'Supply of services' definition in the VAT law

In the Value Added Tax and Supplementary Duty Act 2012 of Bangladesh, ‘supply of services’ means not a supply of good, money, or immoveable property, which, without prejudice to the generality, shall include the following: (a) a grant, assignment, termination, or conferment of a right; (b) making a facility, an opportunity, or an advantage available; (c) an agreement to perform an act, to refrain from performing an act or accepting a situation or to tolerate an act or a situation. [This is also listed as a ‘supply of services’ in Article 25 (b) of the Council Directive 2006/112/EC which reads: ‘the obligation to refrain from an act, or to tolerate an act or situation’];and (d) the issuance, transfer or conferment of a licence, permit, certificate, concession, authorisation, or a similar right.

Of the examples of ‘supply of services’ listed in the definition, a grant, assignment, making a facility or an opportunity or an advantage available, and the issuance, transfer or conferment of a licence, permit, certificate, concession and authorisation seems understandable by a majority of readers of an ordinary prudence. But ‘termination’ as a supply of services needs clarification. Similarly, this scribe’s discussion with VAT executives and students attending training on VAT suggests an impression that there is some confusion in our understanding as to what constitutes a supply of services. Lack of clear understanding is observed regarding the situations that clearly denote or exemplify a supply of services. Sadly, there is little guidance or examples of such services in the VAT and Supplementary Duty Rules, 2016.

The objective of this article is to briefly discuss and present examples of how ‘termination of a right’ can be categorised as a supply of service. It also attempts to facilitate understanding by readers as to how an agreement to ‘refrain from performing an act or accepting a situation or to tolerate an act or a situation’ is a ‘supply of service’.

Termination: In the VAT system, termination can be considered a service when it involves an activity that provides a benefit to a recipient in exchange for payment. This is because VAT is generally imposed on the supply of goods and services, and if termination meets the criteria of a taxable service, it can be subject to VAT. Few examples of Termination as a service in VAT system is discussed here.

Contract Termination Fees: If a customer cancels the contract early, the company charges a termination fee. Since this fee compensates the company for the service provided or loss incurred due to early termination, tax authorities may consider it a taxable service under VAT.

Lease termination fees: Similarly, a contract for lease of movable or immovable property may stipulate that the lessee shall not terminate the lease before a certain period and if he does so he will have to pay certain amount as early termination fee or penalty. Such amounts paid for acceptance of late payment, early termination of lease or the amounts forfeited on cancellation of service by the customer as part of commercial terms agreed to by the parties, constitute consideration for the supply of a facility. Therefore, such payments, even though they may be termed as fine or penalty, are actually payments that amount to consideration for supply, and are subject to VAT, in cases where such supply is taxable. However, not all termination is supply of services. If an employer terminates an employee’s contract and pays a severance package, it is not usually subject to VAT because it is a compensation payment, not a service.
VAT treatment depends on the specific tax laws of the country as well as the intent of the recipient or payers.

As for example, the judgment in the case ‘Vodafone Portugal –Communicaçoes Pessoais SA v Autoridade Tributária e Aduaneira’ (C-43/19) addresses the question as to whether termination fees are subject to value added tax (“VAT”) pursuant to Article 2(1)(c) of the Council Directive 2006/112/EC (the “VAT Directive”). In this case, the Court takes on the perspective of economic reality stating that the amount due on the contract’s early termination seeks to guarantee the operator a minimum contractual remuneration for the service provided. This amount is to be considered as remuneration (consideration) received by an operator for the supply of services and subject to VAT within the meaning of the Council Directive 2006/112/EC.

Refrain from performing an act or accepting a situation or to tolerate an act or a situation: An agreement ‘to refrain from performing an act or accepting a situation or to tolerate an act or a situation’ has been listed as a ‘supply of service’. The following examples make it clear how ‘to refrain from performing an act or accepting a situation or to tolerate an act or a situation’ constitute a VAT-able activity/service.

(A) ‘Agreeing to the obligation to refrain from an act’ would include:

Non-compete agreements. In such agreements, one party agrees not to compete with the other party in a product, service or geographical area against a consideration paid by the other party.

A builder refraining from constructing more than a certain number of floors, even though permitted to do so by the city corporation, against a compensation paid by the neighbouring housing project, which wants to protect its sunlight (Circular No. 178/10/2022-GST, 3rd Aug. 2022 Government of India).

A Steel Manufacturing Unit refraining from manufacturing activity during say 9.00 am to 4.00 pm on school days against an agreed compensation paid by a neighbouring school, which wants to avoid noise during those hours.

In this case, agreement to refrain from performing an act or accepting a situation or to tolerate an act or a situation’ seems to be an example of Negative List based Service Taxation. Indian Central Goods and Services Tax Act, 2017 defined the act of ‘refrain from an act, or to tolerate an act or a situation, or to do an act” as a supply of service under Section 7 in the aforesaid Act.

Agreeing to the obligation to tolerate an act or a situation: Examples of such obligation would include activities such a shopkeeper allowing a hawker to sell his goods from the common pavement in front of his shop in exchange for a monthly payment by the hawker. This act by the shopkeeper can be considered as “making a facility, an opportunity, or an advantage available” to the hawker to run his trading activity and thus comes under the definition of ‘supply of service’.

Tolerating Cancellation of Reservation: In line with the policy of the hotel, a fixed amount of deposit shall be made by the customer for making reservation. In case the reservation is cancelled, the supplier (hotel in this case) may retain or forfeit part of the consideration or security deposit paid by the customer for the intended supply. This cancellation fee is specifically attributable to the service of preparation of the room for the customer; And can be considered as the charges for the costs incurred in making arrangements for the intended supply. This is facilitation service of allowing cancellation of an intended supply against payment of cancellation charge or forfeiture of a part or whole of the security deposit (consideration). This supply (against reservation money retained i.e., consideration) would be subject to VAT at the same rate as applicable to the class of travel (i.e., to the service contract)for which the reservation was booked. (source: https://cbic-gst.gov.in/pdf/cir-178-08-2022-cgst.pdf)

Agreeing to the obligation to do an act: Examples of this obligation may include the situation where a Steel Manufacturing Unit agrees to install equipment for zero emission/discharge at request of the Resident welfare associations (RWA) of an adjacent residential complex in exchange of a consideration paid by such RWA.

In the aforesaid cases, anything which is not a supply of goods but is done for a consideration (including, if so done, the granting, assignment or surrender of any right) has been recognised as a supply of services (source: Isle of Man, Ellan Vannin, VAT Act 1996, Section 5). In other words, in the absence of consideration, the refrainment, toleration, or undertaking of any act shall not be considered a service. And the concept of ‘consideration’ involves an element of contractual relationship as is seen in the aforesaid cases.

To conclude, the expression “agreeing to the obligation to refrain from an act or to tolerate an act or a situation, or to do an act” was intended to cover services not commonly conceived as supply of services by tax payers and tax authority. The VAT authority of Bangladesh may consider inclusion of such clarifications in VAT Rules for greater understanding and clarity of VAT provisions, thereby promoting better compliance.

Mohammad Abu Yusuf, PhD is a VAT analyst and an Additional Secretary, Finance Division, Ministry of Finance.
ma_yusuf@hotmail.com