2025 (12) TMI 762 - AT - Service Tax

Service tax demand on lease income under renting of immovable property set aside; accounting entries under Ind AS 17 insufficient

CESTAT Kolkata set aside the service tax demand raised on the appellant on lease income reflected in its balance sheet pursuant to Ind AS 17 compliance. ... Levy of service tax - lease income entry made in the balance sheet for mere compliance of Ind AS 17 - sustainability of the demand as per the Indian Accounting Standard - HELD THAT:- The said issue has been considered by this Tribunal in the case of M/s. J.B.Mangharam Foods Pvt. Ltd. [2025 (6) TMI 122 - CESTAT NEW DELHI] wherein this Tribunal observed that 'the revenue cannot rely on the entries made in the balance sheet to raise a demand of service tax by attributing the amount received as 'conversion charges' (interest and depreciation) to be towards rental income without proving that the parties had entered into renting of immovable property. The activity under the contract is essentially towards the activity of manufacturing, packaging, etc.' Thus, the demand against the appellant is not sustainable merely on the ground that as per the accounting system they had entered lease income although they have paid Excise duty and VAT on the entire consideration received by them for their sale of goods. The impugned order is set aside - appeal allowed. 1. ISSUES PRESENTED AND CONSIDERED (1) Whether the amount shown as 'lease rent income' in the appellant's books of account, arising solely from application of Ind AS-17 to a contract manufacturing arrangement, constituted taxable consideration for a 'declared service' of renting / lease under the Finance Act, 1994. (2) Whether, on the facts, the underlying activity between the appellant and its principal was in the nature of manufacture covered by the negative list / exemption for processes amounting to manufacture, thereby excluding the transaction from service tax. (3) Whether entries in financial statements and the method of accounting, by themselves and without evidence of a leasing or renting arrangement, could be made the sole basis for levy and demand of service tax. 2. ISSUE-WISE DETAILED ANALYSIS Issue (1): Taxability of 'lease rent income' under declared service / renting Interpretation and reasoning (a) The demand was raised solely on the basis that a portion of the consideration received under the contract manufacturing agreement had been accounted for as 'lease rent income' pursuant to Ind AS-17, and was therefore treated by the Department as consideration for a declared service under section 66E(f). (b) The Tribunal relied on its earlier decision in an identically structured contract manufacturing arrangement for the same principal, where it was held that: * For levy of service tax, there must be an 'activity for a consideration' within a contractual relationship, and the payment must be attributable to a specific taxable service. * Components such as 'interest' and 'depreciation', carved out of conversion charges and disclosed as 'rental income' for accounting-standard compliance, did not constitute consideration for renting or leasing, as there was no service of renting / leasing being provided. (c) It was emphasised that the appellant was not providing any service of renting of immovable property or lease of plant and machinery to the principal; the arrangement was for manufacture and sale of goods, carried out in the appellant's own factory using its own assets, over which the appellant retained exclusive and effective control. (d) The Tribunal adopted the reasoning that mere description of certain components as 'rental income' in the Profit and Loss Account or balance sheet, in compliance with Ind AS-17, cannot convert the manufacturing arrangement into a leasing / renting transaction for purposes of service tax. Conclusions (e) The amount shown as 'lease rent income' in the appellant's books did not represent consideration for any declared service of renting or lease under the Finance Act, 1994, and was not exigible to service tax on that basis. Issue (2): Nature of activity - manufacture covered by negative list / exemption Legal framework (as discussed) (a) The Tribunal, referring to the earlier decision it followed, noted section 66D(f) of the Finance Act, 1994, which includes in the negative list 'services by way of carrying out any process amounting to manufacture or production of goods...'. (b) It also noted the continued exemption, via the relevant exemption notification, for 'services of any process amounting to manufacture or production of goods'. Interpretation and reasoning (c) The agreement between the appellant and the principal was examined in the earlier followed decision and held to be 'solely and exclusively for the purpose of manufacturing of goods' (including related activities such as packaging) by the contract manufacturer for the brand owner. (d) The Tribunal applied that reasoning to the present appeal, noting that the appellant similarly manufactured goods in its own factory, paid central excise duty and VAT on the entire consideration for the sale of goods, and there was no separate service element of leasing / renting property or assets. Conclusions (e) The dominant and real nature of the arrangement was manufacture of goods, an activity covered by the negative list / exemption, and not a taxable service of renting or leasing; therefore, no service tax could be demanded on the consideration received under such manufacturing arrangement. Issue (3): Effect of accounting treatment and balance sheet entries on taxability Interpretation and reasoning (a) The impugned orders proceeded on the footing that once the appellant itself had shown 'lease income' in its accounts following Ind AS-17, it could not dispute taxability on that footing. (b) The Tribunal, following its prior detailed analysis, reiterated that: * Accounting standards (AS-19 / Ind AS-17) are designed to ensure accurate and comparable financial reporting; they may require treating certain arrangements 'in substance' as leases for accounting purposes even where there is no lease in the legal sense. * Such accounting treatment and presentation in the balance sheet or profit and loss account are 'book entries' and cannot, by themselves, create or define a taxable service under the Finance Act, 1994. * Balance sheet entries cannot be treated as 'consideration' or 'gross amount charged' for a taxable service under section 67 without independent evidence of a corresponding taxable transaction or service actually rendered. (c) The Tribunal accepted and adopted the view that figures and classifications in financial statements (including those mandated by Ind AS-17) are not determinative of the nature of the transaction for service tax purposes, and cannot be the sole basis for raising a demand. (d) It was specifically noted that the appellant had paid central excise duty and VAT on the entire consideration for the sale of manufactured goods, and that the 'lease income' arose only from the internal accounting reclassification required by Ind AS-17. Conclusions (e) The Department could not rely merely on the 'lease income' entry in the financial statements to re-characterise a manufacturing arrangement as a leasing / renting service and to raise service tax demand; method of accounting and book entries do not determine taxability in the absence of proof of an underlying taxable service. (f) As the demand was founded exclusively on such accounting entries, without establishing a taxable renting / leasing service, the demand of service tax, interest and the consequential penalty was held to be unsustainable, and the impugned order was set aside with consequential relief.