Under the present service tax laws, normally, it is the supplier of the services, who has to collect the service tax from its clients/customers and deposit the same with the government. However, there are certain services, where it is the duty of the service recipient to pay the service tax, with respect to the services availed by him.
This mechanism, where the recipient pays the service tax, is called as ‘reverse charge mechanism’ (RCM). The same concept, with wider application, has been borrowed from the service tax laws in the Goods and Services Tax (GST) regime.
Reverse charge mechanism under the service tax regulations
Under the service tax regime, the developer is required to pay taxes on certain services that are availed by him. For example, this includes the services of goods transport agencies, where the developer has to pay the service tax with respect to transportation charges paid. Likewise, the developer is required to pay service tax for the services availed from individuals or a firm of advocates, for legal services. Moreover, the developer has to pay service tax with respect to manpower services availed for security services. In case the developer outsources some of his work to any other person, the developer also has to pay partly, the service tax for such works contracts.
Under the service tax regime, there are two categories on which, the reverse charge mechanism will apply. On certain services, the developer has to pay 100 per cent of the service tax, whereas, on other services, he only has to pay a certain percentage of it and the balance is paid by the provider of services. It may be noted that the service tax under the RCM, has to be paid by way of cash or bank payment and the liability cannot be discharged by way of debit to the Cenvat (input tax credit) available to the developer. However the service tax paid under the RCM can be availed as input tax credit by the developer.
How will the reverse charge mechanism work under the GST regime?
The services that are covered under the GST are notified by the GST Council. These services are on the same lines, as were earlier covered under the service tax regime.
So, the developer has to pay GST on services availed, like those provided by a person who is located in a non-taxable area, services provided by goods transporters, legal services provided by an individual or firm, etc. The developer also has to pay GST under the reverse charge mechanism, on the services provided by government or local authorities, like municipalities, etc. Nevertheless, some of the services provided by the government, like renting of premises, specific services provided by the postal authorities, transport of goods by railways or by state transport undertakings, etc., are outside the scope of the GST, similar to the service tax regime.
A significant departure under the GST laws, compared to the erstwhile service tax provisions, is that under the reverse charge mechanism in GST, a person who is registered under the GST has to pay GST on all the services and goods that are procured from a person who is not registered under GST.
This has significantly expanded the scope of the reverse charge mechanism for all taxable persons and it will adversely affect the developers. Under the service tax law, the recipient had to pay the service tax only on specified services. The reverse charge mechanism did not cover services that were availed from a person who was not registered under the service tax rules, due to his total value of services provided not exceeding the basic threshold limit of Rs 10 lakhs. This threshold limit has been raised to Rs 20 lakhs under the GST.
So, earlier, when a builder availed of the services of any professional, like architects or structural engineers, who were not registered under the service tax laws, there was no service tax liability on either of these two parties. However, under the GST laws, the builder will have to pay GST on the services availed from any such persons who are not registered under GST. This will increase the cost incurred by builders, to that extent.
Moreover, the tax payable under the reverse charge mechanism under the GST, cannot be adjusted by the developer against the input credit available from the GST paid on the inputs but has to be paid by cash/bank payment.
So, under the GST, the builders are worse off, due to the dual effect of the levy of GST on the services availed from unregistered person, as well as the requirement to discharge the reverse tax on goods received from unregistered suppliers. The GST council has announced a relief with respect to inter-state supplies of goods and services, where the reverse charge mechanism will not apply, in case the value of the supply of goods, does not exceed Rs 5,000 in a day.
Hence, it is amply clear that the new avatar of reverse charge mechanism under the GST is quite large, as compared to the previous avatar. This will certainly increase the costs for the developer, especially the small developers who were availing goods and services from unregistered suppliers earlier and were not bearing the cost of taxes to that extent.
(The author is a taxation and home finance expert, with 30 years’ experience)