The Service Tax Saga: How It Affects E-commerce

20 Mar, 2012

Everyone waited with anticipation as the budget was announced, in particular the large and the rapidly growing community of e-commerce entrepreneurs in the country.

E-commerce growth in India is more and more in the services space (although sale of rail and air tickets still constitutes the bulk of e-commerce business in our country). And the Finance Minister introduced two changes of note, which we will now discuss from theoretical and practical perspectives.

Rise In Service Tax: Will It Affect Competitiveness?

We need to start with the bad news. As per the budget of this year, the Finance Act of 1994 (by which the Service Tax Law in India was introduced) will see a change in the rate of service tax. Instead of the 10 per cent (plus cess), which all of us have become accustomed to paying, the rate of service tax will increase to 12 per cent on every transaction.

While this may not really affect the entrepreneur much (the service tax is passed on to the client anyway), it will affect the competitiveness of Indian service providers vis-à-vis their counterparts elsewhere in the world.

Additionally, e-commerce entrepreneurs typically compete with their counterparts in the brick-and-mortar world and in some cases, may have to pay tax where their brick-and-mortar counterparts would not have to pay this tax. For example, if you are selling a TV set online, which has to be shipped to the customer's address, your offering consists of two components "the sale of the television and the service of shipping the television set to the customer's address. A Croma or Reliance Digital may not incur the service tax, but you have to pay it.

Is there a way to avoid this? Yes, one good way is to give the delivery (or the service component) away for free. That way, you cannot be charged for it. But that is feasible only if you are operating on reasonable margins, which is not the case with most e-commerce entrepreneurs.

But you can take relief from the fact that the minimum income threshold above which you need to pay service tax has stayed the same, at Rs 10 lakh. Any start-up or e-commerce business earning less than this need not pay Service Tax.

Moving From Positive To Negative List Of Services

Earlier, the service tax regime in India consisted of a positive list of services, which meant services in the list would be liable to pay service tax. For instance, if legal services were included in the list, all those providing legal services would be liable to pay the service tax.

Now, with the latest change, we are moving over to a negative list. A negative list basically means all the items in the list are not subject to the payment of tax. In other words, taking the example above, if legal services were mentioned in the list, legal service providers would not be liable to pay service tax.

A negative list is widely preferred because all the items which are not on the list are immediately liable to pay service tax. With a negative list, it becomes much easier to determine whether or not the service you provide is a taxable service.

For your e-commerce business, you need to determine whether the tax liability will fall on your shoulders. For this, you will need to check the negative list and see if the service you provide has been excluded from the list. You may also need someone to look at the list and advise you on whether you are liable to pay tax or not.

The Bottom Line

In conclusion, the budget seems to be a mixed bag from a service tax perspective. While it is definitely a good thing that in place of a positive list of services, a negative list has been introduced, it is sad that the rate of service tax has been increased. With the service tax becoming a major cash cow for the government, one hopes that this does not set a trend for further increase in the rate in the years to come.

(Hrishikesh Datar is Founder and CEO of vakilsearch.com)