SERVICE TAX REIMBURSEMENT – WHAT COURTS SAY

[Dr. Sanjiv Agarwal]

Rule 5 of Service Tax (Determination of Value) Rules, 2006 deals with circumstances where certain costs or expenses could be excluded from or added to value of taxable services. It has been provided that all expenses and costs incurred by the service provider for providing the taxable services during the course of such service shall be included as part of value of taxable services. In such cases, there will be no exemption or abatement from service tax in respect of such costs or expenses. For example, cost of consumables, office expenses, telephone expenses, rentals etc. However, where the service provider incurs expenses and cost as a agent of service receiver, i.e., for or on behalf of the service receiver (as a pure agent of the client), such costs or expenses shall be excluded from the value of taxable services. For claiming such costs or expenses to be out of scope of value of service, the service receiver should act as a pure agent or agent of the service receiver.

On reimbursable expenditure, it has been clarified by CBEC vide Letter No. B1/4/2006 dated 19.4.2006 (Refer Annexure 13.1) as under -

Value for the purpose of charging service tax is the gross amount received as consideration for provision of service. All expenditures or costs incurred by the service provider in the course of providing a taxable service forms integral part of the taxable value and are includable in the value. It is not relevant that various expenditure or costs are separately indicated in the invoice or bill issued by the service provider to his client.

The service provider in the course of providing any taxable service may incur certain expenditure or cost as a pure agent of the client. The service provider seeks to exclude such expenditure or cost incurred by him as a pure agent of his client (generally known as reimbursable expenditure) from the value of the taxable services.

There could be situations where the client of the service provider specifically engages the service provider, as his agent, to contract with the third party for supply of any goods or services on his behalf. In those cases such goods or services so procured are treated as supplied to the client rather than to the contracting agent. The service provider in such cases incurs the expenditure purely on behalf of his client in his capacity as agent of the client. Amounts paid to the third party by the service provider as a pure agent of his client can be treated as reimbursable expenditure and not includible in the taxable value. However, if the service provider acts as an undisclosed agent i.e. acting in his own name without disclosing that he is actually acting as an agent of his client, he cannot claim the expenditure incurred by him as reimbursable expenditure. Whether the expenditure or cost incurred by the service provider in his capacity as a pure agent of the client or incurred on his own account is a question of fact and law and is to be determined carefully.

Indication of different elements of the transaction in the invoice or bill could often be misleading. One has to carefully examine the exact legal nature of the transactions and other material facts before taking a view as to whether or not the expenditure sought to be excluded from the value is reimbursable expenditure. Not only the form, but also the substance of the transaction should be duly taken into account.

Rule 5 pertains to reimbursable expenditure incurred by the service provider as a pure agent of his client. Explanation (1) to rule 5(2) clearly specifies the criteria to decide whether the service provider acts as a pure agent or not in a given situation. In the case of agency function, the agent neither intends to hold nor holds any title to the goods or services and also never uses such goods or services so procured. It is also important to note that the service provider only receives the actual amount incurred to procure such goods or services.

The service provider who seeks to claim exclusion of certain value from the taxable value should also fulfill all the conditions specified in rule 5(2).

In Rolex Logistics Pvt. Ltd v. CST, Bangalore 2008 (9) TMI 123 - CESTAT BANGLORE, it was held that reimbursement of expresses are not for services rendered but expenditure incurred on behalf of client by service provider. Gross amount for service rendered means only for services rendered. It also interpreted 'reimbursement' as payments made on behalf of service recipient by service provider in the course of rendering services. The gross receipt for the services rendered means only for the services rendered.

It held as follows:

What is a reimbursement? When a service provider provides service to a service receiver or a client, on behalf of his client he incurs various expenditure and these expenditure are all for different purposes. The Service Tax liability in terms of Section 67 is only on the gross amount received towards the services rendered. If the service provider in the course of rendering service has to make certain payments on behalf of the service receiver, they are known as reimbursements. The reimbursements are actually not towards the service rendered but they are only towards other expenditure incurred on behalf of the client by the service provider. Normally, the service provider incurs these expenditures in the interest of quicker service. Suppose the service provider has to first receive the money and then render the service, it would cause lot of delay. Therefore, while providing service to the client, the service provider has to incur various expenditure in order to save time and avoid delay, hence, the expenditure is incurred by the service provider and later these are reimbursed by the client. In fact, the client is supposed to pay all these amounts. For example, take the case of a Custom House Agent in the course of clearance of the goods, the importer may have to incur different expenditures towards the port, stevedoring clearances, stationery, all that. These expenditures are actually to be paid by the importer but the CHA initially incurs all these expenditure and then later collects from the client. These are reimbursements. So what is to be borne in mind is that these reimbursements are not for the services rendered. The gross receipt for the services rendered means only for the services rendered. The amount of money received only for the services rendered not for all the other expenditure which is to be incurred normally by the client."

The above judgment clearly specifies the reimbursements that can be excluded from the taxable value by citing of the example of CHA who incurs expenses such as port charges, customs duties on importation, demurrage charges payable to the wharf etc., actually payable by the client but incurred on behalf of the latter, which were reimbursed on actual basis, and qualify for abatement from the taxable value of CHA which includes his charges for clearing the goods from the customs and the above analogy also holds good for 'pure agent' of the Valuation Rules, as these expenses are not related to the service rendered at all.

The Apex Court in the case of All India Federation of Tax Practitioners v. Union of India 2007 (8) TMI 1 - Supreme Court held that service tax is destination based consumption tax and that may be either performance based or property based. Economic services are provided for valuable consideration without being rendered charitable. No service which is uneconomical or commercially unviable is provided in the commercial world. Various elements of cost contribute to the provision of economic services. Expenses which are indispensable and inevitably incurred to make the economic service performable that contribute to the gross value of service. The provider of economic service recovers his entire cost involved in providing such service in the best possible manner that may be viable to him and the service recipient.

In Intercontinental Conslt. & Tech. Pvt. Ltd. v. Union of India 2008 (9) TMI 84 - HIGH COURT DELHI, it was held by high court that the demand on reimbursement of expenses like air travel, hotel stay, room rent, boarding and lodging charges etc. after including such amounts in taxable value in case of consulting engineer's services can not be coerced. The petitioner contended that reimbursable expenses were not forming part of services and such amounts were also indicated separately in bills. It was held that while proceedings pursuant to SCN may continue, coercive steps need not to be taken till passing of adjudication order.

In CCE & C, Rajkot v. Reliance Industries Ltd. 2009 (3) TMI 859 - SUPREME COURT, where Department was in appeal, apex court held that expenses incurred on account of reimbursable expenses do not form part of value of taxable services. Hence reimbursable charges incurred by assessee for travelling allowances to consulting engineers are not required to be included in the fees for services so paid by them for the purpose of Service Tax. But the Supreme Court did not held that Rule 5(1) is ultra vires the provisions of section 67 of the Finance Act, 1994 which provides for provisions on valuation of taxable services.

Delhi High Court in Intercontinental Consultants and Technocrats Pvt. Ltd. v. Union of India 2012 (12) TMI 150 - DELHI HIGH COURT has over ruled this provision stating that imposing Service Tax on reimbursements is not in the scheme of law and such a provision is ultra vires (illegal) the Act itself. In this judgment, the court has held that what is to be taxed is the gross amount charged by the service provider 'for such service'. The words 'such service' are important for taxation. It is only the value of 'such service' which can be taxed and nothing else. The value of service, to be taxed, can, therefore, never exceed the gross amount charged by the service provider for such service provided. Thus, there can be no Service Tax on reimbursements as such reimbursements (say, travelling, accommodation etc.) as it would amount to double taxation.

The court has upheld that Service Tax cannot be levied on reimbursement of expenses, that too a case of consulting engineer's services. It would also imply that such reimbursements cannot be taxed in case of other service providers also which may include architects, management consultants, chartered accountants, company secretaries, cost accountants, advocates, scientists or even a beautician.

The issue of imposing Service Tax on reimbursement of expenses has always been a issue of debate and dispute both in pre 2006 and post 2006 era when Service Tax (Determination of Value) Rules, 2006 were notified and concept of 'pure agent' was brought in. 'Pure agenf in the rues has been so defined that service provider can never be called a pure agent so long as he utilizes or consumes the services, for which reimbursement is sought in rendering of output taxable service. Such a rule defeats the very purpose of reimbursement and such amounts are subjected to double taxation - one when original service provider provides such service and two, when reimbursement is sought, even on actuals without any markup or profit element.

The Delhi high court judgment would lead to the following understanding -

a)   Rule 5(1) of the Service Tax (Determination of Value) Rule, 2006 is ultra vires the provisions of the Finance Act, 1994.

b)   Rule 5(1) is against the charging provision and has been struck down.

c)   Even if rules are laid before both the houses of the Parliament, such an act cannot confer validity to the rules.

d)   Section 94(4) of the Finance Act, 1994 does not add any greater force to the rules. They continue to be a piece of sub ordinate legislation.

e)   Service Tax is levied at a particular rate (presently 12 percent ) on the value of taxable services in terms of charging section.

f)   Value of taxable service for levy of Service Tax has to be in consonance with the charging section.

g)  Service Tax can be levied on the taxable service and nothing more or nothing less.

h)  It is only the taxable service which needs to be evaluated for the purpose of valuation u/s 67 as it talks of 'such service'.

i)   Thus, value of taxable service shall be the gross amount charged by the service provider 'for such service'. It has to be essentially for 'such service' and nothing else.

j)  The charging section (erstwhile section 66) and valuation provisions (section 67) of the Finance Act, 1994 have to be read together and harmoniously.

k)   If read in consonance, only the consideration paid as quid pro quo for the taxable service can be brought to charge of Service Tax.

l)  The valuation rules, i.e., Service Tax (Determination of Value) Rules, 2006 are expressly made subject to the provisions of section 67(1) and as such, it cannot go beyond what is intended to be in section 67.

m) The common thread running through the provisions of section 66, 67 and 94 of the Finance Act, 1994 is manifest and leads to only conclusion that 'only the services actually provided by the service provider can be valued and assessed to Service Tax'.

n)  What has to be valued is only the output service and nothing else, i.e., not the input services or other expenses which go into rendering of such services.

o)  If it is not held so, the rule 5(1) of valuation rule seeks to extract more as Service Tax than stipulated in section 67(1) by including in the value of service, the other costs and expenditure which are incurred by the service provider in the course of providing the taxable service.

p)  What can be taxed as Service Tax is only the consideration which is further qualified by 'for the taxable service'.

In Sri Bhagavathy Traders v. CCE 2011 (8) TMI 430 - CESTAT, BANGALORE, it was held that reimbursement arises only when person actually paying under no obligation to pay and pays amount on behalf of buyer while recovering same from buyers. Only when service recipient is having obligation, legal or contractual to pay certain amount to any third party and said amount is paid by service provider on behalf of service recipient, question of reimbursing expenses arises. The reimbursement will arise only when the person actually paying was under no obligation to pay the amount and he pays the amount on behalf of the buyer of the goods and recovers the said amount from the buyer of the goods. 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. The claim for reimbursement towards rent for premises, telephone charges, stationery charges, etc. amounts to a claim by the service provider that they can render such services in vacuum. What are cost for inputs services and inputs used in rendering services cannot be treated as reimbursable costs. There is no justification or legal authority to artificially split the cost towards providing services partly as cost of services and the rest as reimbursable expenses. In such cases, effectively double taxation takes place as in the first place, the original service provider charges tax and then when reimbursement is claimed, even without any margin or profit on actuals only, then also Service Tax is leviable.

Reimbursement of expenses has been a contentious issue and actual reimbursements of expenses is not subject to levy of Service Tax; more so when these reimbursements can be substantiated by evidence. Reference can be made to following judicial pronouncements –

(i)    Alathur Agencies v. CCE & C 2007 (3) TMI 64 - CESTAT, BANGALORE

(ii)   Nandini Warehousing Corporation v. CCE 2007 (4) TMI 139 - CESTAT, BANGALORE

(iii)   Hassan Hajee & Co v. CCE 2006 (10) TMI 382 - CESTAT BANGALORE

(iv)   M.P.R. Mercantile Syndicate v. CCE, Cochin 2011 (1) TMI 870 - CESTAT, BANGALORE

(v)    Sri Sastha Agencies Pvt. Ltd. v. Asst. Commr. of C.Ex & Cus. Palakkad 2006 (11) TMI 193 - CESTAT, BANGALORE

(vi)   Bhagyanagar Services v. CCE, Hyderabad [2006 (6) TMI 16 - CESTAT, BANGALORE]

(vii)  CCE, C & ST, BBSR-I v. M/s. Nilaiohita Enterprises [2007 (1) TMI 497 - CESTAT KOLKATA]

(viii) Sangamitra Services Agency v. CCE, Chennai [2007 (7) TMI 33 - CESTAT, CHENNAI]

(ix)  Apco Agencies v. CCE 2008 (1) TMI 71 - CESTAT, BANGALORE.

(x)   S & K Enterprises v. CCE 2008 (1) TMI 72 - CESTAT, BANGALORE

(xi)  E.V. Mathai & Co. v. CCE 2003 (5) TMI 1 - CESTAT, Bangalore

(xii)  Keralam Enterprises v. CCE 2007 (10) TMI 140 - CESTAT, BANGALORE

(xiii)  M/s U.M. Thariath & Company, M/s S.J.C. Pharma v. CCE, Cochin [2007 (6) TMI 39 - CESTAT, BANGALORE]

(xiv)  Al -Baith Steel Pvt. Ltd. v. CCE 2007 (12) TMI 156 - CESTAT BANGALORE

(xv)  Jayalaxmi Enterprises v. CCE Mangalore [2007 (8) TMI 90 - CESTAT, BANGALORE]

(xvi)  M/s. B.S. Refrigeration Ltd. v. CST, Bangalore [2006 (6) TMI 20 - CESTAT, BANGALORE]

(xvii) Rolex Logistics Pvt. Ltd. v. CST 2008 (9) TMI 123 - CESTAT BANGLORE

(xviii) K.D. Sales Corporation v. CCE, Belgaum [2006 (12) TMI 52 - CESTAT, BANGALORE]

However, on the other hand, in the following cases, Tribunals have held that the reimbursement charges to be included in gross value of the taxable services rendered.

In Harveen & Co v. CCE, Chandigarh 2011 (5) TMI 140 - CESTAT, NEW DELHI, in a case relating to clearing and forwarding agency, it was held that expenses of dispatch inspection, octroi and detention charges are not towards any activity that would constitute service rendered by assessee. Clerkage and office telephone expenses even if billed separately to client can not be considered reimbursable expenses. In case of godown rent, if it is for discharging obligation under a contract, rent would form part of taxable value even if it is reimbursed separately by client.

In LSE Securities Ltd v. CCE, Ludhiana 2012 (6) TMI 364 - CESTAT, New Delhi, where assessee, stock broker incurred turnover charges, stamp duty, BSE charges, SEBI fees and Demat charges, it was held that these charges could not be included in assessable value to be taxed on the ground that they were received by stock broker as they were not commission or brokerage, which were recoveries from investors to make payment to respective authorities in accordance with statutory provisions of Indian Stamp Act, 1899 and SEBI guidelines.

In Soni Classes v. CCE, Jaipur-I 2013 (1) TMI 686 - CESTAT, NEW DELHI, it was observed that Notification No. 12/2003-ST dated 20.6.2003 excludes the value of materials sold from the value of taxable services. The Board's Circular No. 59/8/2003-ST dated 20.6.2003 is also to the effect that cost of goods sold on materials sold by the service provider to the receiver of such services during the course of the providing of the taxable services ho to be excluded from the value of the services. The said Circular further clarifies that the exemption to that extent would be available only in cases where the sale of such goods is evidenced and the sale value is quantified and shown separately in the invoices.

Thus, it is seen that the Tribunals have differed in their pronouncements on the same issue of the taxability of reimbursement of expenses and the matter referred to larger bench. With Delhi High Court judgment, it appears that the issue should get settled unless the matter moves to Supreme Court.