NO SERVICE TAX ON REIMBURSEMENT OF EXPENSES – JUDICIALLY SETTLED NOW

[Dr. Sanjiv Agarwal]

During the Service Tax regime, i.e. prior to 1^st July, 2017, valuation of services was governed by section 67 of the Finance Act, 1994 (as amended from time to time) and Service Tax (Determination of Value) Rules, 2006.

Finance Act, 2015 had amended section 67 so as to include reimbursement of expenses in and as consideration. The explanation which provided the meaning of consideration shall include –

1. any amount that is payable for the taxable services provided or to be provided;
2. any reimbursable expenditure or cost incurred by the service provider and charged, in the course of providing or agreeing to provide a taxable service, except in such circumstances, and subject to such conditions, as may be prescribed;
3. any amount retained by the lottery distributor or selling agent from gross sale amount of lottery ticket in addition to the fee or commission, if any, or, as the case may be, the discount received, that is to say, the difference in the face value of lottery ticket and the price at which the distributor or selling agent gets such ticket.

It had been specifically provided that consideration for taxable service shall include all reimbursable expenditure or cost incurred and charged by the service provider. The intention has always been to include reimbursable expenditure in the value of taxable service. However, in some cases courts have taken a contrary view. Therefore, the intention of legislature was specifically stated in section 67.

With this amendment, the controversy as to whether reimbursement of expenses or cost incurred by the service provider and charged in the course of providing taxable services, were to be considered as consideration for value of services except in cases which were covered under exclusion in terms of Rule 5 of Service Tax (Determination of Value) Rules, 2006.

Reimbursements and Pure Agency Concept

Rule 5 of valuation rules dealt 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 incurred 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 were excluded from the value of taxable services. For claiming such costs or expenses to be out of scope of value of service, the service provider should act as a pure agent or agent of the service receiver.

Any out-of-pocket expenses incurred for attending the assignments like travelling expenses, boarding and lodging expenses, and other miscellaneous expenses during the tour for client, which are reimbursed by the client, cannot be considered as service charges, fees or remuneration. These are just like travelling expenses of employees working for employer when he/she was on tour.

If such expenses are also included within the scope of ‘fees’, it may lead to anomalous situation. For example, if expenses are directly made by the client, they will not be termed as fees but if the expenses are incurred by the professionals and reimbursed by the client then these were liable to be considered as ‘fees’. This difference created because of difference in time and manner of payment, may not  be logical, reasonable or justified. Therefore, it cannot be said that the expenses incurred by the professionals or service providers which are reimbursed by the client will constitute a part of fees in every case.

Who is a Pure Agent

A pure agent or agent shall be a person who satisfies the following conditions :

(a) enters into a contractual agreement with his client (recipient of service) to act as an agent of the client to incur expenditure or costs in the course of providing a taxable service;

(b) neither intends not holds any title to the goods or services so provided as an agent of the client;

(c) never uses such goods or services provided; and

(d) receives the actual amount incurred to procure such goods or services.

Following conditions must be satisfied in respect of certain expenses or costs for exclusion from the value of taxable service –

1. the service provider acts as an agent of the recipient of service when he makes payment to the third party for the goods or services procured;
2. the recipient of service receives and uses the goods or services so procured by the service provider as an agent of the recipient of service;
3. the recipient of service is liable for making payment to the third party;
4. the recipient of service authorises the service provider to make the payment on his behalf;
5. the recipient of service knows that the goods and services for which payment has been made by the service provider shall be provided by a third party;
6. the service provider’s payment on the service recipient’s behalf is indicated separately when he invoices the recipient of service;
7. the service provider recovers from recipient of service only the actual amount he has paid to the third party; and
8. the goods or services procured by service provider from third party as a pure agent of recipient of service are in addition to the services he provides on his own account.

On reimbursable expenditure, it was clarified by CBEC vide Letter No. B1/4/2006 dated 19.4.2006 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 pertained 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 received the actual amount incurred to procure such goods or services.

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

In Rolex Logistics Pvt. Ltd v. CST, Bangalore  2008 (9) TMI 123 - CESTAT Bangalore , 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 specified 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 were not related to the service rendered at all.

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 Decision

In Intercontinental Consultants and Technocrats Pvt. Ltd. v. Union of India 2012 (12) TMI 150 - DELHI HIGH COURT , it was 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.

The following references can be drawn from the Delhi high court judgment –

1. Rule 5(1) of the Service Tax (Determination of Value) Rule, 2006 is ultra vires the provisions of the Finance Act, 1994.
2. Rule 5(1) is against the charging provision and has been struck down.
3. Even if rules are laid before both the houses of the Parliament, such an act cannot confer validity to the rules.
4. 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.
5. Service Tax is levied at a particular rate (presently 12%) on the value of taxable services in terms of charging section.
6. Value of taxable service for levy of Service Tax has to be in consonance with the charging section.
7. Service Tax can be levied on the taxable service and nothing more or nothing less.
8. 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’.
9. 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.
10. The charging section (erstwhile section 66) and valuation provisions (section 67) of the Finance Act, 1994 have to be read together and harmoniously.
11. If read in consonance, only the consideration paid as quid pro quo for the taxable service can be brought to charge of Service Tax.
12. 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.
13. 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’.
14. 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.
15. 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.
16. What can be taxed as Service Tax is only the consideration which is further qualified by ‘for the taxable service’.

Union of India appealed against Delhi High Court judgment in Supreme Court on 10-2-2014 and the Supreme Court Bench granted leave in Petition for Special Leave to Appeal (Civil). [Refer (2014) 35 STR J99 (SC)]

Supreme Court's Judgment  

Now, on 7.3.2018, Supreme Court has dismissed the Revenue appeal against Delhi High Court order alongwith bunch of other appeals on same ground and ruled in favour of Assessee. The Apex Court has upheld the Delhi High Court judgment by striking down levy of Service Tax on reimbursement of expenses and confirming Rule 5(1) of valuation rules to be ultra vires. An important issue finally settled.

The assessee's case was that Rule 5(1) of the Rules, which provided that all expenditure or cost incurred by the service provider in the course of providing the taxable services shall be treated as consideration for the taxable services and shall be included in the value for the purpose of charging service tax, goes beyond the mandate of section 67. It was argued that section 67 which deals with valuation of taxable services for charging service tax does not provide for inclusion of the aforesaid expenditure or cost incurred while providing the services as they cannot be treated as element/components of service.

The Government's argument was that the High Court had committed serious error in relying upon Section 66 of the Act (which is a charging section) while interpreting section 67 of the Act, or for that matter, while examining the validity of Rule 5 of the Rules. The learned counsel also relied upon the dictionary meaning that is given to the word ‘gross amount’. section 67 which uses the term ‘any amount’ would include quantum as well as the nature of the amount and, therefore, cost for providing services was rightly included in Rule 5, which was not ultra vires section 67 of the Act.

The apex court observed that Rule 5 of the Rules, 2006 brings within its sweep the expenses which are incurred while rendering the service and are reimbursed, that is, for which the service receiver has made the payments to the assessees. As per these Rules, these reimbursable expenses also form part of ‘gross amount charged’. Therefore, the core issue is as to whether section 67 of the Act permits the subordinate legislation to be enacted in the said manner, as done by Rule 5. Prior to April 19, 2006, i.e., in the absence of any such Rule, the valuation was to be done as per the provisions of section 67 of the Act.

According to charging section (section 66 of Finance Act, 1994), reference is to Service Tax in respect of taxable services and such Service Tax is with reference to the value of taxable services. Thus, it is the value of the services which are actually rendered, the value whereof is to be ascertained for the purpose of calculating the service tax payable thereupon.

The expression ‘such’ occurring in Section 67 of the Act assumes importance. In other words, valuation of taxable services for charging service tax, the authorities are to find what is the gross amount charged for providing ‘such’ taxable services. As a fortiori, any other amount which is calculated not for providing such taxable service cannot a part of that valuation as that amount is not calculated for providing such ‘taxable service’. That is the plain meaning which is to be attached to section 67. Once this interpretation is to be given to Section 67, it hardly needs to be emphasized that Rule 5 of the Rules went much beyond the mandate of section 67. It was held that High Court was right in interpreting Sections 66 and section 67 to say that in the valuation of taxable service, the value of taxable service shall be the gross amount charged by the service provider ‘for such service’ and the valuation of tax service cannot be anything more or less than the consideration paid as quid pro qua for rendering such a service.

Court also emphasized that it is a settled legal position that rules can not go beyond the statute. The statutory provisions have precedence and must be complied with. Thus, a rule which comes in conflict with the main legal provision has to give way to the provision of the enactment. Further, it is also settled that rules are framed the provision of the Act.

The apex court further observed realizing that section 67, dealing with valuation of taxable services, does not include reimbursable expenses for providing such service, the Legislature amended by Finance Act, 2015 with effect from May 14, 2015, whereby Clause (a) which deals with ‘consideration’ is suitably amended to include reimbursable expenditure or cost incurred by the service provider and charged, in the course of providing or agreeing to provide a taxable service. Thus, only with effect from May 14, 2015, by virtue of provisions of section 67 itself, such reimbursable expenditure or cost would also form part of valuation of taxable services for charging service tax. Though, it was not argued by the learned counsel for the Department that section 67 is a declaratory provision, nor could it be argued so, as we find that this is a substantive change brought about with the amendment to section 67 and, therefore, has to be prospective in nature.

Court also relied upon Supreme Court Constitution bench judgment in Commissioner of Income Tax (Central-I), New Delhi v. Vatika Township Pvt. Ltd. 2014 (9) TMI 576 - SUPREME COURT .

SC on Free Supplies

Since some of the appeals in the bunch also related to taxability of free supplies, apex court and adjudged the same by referring to section 67 itself. It was held that the value of such material which is supplied free by the service recipient cannot be treated as ‘gross amount charged’ and that is not the ‘consideration’ for rendering the services. Therefore, value of free supplies of diesel and explosives would not warrant inclusion while arriving at the gross amount charged on its service tax is to be paid.

Reimbursements under GST

Under CGST Act 2017, 'consideration' has been defined in section 2(31) and section 15 deals with value of taxable supply. Rules 27 to 35 provide for determination of the value of taxable supply in specified situations in terms of section 15 of the Act.

Accordingly, ‘consideration’ includes:

(a)   Any payment made or to be made, whether in money or otherwise

(b)  The monetary value of any act or forbearance, whether or not voluntary

(c)   In respect of, in response to, or for the inducement of, the supply of goods and services, whether by the said person or by any other person,

but shall not include any subsidy given by Central or State government.

In the ordinary course, the value of supply of goods and/or services will be transaction value, i.e the price actually paid or payable for the supply of such goods and/or services to the recipient.

As per section 15 of the GST Act, transaction value is the price actually paid or payable by recipient for the supply of goods and/or services to him by the supplier, where supplier and recipient of supply are not related and price is the sole consideration for the supply.

As per section 15(2) of the GST Act, the transaction value shall include the following considerations/amounts-

(a)   Any taxes, duties, cesses, fee and charges other than CGST, SGST, GST cess, if charged separately

(b)  Amount paid by recipient w.r.t supply on behalf of supplier.

(c)   Incidental expenses such as commission and packing including amount charged for anything done by supplier at or before delivery of goods.

(d)  Interest, late fee or penalty for late payment.

(e)   Value of subsidies linked to supply excluding subsidy by Central or State government.

As per rule 33 of the GST Rules, the amount incurred and claimed by supplier of services as pure agent of recipient will not form part of taxable value of services, if following conditions are satisfied.

(a)   The supplier as pure agent makes payment to third party on authorization of such recipient.

(b)  The payment made by pure agent is separately indicated on the invoice issued by pure agent to recipient.

(c)   The goods and/or services procured as pure agent of recipient from the third party are in addition to the services he provides on his own account.

According to explanation to rule 33 of the GST Rules, ‘pure agent’ is a person who on behalf of the recipient:

(a)   Incurs expenditure or costs in the course of supply of goods or services or both.

(b)  Neither intends to hold nor holds any title to goods and/or services so procured or supplied.

(c)   Does not use such goods and/or services so procured

(d)  Receives from the recipient only the actual amount incurred to procure such goods and services

Pure agent enters into a contractual agreement with the recipient of goods and/or service to act as his pure agent.

Epilogue

Though Supreme Court has finally settled the dust on taxability of reimbursement of expense under Service Tax era, it will still holds good under the present GST era subject to the fulfillment of requirements of criteria for pure agent. What is relevant is that taxpayers and businesses ought to take care of proper documentation, accounting and invoicing. However, reimbursements in the garb of reducing the valuation may land up in trouble for assessees and unwanted litigation.

= = = = = = = = =