system under Section 65(105) of the Finance Act. From July 1, 2012, the negative-list regime under Sections 66B and 66D became applicable.
CESTAT found that neither regime brought the transportation of goods by vessel or aircraft from a place outside India to a customs station in India within the service tax net during the disputed period.
Prior to July 1, 2012, no entry in Section 65(105) taxed such international transportation. From July 1, 2012, the activity was expressly covered by the negative list under Section 66D(p)(ii). This exclusion continued until it was omitted with effect from June 1, 2016.
The freight paid by assessee to shipping lines and airlines, and subsequently recovered from its customers, therefore represented consideration for an activity that the legislature had deliberately kept outside the service tax net, the Tribunal held.
The adjudicating authority had proceeded on the ground that the freight was recovered with a mark-up and that the company did not satisfy the pure-agent conditions under Rule 5(2) of the Valuation Rules. On that basis, the margin was treated as consideration for a separate business support service.
Rejecting this approach, CESTAT said it reversed the correct order in which the legal issues should have been examined.
The Bench explained that Rule 5 of the Valuation Rules, read with Section 67 of the Finance Act, deals with the value of a service that is otherwise taxable. The provisions do not independently create a service tax liability.
Accordingly, Rule 5 cannot transform a non-taxable activity into a taxable service merely because the person recovering the amount does not qualify as a pure agent.
The classification and taxability of an activity must be determined on the basis of its actual substance and the applicable charging provisions, rather than the method of billing or the existence of a commercial margin, the Tribunal said.
On examining the transactions, CESTAT found that assessee engaged shipping lines and airlines for transporting cargo and recovered the transportation cost, together with a commercial margin, from customers on a principal-to-principal basis.
The department’s show-cause notice itself acknowledged that service tax had already been paid on documentation, terminal handling, delivery order and other ancillary charges. Only the freight component and the mark-up included in it were sought to be reclassified as an independent business support service.
The Tribunal concluded that this reclassification was impermissible because the mark-up formed part of the same freight transaction that was outside the service tax net.
CESTAT also referred to a 2016 Central Board of Excise and Customs circular explaining the distinction between a simple booking agent and a freight forwarder who negotiates separate freight terms with the carrier and the importer or exporter.
The circular clarified that where a freight forwarder undertakes transportation responsibility and deals with the parties on a principal-to-principal basis, the resulting transaction would not attract service tax in the manner applicable to an intermediary or booking agent.
The Bench found that assessee’s contractual arrangements were consistent with a principal-to-principal transaction.
CESTAT noted that the controversy was no longer unsettled and had been decided in the assessee’s favour in assessees own earlier case before the New Delhi Bench of the Tribunal.
The same view had also been consistently adopted in cases involving Gudwin Logistics, Agility Logistics, APL Logistics, Greenwich Meridian Logistics, Interfreight Services, PVGT Freight Forwarders and Logistics, LA Freight, Seamax Logistics, K. Steamship Agencies and United Shippers.
These decisions held that the mark-up earned by a customs house agent or freight forwarder on ocean or air freight, where the transactions were undertaken on a principal-to-principal basis, did not constitute consideration for business support service.
The department’s representative also acknowledged that the issue stood settled in favour of the company and placed two additional decisions—Fairmacs Shipping and Transport Services and Team Global Logistics—before the Bench.
CESTAT consequently held that the service tax demand on the freight and mark-up for the entire period from April 2010 to March 2015 was legally unsustainable.
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