FOB vs. CIF

Import of goods on FOB basis vs CIF basis: Service tax on ocean freight

In the positive regime of taxation of services w.e.f. 01.07.2012, ocean freight and air freight payable on import of goods into India was kept out of the service tax net by placing them in the negative list. The relevant entry in the negative list has been reproduced below (Section 66D of the Finance Act, 1994):

“(p) services by way of transportation of goods –

(iii) by an aircraft or a vessel from a place outside India to the customs station of clearance in India”

In the last year’s budget (presented in February, 2016), the above entry was deleted w.e.f. 01.06.2016 and the following exemption was added to the mega exemption notification no. 12/2012-ST dated 20.06.2012, vide Notification No. 09/2016-ST w.e.f. 01.06.2016:

“(53)    services by way of transportation of goods by an aircraft from a place outside India upto the customs station of clearance in India.”

Therefore, from 01.07.2016 onwards, air freight was completely exempt, however ocean freight was subjected to payment of service tax. In respect of service tax payable on ocean freight, the Government prescribed an abatement of 70% vide carrying out amendments in Notification No. 26/2012-ST dated 10.06.2012.

The position which thus emerges in respect of levy of service tax on ocean freight has been detailed below, for different-different situations:

1. When goods are supplied on FOB basis:
   1. The Indian importer undertakes to bear the ocean freight by entering into a contract with an Indian freight forwarder – The Indian freight forwarder will be subject to payment of service tax on the freight amount, under the forward charge mechanism. The Indian importer will be in a position to take CENVAT credit of this service tax paid on ocean freight[1];
   2. The Indian importer undertakes to bear the ocean freight by entering into a contract with a Foreign freight forwarder (one who is located in a non-taxable territory) – In terms of Rule 10 of the Place of Provision Rules, 2012 (POP) the place of provision will be India, being the place of destination of imported goods. Since in this situation, the service provider is located outside India, the Indian importer will be liable for payment of service tax under the reverse charge mechanism. The Indian importer will be in a position to take CENVAT credit of this service tax paid on ocean freight[2];
2. When goods are supplied on CIF basis:
   1. The foreign exporter undertakes to bear the ocean freight by entering into a contract with an Indian freight forwarder – In terms of Rule 10 of the POP Rules, the place of provision will be India, being the place of destination of imported goods. The Indian freight forwarder will be subject to payment of service tax on the freight amount, under the forward charge mechanism. However, no Cenvat credit of this service tax payable on ocean freight will be available to the Indian importer, being an added cost to the entire transaction.
   2. The foreign exporter undertakes to bear the ocean freight by entering into a contract with a foreign freight forwarder – In this situation, both the service provider and service receiver are located outside India i.e., outside the taxable territory. This situation was earlier covered under the mega exemption notification providing exemption from payment of service tax. It was covered under the following entry (Sl. No. 34 of Notification No. 12/2012-ST):

“(34)    services received from a provider of service located in a non-taxable territory by-

(c)        a person located in a non-taxable territory”

By virtue of the above entry, ocean freight when payable by a foreign exporter to a foreign freight forwarder, was exempt from payment of service tax in India.

The above was creating an anomaly in the system that in all cases ocean freight is subject to payment of service tax, as detailed above, except this last situation. Accordingly, the law was recently amended to provide that the above exemption will not be available in respect of transportation of goods from a place outside India to the customs station of clearance in India. In other words, the situation wherein ocean freight when payable by a foreign exporter to a foreign freight forwarder, which was earlier not subject to service tax was sought to be brought within the service tax net, by removing the above exemption thereon.[3]

As to who will be subject to payment of service tax, in this situation, it has been provided that the person in-charge of the vessel (who files the IGM with the customs authorities) will be liable for discharging the said service tax liability. These amendments have been carried out vide Notification No. 01/2017-ST, 02/2017-ST and 03/2017-ST dated 12.01.2017. Again, in this situation no CENVAT credit of the service tax paid will be available to the Indian importer adding to the cost of the entire transaction.

In both the above situations, wherein the imported goods are on CIF basis, the person in-charge of the vessel / freight forwarder, as the case may be, will recover the service tax amount from the foreign exporter. The foreign exporter will in turn recover this service tax amount from the Indian importer as a part of his cost of imported goods. This will in turn increase the assessable value of the imported items for the purpose of calculation of customs duty, further leading to added costs to the Indian importer.

The above scenarios can be understood hypothetically wherein the FOB value is INR 1000, ocean freight is INR 100, service tax is 4.5% and basic customs duty[4] is 30%. The insurance amount has been deemed to be zero. The impact of service tax on ocean freight on the cost of the Indian Importer, when the value is CIF or FOB, has been detailed below:

Conclusion – From the above, matrix, it clear that bringing goods into India on FOB basis is more cost effective as compared to goods when imported into India, in the above context. In case of FOB valuation, the cost of the transaction (including freight and taxes) will be INR 1430, whereas in case of CIF valuation the cost of the transaction (including freight and taxes) will be INR 1435.85. The reason for the same has been detailed below:

1. The cost of service tax, in case of CIF valuation, will be recovered by the foreign exporter from the Indian importer as a part of his cost. This will in turn increase the customs duty element; and
2. The service tax payable, in case of CIF valuation will not be available as an CENVAT credit to the Indian Importer. On the other hand, in case of FOB valuation, the amount of service tax paid will be available as CENVAT credit to the Indian importer.

The above amount may appear to be very small in percentage terms of the overall cost but in situations wherein the freight amount is a lot, these small percentages may also run into very large sums of money.

[1] Assuming the import relates to importation of inputs or capital goods

[2] Assuming the import relates to importation of inputs or capital goods

[3] Recently, it has been clarified vide CBEC circular No. 204/2/2017, that no service tax will be applicable on the services by way of transportation of goods by a vessel from a place outside India to the customs station in India w.r.t. goods intended for transshipment to any country outside India.

[4] The impact of CVD and SAD has not been considered as the CENVAT credit of these duties will be available

[5] TRU letter of Ministry of Finance, circulated with the Budget Documents in February, 2016, has clarified that assessable value for customs duty calculation will not include the service tax paid on ocean freight

[6] The foreign exporter will increase his cost by INR 4.5, towards the amount recovered as service tax from him either by the Indian freight forwarder / person – in – charge of the vessel