Service tax amendment includes reimbursements

Section 67 of the Finance Act states that where a service is provided for a “consideration” in money, the value of taxable services for charging service tax will be the “gross amount charged” by the service provider to the service recipient. The Finance Bill, 2015, seeks to amend the definition of “consideration” in the explanation to section 67 to include “any reimbursable expenditure or cost” incurred and charged by the service provider in the course of provision of service, i.e. all the expenses the provider incurs for rendering the service must be included when calculating service tax.

With this amendment, the Ministry of Finance (MoF) has sought to make clear that reimbursable expenses were “always” intended to form part of taxable service valuation despite contrary court decisions. In the most prominent case, involving Intercontinental Consultants and Technocrats, Delhi High Court held that valuation rules which provided for inclusion of reimbursable expenses in gross amount for charging service tax were ultra vires of section 67.

Background

When the issue of including reimbursable expenses such as travel, meals and lodging within “gross amount” for discharge of service tax arose in the late 1990s, some service tax commissionerates clarified that such expenses would not form part of “gross amount” for payment of service tax provided that documentary evidence substantiating them was adduced. However, there was no uniformity in approach nor was there any clarification by the Central Board of Excise and Customs (CBEC) on the issue. The introduction of the Service Tax (Determination of Value) Rules in 2006, for the first time, sought to grant statutory recognition to inclusion of reimbursable expenses in gross amount for payment of service tax.

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Rule 5 of the valuation rules provided for inclusion or exclusion of certain expenses or costs. While rule 5(1) provided that any reimbursable expenditure incurred by the service provider in the course of providing taxable service was to be treated as consideration for the taxable service and included in the value for the purposes of charging service tax, rule 5(2) carved an exception that if such expenses were incurred by the service provider as a “pure agent” and met the specified conditions, such expenses could be excluded from “gross amount” for the payment of service tax.

The CBEC, through a circular dated 19 April 2006, further clarified that all expenditure or costs incurred by the service provider in the course of providing service forms part of the taxable value and all earlier CBEC circulars regarding valuation were withdrawn.

Rule 5 and the clarification led to uniformity of the service tax authorities’ position that reimbursable expenses were subject to service tax except in the case of a pure agent. However, the concept of pure agent presupposes a prior contractual agreement, and most service providers have found it impractical to satisfy the specified conditions.

High court ruling

The ambiguity in position as to what could be included or excluded as expenses for the levy of service tax on reimbursements led to disputes between assessees and service tax authorities. The most authoritative ruling on the issue was in the Intercontinental Consultants case mentioned above. Delhi High Court was of the view that expenditure/cost incurred by the service provider in the course of providing the taxable service can never be considered as the gross amount charged by the service provider. Section 66 levies service tax at a particular rate on the value of taxable services. As section 67(1) is subject to the provisions of chapter V, which includes section 66, the value of taxable services for charging service tax has to be in consonance with section 66, which levies a tax only on the taxable service and nothing else. Thus, there is an in-built mechanism to ensure that only the taxable service is evaluated under the provisions of section 67.

Conclusion

As stated above, the recent amendment was brought to overcome the Delhi High Court ruling and to reassert the MoF’s intention to charge service tax on reimbursements. However, most assessees (despite the high court ruling) continued with the practice of valuing service tax on reimbursements, mainly to avoid any unwarranted litigation with the authorities but also because in most cases central value-added tax credit of such service tax payment was available.

Be that as it may, it remains to be seen whether the amendment can withstand the basic proposition that reimbursements, which are normally understood as acts of compensation for an expense, can be called “consideration” for rendering of “taxable service”. It would have been more appropriate if the MoF had recast the conditions of pure agent so as to make them practical and workable. The current conditions of pure agent in rule 5(2) leave much desired.

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Kumar Visalaksh is an associate partner and Rahul Khurana is an associate manager at Economic Laws Practice. This article is intended for informational purposes and does not constitute a legal opinion or advice.