The Allahabad Bench of the Customs, Excise and Service Tax Appellate Tribunal (CESTAT) has held that, for the period prior to July 1, 2012, service tax could not be demanded merely on the basis of payments made to foreign entities without identifying the particular taxable service under which the transactions were liable to tax.

The Bench of P.A. Augustian (Judicial Member) and Sanjiv Srivastava (Technical Member) observed that the show cause notice as well as the adjudication order failed to establish the taxable category applicable to the services received during the period preceding the introduction of the negative list regime.

The Tribunal consequently set aside the demand for the period prior to July 1, 2012, while upholding the demand falling within the normal limitation period under the post-July 2012 regime. It also set aside the penalties imposed under Sections 77 and 78 of the Finance Act, 1994.

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Fibcom India Limited was engaged in the manufacture of optic fibre-based transmission systems and their parts. It was also registered for providing and receiving several taxable services, including maintenance or repair, manpower supply, erection and commissioning, transportation, information technology software and legal consultancy services.

The company had entered into an agreement with Tellabs A/S, Denmark, for technical know-how relating to the manufacture and sale of licensed products.

Fibcom subsequently established an office in Denmark for carrying out research and development activities, training its Indian R&D personnel and providing design support for product development. The facility was also used for technological implementation and development activities concerning the company’s products.

During an audit of the company’s records, the department noticed payments made in foreign currency under different heads, including:

• Service charges;
• Repair, maintenance and tooling;
• Professional fees;
• Insurance;
• Bank charges and commission; and
• Miscellaneous charges.

The department alleged that Fibcom had received taxable services from outside India and was therefore required to discharge service tax under the reverse charge mechanism.

A show cause notice dated October 22, 2014 proposed recovery of approximately ₹2.24 crore as service tax, including education cess and secondary and higher education cess. It also proposed interest and penalties under Sections 77 and 78 of the Finance Act.

A second show cause notice dated March 18, 2016 proposed a further demand of ₹99,461 for a subsequent period.

The Commissioner dropped the demands relating to intellectual property right services but confirmed a service tax demand of ₹55,24,252 on services allegedly received by Fibcom from foreign entities for its Denmark R&D facility during the period from April 1, 2009 to March 31, 2013.

Interest under Section 75 was also confirmed.

The Commissioner further imposed a penalty of ₹10,000 under Section 77 for allegedly failing to file true and correct service tax returns. Penalties of ₹38,58,611 and ₹8,32,821 were imposed under Section 78 for different parts of the disputed period.

Aggrieved by the adjudication order, Fibcom approached the CESTAT.

Fibcom argued that the show cause notice was vague because it did not examine the actual nature of the foreign currency expenditure or explain how each transaction satisfied the statutory ingredients of the taxable service under which it was classified.

It also contended that the adjudicating authority had travelled beyond the scope of the show cause notice.

According to the company, the expenses were primarily reimbursements relating to the Denmark R&D facility and could not be included in the taxable value. It relied on the Supreme Court’s ruling in Union of India v. Intercontinental Consultants and Technocrats Private Limited.

Fibcom further submitted that the services had been incorrectly classified and that the entire exercise was revenue-neutral because any service tax paid under reverse charge would have been available as CENVAT credit.

It argued that the extended limitation period could not be invoked in the absence of fraud, suppression of facts or an intention to evade tax. The company also opposed the levy of interest and penalties.

The Revenue, on the other hand, supported the findings recorded in the adjudication order.

The Tribunal first rejected Fibcom’s general contention that the entire show cause notice was vague.

It noted that demands relating to other annexures had already been dropped by the Commissioner. The surviving demand related to Annexure C, which identified the nature of the services received and the foreign currency expenditure incurred through the Denmark office.

The Bench observed that Fibcom had filed detailed submissions before the adjudicating authority covering the individual transactions, invoices, financial years and payments. It had also provided explanations regarding each category of expenditure.

The Tribunal held that a person who had furnished detailed transaction-wise submissions could not subsequently claim that it had been unable to understand the case made out in the notice.

Accordingly, the plea that the demand under Annexure C was entirely vitiated by vagueness was rejected.

CESTAT also declined to accept Fibcom’s argument that the disputed amounts represented reimbursable expenditure falling outside the taxable value.

The Bench explained that reimbursable expenses ordinarily refer to expenses incurred by a service provider over and above the value of the service, depending on the terms of the agreement between the provider and recipient.

In the present case, however, Fibcom had received services against payment of the disputed charges. The amounts were paid to foreign service providers either directly or through the Denmark branch.

The Tribunal therefore held that the payments could not be treated as reimbursements merely because they related to expenses incurred for operating the R&D facility.

Consequently, the company could not claim the benefit of the Supreme Court’s ruling in Intercontinental Consultants and Technocrats on this ground.

The Tribunal, however, found a material defect in the demand relating to the period before July 1, 2012.

It noted that the adjudication order itself recognised that the demand covered two distinct statutory regimes—one preceding July 1, 2012 and the other following that date.

Under the earlier regime, the Finance Act, 1994 did not contain the broad definition of “service” introduced with effect from July 1, 2012. Service tax could be levied only when an activity fell within one of the specifically defined taxable service categories.

The department was therefore required to identify the particular taxable service, establish that the activity satisfied the ingredients of that category and explain the basis on which the transaction was taxable.

The Tribunal observed that neither the show cause notice nor the adjudication order properly undertook this exercise for the pre-July 2012 period.

It ruled that a payment made to a foreign entity could not automatically be treated as consideration for a taxable service without first establishing the taxable classification applicable to the transaction.

“Without establishing the category in which the services were required to be taxed during this period, the demand confirmed by treating the amount paid as consideration to any foreign recipient against the invoices issued by him cannot directly mean that the same was to be subjected to service tax,” the Bench observed.

The demand for the period prior to July 1, 2012 was consequently held to be unsustainable.

The Tribunal distinguished the legal position applicable after July 1, 2012.

With the introduction of the negative list regime, the scope of service taxation was substantially widened. Subject to statutory exclusions and exemptions, an activity undertaken by one person for another against consideration became taxable under Section 65B(44), read with the charging provisions of the Finance Act.

CESTAT therefore found no fault with the approach adopted by the Commissioner for the period following July 1, 2012.

The demand falling within the normal period of limitation was accordingly upheld.

Fibcom had alternatively requested that the payments made to foreign entities be treated as inclusive of service tax under Section 67(2) of the Finance Act.

The Tribunal rejected this contention.

It observed that Section 67(2) applies where the gross amount charged by the service provider is inclusive of the service tax payable. The provision ordinarily operates where tax is recovered from the service provider under the forward charge mechanism.

In Fibcom’s case, however, the demand was raised on the Indian service recipient under the reverse charge mechanism in respect of services received from outside India.

The Tribunal therefore held that the statutory cum-tax benefit could not be extended to the payments made to the foreign service providers.

On limitation, the Tribunal accepted Fibcom’s submission that the transactions were revenue-neutral.

Had the company discharged service tax under the reverse charge mechanism, the corresponding amount would have been available to it as CENVAT credit. The Bench held that this revenue-neutral position supported the company’s case that there was no mala fide intention to evade payment of tax.

In the absence of a deliberate attempt to evade tax, the department could not invoke the extended limitation period.

The Tribunal accordingly confined the surviving demand to the normal period of limitation.

The Tribunal noted that Fibcom had admitted part of the service tax liability in its reply to the show cause notice and had made payments before adjudication or issuance of the notice.

The payments related to expenses such as repair and maintenance, professional fees, insurance, bank charges and commission.

CESTAT clarified that the relief granted on classification and limitation would not result in a refund or reversal of amounts already deposited against admitted liability.

Accordingly, the amount of ₹6,58,184 already deposited by the company was confirmed, together with interest, if any, legally payable.

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