MRO activity in SEZ: a taxable service!
Export promotion and increased foreign investment are words that have become almost synonymous with the concept of Special Economic Zones (“SEZ”). The government has provided numerous tax benefits to the developers and the entrepreneurs who have set up units in SEZs. It is often assumed that by virtue of setting up in a SEZ, the unit becomes entitled to all the tax exemptions so long as it conducts its activity i.e., production of goods or rendering of services, within the SEZ itself. In a recent case MAS – GMR Aerospace Engineering Company Limited Vs. The Commissioner of Central Excise & Customs, in the context of the applicability of service tax on a SEZ unit providing MRO – maintenance, repair and overhaul services within the SEZ itself, the Authority for Advance Rulings (Central Excise, Customs and Service Tax) (“AAR”) clarified the position.1 This bulletin examines the contentions raised by the parties, the decision of the AAR and the principle behind it.
1. Brief facts
In this case, MAS-GMR Aerospace Engineering Company Limited (“the Applicant”) proposed to set up a unit in the aviation SEZ at Hyderabad to provide MRO facilities to domestic as well as foreign aviation entities. The Applicant wanted to enter into a contract with an overseas entity located in Singapore who in turn would procure contracts for MRO services from domestic and foreign airlines. Essentially, the overseas entity would sub-contract to the Applicant the contract for MRO services, which were to be carried out in the SEZ itself. As part of the long terms plans, the Applicant also proposed to directly contract with domestic and foreign airlines who would pay the Applicant in convertible foreign exchange.
The activities were to be carried on in entirety within the SEZ itself. Based upon the opinion that MRO activities, for instance, repair is carried out on the aircraft itself and therefore would be completed within the SEZ, the Applicant applied to the Commissioner of Central Excise and Customs (“Commissioner”) seeking response to a series of questions, namely;
- Whether service tax applies to services rendered by the Applicant to an overseas entity for a contract with domestic airlines who operate domestic flights to India, with domestic airlines who operate international flights to India, with foreign entities who operate international flights?
- Whether service tax applies to services rendered directly to domestic airlines who operate domestic flights to India, domestic airlines who operate international flights to India, foreign entities who operate international flights?
- Whether or not, in light of section 51 and 53 of the SEZ Act, 2005 (“SEZ Act”), service tax was chargeable on services rendered within the SEZ?
- Whether MRO services proposed to be carried on by the Applicant will be chargeable to service tax on an interpretation of section 66A of the Finance Act, 1994 (“the Finance Act”) read with Rule 3 (ii) of the Import of Service Rules?2
- Whether MRO services rendered to domestic airlines who operate domestic flights to India, domestic airlines who operate international flights to India, foreign entities who operate international flights will qualify as export of services under the Export of Service Rules, 2005?
2. Contentions of the Applicant
2.1 The Applicant placed substantial reliance on the provisions contained in sections 53
(1) and section 51 of the SEZ Act. Section 51 provides that the provisions of the SEZ Act shall have an overriding effect on any provision inconsistent with its contents. Further, section 53 (1) creates a deeming fiction whereby a SEZ is deemed to be a territory outside the customs territory of India for the purpose of carrying on its authorized operations. The Applicant read the two sections and interpreted them to imply that SEZ was a “territory outside India” and all laws including the Finance Act3 would not apply to SEZ for the purposes of the authorized operations. Based upon this interpretation the Applicant contended that;
- All laws including Chapter V of the Finance Act would not apply to activities in relation to the authorized operations carried on in the SEZ. Since the proposed MRO activities were part of the Applicant’s authorized operations, service tax would not apply on them.
- The deeming fiction created by section 53 (1) of the SEZ Act must be interpreted to benefit the SEZ and, therefore, service tax would not apply to services carried out by the Applicant within the SEZ. The contention was that since all MRO services were being provided within the SEZ itself, there was no territorial nexus with the DTA4 where the Finance Act was applicable. In the absence of any territorial nexus, the activity of the Applicant was not eligible to service tax.
- In light of the deeming fiction created by section 53 (1) of the SEZ Act and in the absence of a specific provision in the SEZ Act permitting levy of service tax on services rendered in the SEZ, the Finance Act would not apply to a SEZ.
2. 2 The Applicant drew comparisons between the express provisions contained in the SEZ Act with respect to (a) levy of income tax with modifications to a unit or developer for carrying on the authorized operations, and (b) levy of customs duty on cleared goods from
the DTA to the SEZ, with the absence of any express provision governing service tax. The contention was that in the absence of an express provision in the SEZ Act or the Finance Act regarding levy of service tax in the SEZ, service tax will not apply.
2.3 It was also contended that while the MRO activities did fall within “taxable services” under the Finance Act,5 since there was no territorial nexus and since the MRO services were being provided wholly outside India they did not classify as “import of service” under the Import of Service Rules. As a consequence no service tax is leviable on MRO services proposed to be rendered by the Applicant to foreign and domestic airlines within the territory of the SEZ.
The Applicant further contended that under the Export of Service Rules, 2005 (“Export of Service Rules”), services wholly or partly performed outside India for which payment is received in convertible foreign exchange qualify as export of services. Therefore, since MRO services were to be performed within the territory of the SEZ i.e., outside India and payment was to be received in convertible foreign exchange, MRO activities would classify as export of services in terms of Rule 4 of the Export of Service Rules, 2005 and therefore be exempt from payment of service tax.
3. Contentions of the Commissioner
3.1 The Commissioner contested each of the contentions raised by the Applicant. It was submitted that majority of the contentions raised by the Applicant stemmed from his interpretation of section 53 (1) and 51 of the SEZ Act, whereby he had come to the conclusion that the SEZ was outside the territory of India and provisions of the SEZ Act would have an overriding effect on provisions inconsistent with it. The Commissioner negated this interpretation on several grounds. He relied upon judgments delivered by the High Courts of Gujarat and Karnataka wherein the judges had provided decisions supporting his contention that a SEZ forms a part of India and cannot be considered as an area outside India.6
He further re-emphasized the language and contents of section 53 (1) of the SEZ Act pointing out that the section clearly provides that a SEZ will be deemed to be a territory outside the “customs territory” of India for the purpose of undertaking the authorized operations. He submitted that the word “customs territory”7 in international parlance means “the territory within which customs law applies in full.” As a consequence, in section 53 (1) the deeming fiction is that the authorized operations undertaken in SEZ shall be beyond the customs laws of the country and not that a SEZ lies physically outside India.
3.2 After establishing the fact that SEZ cannot be considered a territory outside India, the Commissioner dealt with the other contentions of the Applicant that were flowing primarily from this presumption. With respect to the contention that the Finance Act did not apply to a SEZ, the Commissioner submitted that since the SEZ was a part of India, it
could not be said that the Finance Act would not apply to it. The Finance Act was applicable to the whole of India including a SEZ. The MRO activities fell within the definition of “taxable services” under the Finance Act and were to be provided within the SEZ not for the authorized operations but to various Indian and foreign customers. Hence, it was concluded that the MRO services were to be treated as services provided within the territory of India and, therefore, subject to service tax.
On the question of whether MRO activities constituted an “export of services” under the Export of Service Rules, the Commissioner submitted that since the SEZ was a part of India, the services were being provided in India. To qualify as a “export of services” they would need to be provided wholly or partially outside India, that not being the case, they did not constitute an “export of services”.
The question of the applicability of section 51 making the Finance Act inapplicable to a SEZ was also settled by the Commissioner. He submitted that the overriding powers of section 51 came into play only in case of an inconsistency with a provision of the SEZ Act and any other law for the time being in force. In light of the fact that the Finance Act applies to the whole of India including the SEZs, services provided to and from an entity in a SEZ were considered as provided in India and section 53 (1) does not make the Finance Act inapplicable, there was no inconsistency to invoke section 51.
4. Decision of the AAR
Thus it was concluded that since the MRO activities provided in the SEZ are provided within India, the Finance Act would be applicable to such services subjecting them to service tax. Only exception could be an express exemption under the SEZ Act or the Finance, which currently does not exist in this respect. Further, the MRO activities proposed by the Applicant cannot be considered an “export of taxable services.” They were subject to service tax even when read with the Import of Service Rules and finally, service tax was chargeable on the services rendered within the SEZ in all the specific circumstances mentioned by the Applicant in his initial questions.
There has been a common belief amongst companies with units within the SEZ or those looking at setting up in SEZ that, the “SEZ” itself is a tax free territory and any activity undertaken within it would be exempt from taxes including service tax. This ruling has clarified the position not only as far as provision of MRO activities is concerned but also provides insight into how other similar services will be considered by the Commissioner. This ruling has expressly laid out that a SEZ is not a “territory outside of India.” As long as a service provider undertakes activities i.e., provide services to others and which do not form a part of their authorized operations, whether or not these are rendered within the SEZ itself, they will be subject to service tax.
1 Decided by the AAR on May 13, 2011, citation awaited
2 Taxation of Service (Provided from outside India and received in India) Rules, 2006
3 Dealing with all provisions relating to service tax
4 Domestic Tariff Area has been defined in the SEZ Act as the entire territory of India barring the SEZ.
5 Section 65 (105) (zzg)of the Finance Act
6 Essar Steels V. UOI and Shyamraju and Co (India) Pvt Ltd V. UOI
7 Defined as territory in which the customs law of a contracting party applies.