"I realise that some of my criticisms may be mistaken; but to refuse to criticize judgements for fear of being mistaken is to abandon criticism altogether... If any of my criticisms are found to be correct, the cause is served; and if any are found to be incorrect the very process of finding out my mistakes must lead to the discovery of the right reasons, or better reasons than I have been able to give, and the cause is served just as well."

-Mr. HM Seervai, Preface to the 1st ed., Constitutional Law of India.

Friday, March 4, 2011

Arbitration is a Service and Parties- Bleed More! Bear Service Tax!

In the budget speech a few days back, our Finance Minister (FM) proposed:
"I propose to expand the scope of legal services to include services provided by business entities to individuals as well as representational and arbitration services by individuals to business entities."
On the face of it I thought that the FM was trying to fill gaps and was proposing to levy service tax on lawyers representing parties in arbitration. How wrong can one be! (how right can one be on that on a different count- see amendment to Section 105(zzzzm)(ii) in the Finance Bill, 2011) The FM was not targeting lawyers. He was rather targeting arbitrators and consequently, the parties! If the Finance Bill becomes the law, the relevant portion of the Finance Act would read:
"105. "taxable service means any service provided or to be provided-
(iii) to any business entity, by an arbitral tribunal, in respect of arbitration."
Thus, as per Section 105(zzzzm)(iii), if any person acts as an arbitrator, he would be liable for service tax. This blawgger has the following comments:
  1. Service tax is an indirect tax. Essentially, parties would have to bear the burden of service tax though the arbitral tribunal is liable to pay tax to the authorities.
  2. The above quoted provision uses the expression "to any business entity". Thus, each party to the arbitration will have to bear service tax. Hypothetically, if the rate of service tax is 10% of the fee charged, then each party to the arbitration has to reimburse service tax to the arbitrator(s).
  3. This blawgger has all the sympathies for the ongoing arbitrations. They have to bear service tax for no fault of theirs. If they had known that the learned FM would call the "service" performed by the arbitral tribunal a taxable service, they would probably have never arbitrated at all.
  4. Already companies keep complaining that arbitration is a very costly process. Why would the FM make it more costly? I cannot fathom the reason for the amendment.
  5. Tax is a negative incentive. By charging service tax and thereby making arbitration more costly, is the learned FM trying to:
    • Encourage litigation once (if at all) the Commercial Divisions Bill is passed and each High Court gets a Commercial Division?
    • Encourage single arbitrator tribunal (with three arbitral tribunals becoming more costly)? In the alternative, the term used is "arbitral tribunal", thus referring to the tribunal as a whole rather than each of the arbitrators forming a part of the arbitral tribunal
    • Encouraging parties to involve in passive ADR mechanisms such as mediation, negotiation etc?
Wonder what was going on in the Finance Ministry when some one mooted this proposal. The Law Minister in each and every conference keeps saying that India should become a very important arbitration destination. But the motive of the FM seems to be the contrary. If the intention of the FM was to tax parties for arbitrating, this blawgger feels it is a very bad move. It is also bad for the parties who are currently arbitrating. Already arbitration in India is considered to be a very costly process. This blawgger invites the FM to read the decision of Dolphin Drilling Limited v. ONGCL and the news reports on the arbitration between Chandigarh Housing Board (CHB) and Parsvanath Builders. Posts on the Dolphin case and the CHB-Parsvanath arbitration can be accessed from here and here. Parties bleed while the arbitrators and the government make merry!

Updates: The provision quoted above states that a service provided by an arbitral tribunal to a business entity is a taxable service. Wouldn't it mean that a service provided by an arbitral tribunal to an individual is not a taxable service? For example, two brothers go for arbitration to resolve a family dispute. The service provided by the arbitral tribunal to decide the said family dispute would not be a taxable service. Similarly consumer arbitrations should ideally not be covered as regards the consumer at least (though it might make better sense for the consumer to go to the tribunals established under the Consumer Protection Act). So is the case with labour/ employment arbitrations as regards  labour/ the employee.


Bedavyasa said...

Pardon my ignorance sir, but does the bill imply to impose a service tax only on arbitral award to business entities and nothing else? (litigators etc.)

Badrinath Srinivasan said...

Bedavyasa, many thanks for the comments. Two points to be noted: (1) The imposition of tax is not on the award but in respect of amount received for services provided. This means that any payment made such as reading fees, hearing fees etc by the parties to the tribunal would be taxable. The service need not result in an award.
(2) As an indirect tax, it is expected that the service receiver (i.e., the litigating business entities) would have to bear the burden of the tax ultimately.
Considering that arbitration has been regarded in India as a costly way to resolve disputes, service tax adds to the burden.