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Service Tax Issues in Relation to Legal Consultancy Service

Rajiv K. Luthra comments on the service tax issues related to the legal industry, which were recently announced by the Union Finance Ministry during the Union Budget for 2011-12.
New rules announced by the Finance Ministry
1. Payment of Service Tax On Accrual Basis
  • Per the recently proposed Point of Taxation Rules, 2011 (‘Rules’), service tax would be payable on accrual basis i.e. in case the invoice is raised or payment is received before the provision of service, the service tax would need to be deposited upon the date of invoice or receipt of payment whichever is earlier.

  • However, it is pertinent to mention that taxable event is provision of service and in case no service is provided subsequently, the service tax would still need to be paid.

  • In the service sector, payments are often received well after the service has been provided. Often either the payment is not received at all or the same is not received in full. In such cases, the Rules do not contemplate an alternate refund mechanism for the service tax so paid in excess.

  • The proposed change to accrual based liability to service could seriously and adversely affect the growth of the service sector.
2. Service tax on retainers of a law firm
  • The proposed amendment in the definition of ‘legal consultancy service’ vide the Finance Bill, 2011 seeks to extend liability of service tax also on individual lawyers providing representational services to business entities is not clear and confusion in respect of leviability of service tax on lawyers retained by law firms remains.

  • It is common practice for professionals to be engaged by law firm on retainership basis.

  • It is pertinent to mention that the full time retainers in a law firm do not represent the clients in their own name but in the name of the firm. The services provided to clients are billed for by the firm and not by individual retainers directly.

  • Also, the law firm would pay service tax on the fees received from the client in relation to representational services provided by the firm.

  • In our opinion the retainers should not separately get covered in the service tax net. There is no additional revenue that may be expected by Revenue by including such retainers in the tax net. There is, however, no clarity, in the law on this aspect.
3. Service tax on arbitral tribunal
  • The proposed amendment in the ‘legal consultancy service’ has also brought any service provided by an arbitral tribunal in relation to arbitration under the service tax net.

  • Arbitration in India is relatively a new area and still needs impetus by the Government to be able to grow and become attractive for foreign parties to choose India as a seat for arbitration.

  • Levying service tax on the services provided by arbitral tribunal may be negatively perceived by the companies/ individuals and may give an impression that the government is not serious about making Indian an attractive destination for arbitral proceedings.
Possible Solutions to the Issues in Relation to Legal Consultancy Service

1. Payment of Service Tax On Accrual Basis
  • The prevailing system of liability of service tax on receipt of payment has been working well, and should be continued. Revenue’s interest is protected also because credit to the service receiver, in any case, is allowed only after he makes the payment for the service received by him.
2. Service tax on retainers of a law firm
  • A clarification may be issued to the effect that professionals retained by law firms would not be required to pay service tax where the clients are billed, and the service tax is discharged by the law firm.
3. Service tax on arbitral tribunal
  • An exemption may be provided to arbitral tribunals providing any service in relation to arbitration.
RAJIV K. LUTHRA is the Founder & Managing Partner of Luthra & Luthra Law Offices.
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