The Customs, Excise & Service Tax Appellate Tribunal (CESTAT), Chennai Bench, has held that tax deducted at source (TDS) borne and paid by a service recipient from its own funds, without recovering or deducting the amount from the consideration payable to the foreign service provider, cannot be included in the taxable value of services for the purpose of service tax.
The bench of upheld a service tax demand of ₹1,47,574 on account of adoption of an incorrect service tax rate, holding that in the case of services received under the reverse charge mechanism, the applicable rate was the rate prevailing on the date of receipt of the service and not the rate applicable on the date of payment to the foreign service provider.
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The appellant/assessee was engaged in the manufacture of forgings and was also registered under the service tax law. Apart from providing services to its clients, the company received certain services from foreign service providers.
The company discharged service tax liabilities, including liabilities relating to services received from foreign service providers under Section 66A of the Finance Act, 1994.
During verification of the company’s records, the Department noticed that the assessee had received Consulting Engineer Service and Business Auxiliary Service from foreign service providers. According to the Department, the company had not paid service tax on a portion of the value shown as withheld, which represented TDS paid towards income tax.
The Department also alleged a short payment of service tax for 2007-08 amounting to ₹1,47,647 on account of adoption of an incorrect service tax rate. Four show cause notices were consequently issued covering the periods from 2007-08 to 2011-12.
The adjudicating authority, confirmed the service tax demands proposed in the show cause notices.
The demands included ₹20,25,962, ₹14,77,860, ₹35,901 and ₹97,109 for the respective periods. A penalty equivalent to the service tax demand of ₹20,25,962 was also imposed under Section 78 of the Finance Act, 1994 for 2007-08.
For the subsequent periods 2009-10, 2010-11 and 2011-12, penalties equivalent to 10% of the respective service tax demands were imposed under Section 76. An additional penalty of ₹10,000 was imposed under Section 70. The adjudicating authority also appropriated ₹15,337 paid towards the demand relating to SHE Cess along with interest of ₹5,145.
The company challenged the order before the Commissioner (Appeals). The Commissioner (Appeals) upheld the demand relating to the alleged short payment arising from the incorrect rate of service tax, while remanding the question concerning inclusion of TDS in the taxable value for factual examination. The company thereafter approached the CESTAT.
Advocate G. Natarajan, the Counsel for the assessee argued that the TDS amount had been borne entirely by the appellant and had never been deducted from the amount payable to the foreign service provider.
According to the appellant, the original adjudicating authority itself had recorded a finding that the TDS was borne by the assessee and was not deducted from the consideration payable to the foreign service provider. Despite this finding, the authority subsequently treated the TDS as part of the consideration for the purpose of determining taxable value.
The appellant contended that the Commissioner (Appeals), having noticed the inconsistency, should have resolved the issue instead of remanding it for another round of factual examination.
Reliance was placed on several Tribunal decisions, including FCI OEN Connectors Ltd., Adani Bunkering Pvt. Ltd., Garware Polyester Ltd. and Magarpatta Township Development and Construction Co. Ltd., in support of the proposition that withholding tax borne by the recipient should not form part of the taxable value where it is not recovered from the service provider.
On the rate dispute, the appellant argued that although the services were received when the service tax rate was 12%, payment to the foreign service provider was made on February 24 and February 26, 2009, after the rate had been reduced to 10%.
The appellant therefore contended that the rate prevailing on the date of payment should govern the reverse-charge liability under Section 66A of the Finance Act, 1994.
The Tribunal first examined whether the Commissioner (Appeals) was legally justified in remanding the question concerning inclusion of TDS in taxable value.
The appellant had argued that, following the amendment to Section 35A(3) of the Central Excise Act, 1944, the Commissioner (Appeals) no longer possessed the power to remand matters to the adjudicating authority.
The CESTAT, however, rejected this contention in the context of the present service tax proceedings.
The Tribunal noted that the appeal before the Commissioner (Appeals) arose under Section 85 of the Finance Act, 1994. Section 83 of the Finance Act specifies the provisions of the Central Excise Act that are made applicable to service tax, and Section 35A was not among those provisions.
The Tribunal referred to the Madras High Court’s decision in A.S. Babu Sah Designs v. Commissioner of Central Excise (Appeals), Chennai-I, wherein it was held that the amendment to Section 35A(3) did not affect an order passed under the Finance Act, 1994 and that the Commissioner (Appeals) retained the power to pass an order of remand in an appeal under Section 85.
It also referred to the Gujarat High Court’s decision in Commissioner of Service Tax v. Associated Hotels Ltd., which reached a similar conclusion based on the powers available under Section 85 of the Finance Act.
Accordingly, the CESTAT held that the Commissioner (Appeals) did possess jurisdiction to remand the matter.
Although the Tribunal accepted the power of remand, it observed that such power should not be exercised as a matter of course, particularly in revenue matters where unnecessary remand proceedings could lead to prolonged litigation.
The Tribunal referred to the Bombay High Court’s decision in Commissioner of Central Excise, Pune-I v. Syntel International Pvt. Ltd. and also relied upon the Supreme Court’s observation in Sujeet Singh v. Ram Naresh and Ors., 2025 INSC 1405, that the purpose of adjudication should be to curtail litigation rather than generate additional rounds of proceedings.
The Tribunal observed that remand is appropriate where a material fact necessary for deciding the dispute remains to be ascertained. However, where the relevant fact has already been recorded and is not in dispute, another round of adjudication serves no useful purpose.
On the substantive issue, the CESTAT noted that the original adjudicating authority had itself recorded that the withholding tax was borne by the assessee and was neither recovered from nor deducted from the consideration payable to the foreign service provider.
Despite recording this factual finding, the authority treated the TDS as part of the consideration while confirming the demand.
The Tribunal held that an adjudication cannot simultaneously accept a fact as established and then confirm a demand on the basis of the opposite factual position. Since the Commissioner (Appeals) had also noticed the inconsistency, the Tribunal held that the issue should have been resolved rather than remanded.
The CESTAT then examined the established line of Tribunal decisions concerning withholding tax.
It observed that TDS paid by a service recipient to the Central Government out of its own funds, without recovering the amount from the foreign service provider, does not constitute consideration flowing to the service provider. Consequently, such TDS does not form part of the value of taxable services under Section 67 of the Finance Act, 1994.
The Tribunal relied upon decisions including Magarpatta Township Development and Construction Co. Ltd., Garware Polyester Ltd., Hindustan Oil Exploration Co. Ltd., T.V.S. Motor Company Ltd., FCI OEN Connectors Ltd. and Adani Bunkering Pvt. Ltd..
Applying these principles, the Tribunal held that since the TDS in the present case was never part of the amount paid or payable by the assessee to the foreign service provider, it could not be included in the taxable value.
The Tribunal therefore held that no service tax was payable on the TDS component and that the remand ordered by the Commissioner (Appeals) was unnecessary and was liable to be set aside.
The Tribunal then considered the second dispute concerning the applicable service tax rate.
It was undisputed that the services had been received when the service tax rate was 12%. It was also undisputed that payment to the foreign service provider was made only on February 24 and February 26, 2009, after the rate had been reduced.
The appellant argued that under the reverse charge mechanism under Section 66A, the tax liability arose when payment was made and therefore the reduced rate should apply.
The CESTAT rejected this argument.
The Tribunal referred to Commissioner of Service Tax, Delhi v. Consulting Engineering Services (India) Pvt. Ltd. and Commissioner of Service Tax, Delhi v. Lea Associates South Asia Pvt. Ltd., where it was held that the applicable service tax rate is the rate prevailing when the service is rendered rather than the rate applicable on the date of billing or payment.
It further considered Tech Mahindra Ltd. v. Commissioner of Central Excise, Pune III, where the Tribunal had applied the same principle to reverse charge transactions and held that the date of receipt of service determines the applicable rate under Section 66A.
The appellant had relied upon the Tribunal’s decision in Adani Enterprises Ltd. v. Commissioner of Service Tax, Ahmedabad, which had taken the view that the rate prevailing at the time of realisation governed the liability in the facts of that case.
The Chennai Bench, however, declined to follow that decision.
The Tribunal observed that the Adani Enterprises decision did not consider the decisions in Consulting Engineering Services and Lea Associates, including the fact that the former had been affirmed by the Delhi High Court.
Consequently, the CESTAT held that the date of receipt of service, and not the date of payment, determines the applicable service tax rate. Since the services received by the assessee were rendered when the applicable rate was 12%, the subsequent payment in February 2009 did not entitle the appellant to the reduced rate.
The Tribunal also examined the consequential interest and penalties.
Since the demand relating to the TDS component was held unsustainable, the penalty attributable to that demand could not survive.
However, the demand arising from the incorrect service tax rate was upheld and the Tribunal held that interest associated with the sustainable demand would follow.
On the question of penalty, the Tribunal took note of the nature of the dispute and observed that it involved an issue of interpretation. It therefore held that no penalty was leviable in respect of the rate dispute.
The Tribunal set aside the remand concerning the inclusion of withholding tax in the taxable value and categorically held that no service tax was payable on the TDS component because the amount had been borne by the appellant from its own funds and did not constitute consideration paid to the foreign service provider.
However, the Tribunal sustained the service tax demand of ₹1,47,574 arising from adoption of the wrong service tax rate, along with applicable interest.
The appeal was accordingly partly allowed with consequential reliefs in law, if any.
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