Service Tax – Some interesting situations

Lawyers at VakilSearch tell you more

As a continuation of the last part, where we promised to explain the reverse charge mechanism, here we will be discussing the concept in detail.

Reverse charge refers to the slightly strange legal rule where you pay service tax not for providing the service, but for receiving the service.

Confused?

Let us take an example where you obtain a service from a foreign company, say design services for your website. You pay the Company in U.S. Dollars.

Now, a foreign company would not be liable to pay Service Tax in India. It would in fact not be liable to pay any tax in India under most circumstances.

No tax then, right?

Wrong. In comes the reverse charge mechanism, wherein companies which received or ‘imported’ services, so to speak, would be treated as if they had provided the service.

This will apply to your Company as well if you have either your place of business, permanent residence, usual place of residence or fixed establishment here in India as per the provisions of

Section 66A (2) of the Finance Act, 1994.

So what do I have to do?

Very simply, you will need to file service tax returns and pay service tax on this transaction. You are entitled to deduct this from the total amount paid to the company for providing the service. To help you out, we have added a short illustration below.

No Income tax to be paid, I suppose?

Unfortunately, you may also have to deduct a certain percentage as Income Tax and pay it to the Income Tax department. The rate of tax and whether you have to pay tax will have to be determined by looking at the tax avoidance agreements that we have in place with many countries.

For instance, as per the India China Tax Avoidance Agreement, you will still have to pay Income Tax on the transaction and deduct it from the amount paid to the foreign company.

How do I calculate my tax liability?

Let us assume that you have to pay 100 dollars to the foreign company. You may have to pay both Service Tax and income tax. The formula for the calculation is as follows:

Fees + Service Tax + Income Tax = 100 dollars

So first calculate the amount such that after adding Service Tax to that amount, you get a total of 100 dollars. At around 10.3%, that should be close to 90 dollars.

Then from this amount, deduct income tax at the appropriate rate. This should give you the net amount that you have to pay to the foreign Company.

Please note:

1. First, have a discussion with the foreign company before you sign the contract and have the total tax amount calculated.
2. Once the tax amount is calculated, have a clear understanding as to the total amount payable, after tax.
3. Not doing this can create a lot of complications later on.
4. Some agreements use the word ‘net of tax’ which means that the entire tax liability has to be borne by you. Therefore, make sure that you draft all your agreements carefully as well.

YourStory.in readers can now use the code YST10 to get a 10% discount on legal advice and other services on vakilsearch.com

About VakilSearch

VakilSearch is India’s leading online legal services provider for businesses and individuals. As the official partner of the Confederation of Indian Industry (CII) and knowledge contributor to Sulekha.com, the Hindu Business Line, Entrepreneur Magazine and the All India Rubber Association, VakilSearch reaches out to thousands of businesses, entrepreneurs and individuals on a regular basis. So when you visit vakilsearch.com, you can be assured of quality legal guidance and comprehensive documentation for your business and personal needs, at affordable prices.