Ever since the introduction of Service Tax we have had to contend with a plethora of issues concerning the subject. While issues concerning levy and classification are being faced by assesses even today, one issue which has attracted attention in the last five years or so is the one pertaining to taxing of reimbursements. The reason for this is because of the presence of two schools of thoughts regarding taxation of reimbursements as well as certain degree of ambiguity associated with the concept of valuation under service tax.
While one school of thought is to keep reimbursement of expenses and costs incurred by the service provider during the course of providing the service, outside service tax net, the other school of thought is to regard the reimbursements as also being subject to tax. While assesses generally take the former view, the Department invariably takes the latter. Their reliance on the latter view has also led to the introduction of Service Tax (Determination of Value) Rules 2006 with effect from 19.04.2006 and their subsequent reliance on the principles of valuation set out there under. The introduction of these Rules was significant because the Tribunal in a number of cases had held reimbursement of expenses at actuals as not being subject to service tax for the period prior to the date of introduction of these Rules.
Rule 5 (1) of the said Rules is relevant in the context of reimbursements suffering service tax as it seeks to treat all expenditures and costs incurred by the service provider in the course of providing taxable service as consideration for the taxable service provided or to be provided thereby requiring the same to be included in the value for the purpose of charging service tax thereon. The said Rules provide for exclusion of reimbursements only in one specific scenario and that is where the service provider incurs these expenses as a pure agent of the service receiver. The definition of the term “pure agent” has been framed quite stringently to specify the requirement for the service provider to satisfy the following norms –
a. Need to enter into a contractual agreement with the recipient of service to act as his pure agent to incur expenditure or costs in the course of providing taxable service;
b. Neither intending to hold nor holding any title to the goods or services so procured or provided as pure agent of the recipient of service;
c. Requirement of not using such goods or services so procured; and
d. Receiving only the actual amount incurred to procure such goods or services
Once the service provider can be said to be acting as a “pure agent” of the service receiver, the question of not charging service tax on reimbursements would arise only if he/she satisfies the following addition conditions specified by Rule 5(2) of the said Rules –
a. He/she uses the goods or services so procured from another service provider in his/her capacity as pure agent of the recipient of service;
b. The recipient of service/client is liable to make payment to the third party;
c. The recipient of service/client authorises him/her to make payment on his behalf;
d. The recipient of service/client knows that the goods and services for which payment has been made by him/her shall be provided by the third party;
e. The payment made by him/her on behalf of the recipient of service/client has been separately indicated in the invoice issued to the said recipient of service/client;
f. He/she recovers from the recipient of service/client only such amount as has been paid by him/her to the third party; and
g. The goods or services procured by him/her from the third party as a pure agent of the recipient of service/client are in addition to the services he/she provides on his own account.
Even though this provision sought to exclude reimbursements from service tax, assesses often found it tough to exclude reimbursements from value for charging service tax in practice as each one of the aforesaid conditions had to be fulfilled. In the event of any one or more of the condition/s not being fulfilled, the exclusion benefit was being denied by the Department. When the assessees challenged the view of the Revenue, the matter had ultimately to be referred to the Tribunal where efforts were made to analyse the true nature of reimbursements. The Larger Bench of the Tribunal in M/s Shri Bhagavathy Traders Vs CCE Cochin (2011 (24) STR 290 (Tri-LB)) held that costs for input services and inputs used in rendering services could not be treated as reimbursable costs and that there was no justification to artificially split the cost towards providing services, partly as cost of services and the rest as reimbursable expenses. The Tribunal consequently held rent for premises, telephone charges, stationary charges, courier charges, salary to staff, electricity etc. sought to be collected for C&F services as liable to service tax as they could not be regarded as reimbursable costs at all. The Tribunal also clarified that only when the service recipient has an obligation legal or contractual to pay certain amount to any third party and the said amount is paid by the service provider on behalf of the service recipient, the question of reimbursing the expenses incurred on behalf of the recipient shall arise. This issue has already been referred to the Apex Court though similar views were also held in quite a few other cases.
In M/s Baid International Services Vs CST Kolkata (2012 (06) TMI 119 – CESTAT Kolkata), the Tribunal relied on the decision of the Larger Bench in Shri Bhagavathy Traders’ case to remand the issue to the Commissioner to decide the reimbursement issue afresh. In Hira Industries Ltd Vs CCE Raipur (2012 (04) TMI 430 CESTAT New Delhi), the Tribunal once again relied on the decision of the Larger Bench referred to above in holding cost of transportation services received from the sub-contractor as being includible in value charged for providing service by the principal where the same had been recovered separately from the client. In Andhra Pradesh Tourism Development Corporation Ltd Vs CCE Hyderabad (2012 (05) TMI 346 CESTAT Bangalore) TTD darshan ticket charges, RFC entry fees, hill transportation charges and water fleet charges were held to be charges for supplementary services rendered by the appellant in relation to package tour, and the collections thereon from the tourists could not be typified as 'reimbursements'.
In Raj Wines Vs CCE Raipur (2012 (07) TMI 564 CESTAT New Delhi) wages of personnel, office rent and telephone expenses incurred for business promotion activity for the client were held to be includible in the value for charging service tax even if these were collected as reimbursements. It was however in Team S&S Vs CCE Chandigarh (2011 (21) STR 290 (Tri-Del)) that the Tribunal sought to go one step further and analyse the possibility of taxing reimbursements considering the very nature of service tax levy. The Tribunal relied on the decision of the Honorable Supreme Court in All India Federation of Tax Practitioners v. Union of India (2007 (7) S.T.R. 625 (S.C.)) and held that service tax was a destination based consumption tax which may be either performance based or property based. Economic services were provided for valuable consideration without being rendered charitably. No service which was uneconomical or commercially unviable was provided in the commercial world. Various elements of cost contributed to the provision of economic services and that expenses which were indispensable and inevitably incurred to make the economic service performable contributed to the gross value of service.
The Tribunal further went on to add that the provider of economic service usually recovers his entire cost involved in providing such service in the best possible manner that may be viable to him and the service recipient. The basic principle with service tax being a destination based consumption tax, would mean that till the service reached its destination, all expenses incurred till that point and time become essential consideration of cost of service. The gross value takes into its fold entire cost of service enabling that to be performable. Therefore, by no stretch of imagination neither the arrangements of the parties nor their mutuality or nomenclature or format of their agreement and mode of discharge of consideration shall prevail on the law relating to service tax. Legislature accordingly intended that the gross value of the service should be the measure of value for taxation whether paid as consideration directly or by reimbursement of expenses relating to providing of taxable service.
Recent High Court Verdict
The aforesaid view was finding increasing acceptance till the Delhi High Court very recently came up with a contrary view. In Intercontinental Consultants & Technocrats (P) Ltd Vs UOI & Anr (2012 (12) TMI 150 – Delhi High Court), the High Court in response to a writ petition filed in 2008 questioning the constitutional validity of Rule 5 of Service Tax (Determination of Value) Rules 2006, held that Rule 5(1) which provides for inclusion of the expenditure or costs incurred by the service provider in the course of providing the taxable service in the value for the purpose of charging service tax was ultra vires Section 66 and 67. The Court also held that while Rules can be framed under Section 94, the same could not go beyond the Section that provided for charging and collection of service tax as it sought to extract something more from the service provider by including in the valuation of the taxable service the other expenditure and costs which were incurred by the service provider “in the course of providing taxable service”. The Court further clarified that what could be taxed was only the consideration charged for the taxable service and not reimbursements of costs. Thus, air travel and hotel charges reimbursed were held to outside service tax levy in the hands of the consulting engineer service provider.
The aforesaid verdict in a way contradicts the view expressed by the Tribunal in the various cases indicated earlier. The bone of contention would be the concept of consideration and whether the same would include reimbursements at all. It is worthwhile noting that while the Tribunal has sought to address what could be construed as reimbursements, the High Court has held Rule 5(1) which seeks to treat expenditure and costs as consideration, to be ultra vires Section 66 and 67. Having said this, it would be interesting to see whether this view would prevail in the long run as it is likely to be subjected to intense scrutiny especially by the Revenue.
It is also worthwhile noting that Section 67 seeks to levy service tax on the gross amount charged for the service where consideration is in monetary terms. The concept of “consideration” though has not been given a precise definition which would enable one to clearly establish what it would include and what it would not. What we instead have, is an inclusive definition which seeks to cover any amount that is payable for the taxable services provided or to be provided.
Whether this definition which is by way of an explanation to Section 67 would go to the extent of including reimbursements as well is something to be reviewed by the judiciary. There is a certain degree of ambiguity here though the High Court has given its verdict. This could also be inferred from paragraph 12 of the said decision where the Court has specifically referred to non-consideration of the argument from Revenue that the term “consideration” itself could be seen to have wider connotation though seeking to highlight the fact of non-inclusion of anything specific pertaining to reimbursements in the said explanation.
Though the decision is a welcome one from the assessees’ point of view it has come a little too late. Service providers would have to proceed with caution especially where the principles for exclusion of reimbursements as explained earlier are not satisfied. While reimbursements at actuals could be argued to fall outside service tax net relying on the Delhi High Court decision, the same could be opposed by the Revenue unless all the conditions under the concept of “pure agent” happen to be satisfied by the service provider with the possibility of amendments in the forthcoming budget also not being ruled out.
By: CA. Srikantha Rao T