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THE INSIGHT

Taxability of Reimbursements in Service Tax and GST regime
By CA Neha Sethi
Sep 17, 2019

REIMBURSEMENT is a process through which a person is compensated by another for expenses, damages, losses or such other instances. While referring to the legal dictionary, reimbursement means compensation, damages, disbursement, giving back, indemnification, recompense, reparation etc. Further, while referring to Wikipedia, reimbursement is the act of compensating someone for an out of pocket expenses by giving them an amount of money equal to what was spent. Meaning thereby, reimbursement of expenses i.e. out of pocket expenses (OPE) are being incurred by the service provider or seller of goods and such expenses are reclaimed from the recipient of service or buyer as the case may be. In the prior indirect tax regime, i.e. service tax regime, taxability of reimbursements was under a huge dispute and the same was challenged in Hon'ble Delhi High Court in case of Intercontinental Consultants and Technocrats Private Limited. Before discussing the contents of the aforesaid judicial pronouncement, it is worthwhile to note the applicable provision for taxability of reimbursements i.e. section 67 of the finance Act, 1994 read with Rule 5(1) of the valuation rules. Prior to 18.04.2006, the valuation provision i.e. section 67 read as under:

"For the purpose of this chapter, the value of any taxable service shall be the gross amount charged by the service provider for services provided or to be provided by him."

Thereafter, the said provision was amended wef 18.04.2006 and prior to 14.05.2015 as under:

"(1) Subject to the provisions of this chapter, where service tax is chargeable on any taxable service with reference to its value, then such value shall:

(i) In a case where the provision of service is for consideration in money, be the gross amount charged by the service provider for such service provided or to be provided by him;

(ii) …

(iii) …

Explanation- For the purpose of this section-

(a) "consideration" includes any amount that is payable for the taxable services provided or to be provided;

Rule 5: Inclusion in or exclusion from value of certain expenditure or costs:

(1) Where any expenditure or costs are incurred by the service provider in the course of providing taxable service, all such expenditure or cost shall be treated as consideration for taxable service provided or to be provided and shall be included in the value for the purpose of charging service tax on the said service.

Consideration in itself infers that money or other payment provided in exchange for an act or service. Consideration may be cash, in which case it is more like a sale, or in kind. Further, On a bare perusal of provision of section 67 i.e. prior to 18.04.2006 and post such date, broadly the value for the purpose of charging service tax shall be the consideration, which service provider obtains from the recipient for providing taxable services. Moreover, consideration is quid pro quo i.e. the return by the recipient as a result of procuring services from the service provider. However, the term reimbursement means to restore or repay that which has been incurred. In the context of service provider and service recipient means that something which has been expended by the service provider and which is to be repaid by the service recipient. A service provider can/ may Incur cost for providing taxable services and charge such expenses (Out of Pocket Expenses) along with fees from the service recipient. The service recipient is also required to pay such expenses to the service provider. Here the issue to be examined is whether reimbursements do fall in the definition of consideration so as to be covered in the ambit of taxability under the Finance Act, 1994.

Later on wef 18.04.2006 and upto 14.05.2015, consideration was also defined in the explanation to section 67 as the amount which is paid or payable for the taxable service. Thus, on the basis of plain reading of section 67 it can suitably be understood that the value for the purpose of charging service tax on taxable service shall be the amount i.e. consideration paid or payable for the taxable service.

Now, as far as the issue of reimbursement is concerned, the law of taxability of reimbursement prior to 18.04.2006 was examined by the larger bench of the Tribunal in case of Shri Bhagavathy Traders Vs. CCE, Cochin - TOG-1514-CESTAT-BANG-2011, in which assesse was providing taxable service under the category of clearing and forwarding agent. They received certain reimbursements as transportation charges, loading and unloading charges, rent, electricity, telephone charges, stationery charges, courier charges, etc. and did not include in value of taxable service. Revenue included such charges in the gross value for the purpose of discharging service-tax liability. It was observed by the larger bench of tribunal that where service recipient had an obligation, be it legal or contractual to pay certain amount to any third party and the said amount was paid by the service provider on behalf of the service recipient, the question of reimbursing the expenses incurred on behalf of recipient should arise. Therefore, when a service provider incurs costs on his own account for providing the taxable service and not as an agent of the recipient of such service, such expense does not become the reimbursable expenditure and thus excludible from the value of Taxable Service.

To summarise, in the above said judicial pronouncement it was concluded that reimbursement expenses would be excludible from the value for the purpose of charging service tax only if the service recipient had any legal or contractual obligation to bear such expenses. Cost on input service or inputs which are used for providing output service cannot be treated as reimbursable expenditure at all.

Now, while referring to Rule 5(1) of valuation rules, it is being conferred that all expenditure or costs which are incurred in course of providing taxable service are includible in value of taxable service for the purpose of charging service tax. The validity of the same was challenged before hon'ble Delhi High Court in case of Intercontinental (Supra), in which the petitioner was the consultant engineer and was acting as consultant to NHAI. In course of providing consulting services to the client, it used to recover travelling expenses, accommodation charges from the client. In the invoice, the petitioner used to quote his fees component along with service tax and OPE without charging service tax. The show cause notice was issued to the petitioner by the Superintendent (Audit) for levying tax on reimbursement expenditure in light of Rule 5(1) of Valuation Rules. Since, the value for the purpose of levying tax on taxable service was consideration payable and consideration was the amount paid or payable for procuring services was subject to tax. The revenue contended reimbursement expenditure to be the part of the consideration in the light of Rule 5(1). In the writ filed by the petitioner, validity of Rule 5(1) was challenged contending that it is ultra vires to the provision of section 66 and 67 of the Finance Act, 1994 since in as much as it provides that all expenditure or costs incurred by the service provider in the course of providing the taxable service shall be treated as consideration for the taxable service and shall be included in value for the purpose of charging service tax goes beyond the mandate of section 67. The charging under section 66B is only on taxable service and further section 67 confers the gross amount charged for such service shall be value for the purpose of charging service tax. As the hon'ble apex court in case of Babaji Kondaji Garad has laid down the principle that rules cannot go beyond the statue on the same line, the hon'ble Delhi High Court had held that the rules framed under the act even if laid before both houses of parliament, does not confer validity if it is not made in conformity with section. Accordingly, the rule 5(1) has tried to enlarge the scope of consideration envisaged by section 67 i.e. Act the law, hence rule 5(1) is bad in law.

The department filed the Special Leave Petition in the hon'ble Supreme court and on 07.03.2018 - TOG-354-SC-ST-2018, while upholding the judgement of hon'ble Delhi High Court it has been held that for 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 be part of that valuation as that amount is not calculated for providing such taxable service. (Para 24 of verdict may be referred to).

However, it is worthwhile to note that definition of consideration contained in explanation to section 67 was amended w.e.f. 14.05.2015 and reimbursement expenses were included in the definition of consideration meaning thereby, reimbursement expenses were subject to service tax post 14.05.2015.

Applicability of Case Law in GST Era:

Since, the hon'ble apex court has decided the fate of reimbursement expenses till 14.05.2015, and thereafter, the definition of Consideration was suitably amended so as to include reimbursement expenses into the tax net, it is imperative to examine the applicability of ruling in GST era. Provision of section 9 of CGST Act, 2017 envisages that tax shall be levied on intra state supplies of goods or services on the value declared under section 15 at the rate as notified by the government. Now referring to the provision of section 15, it appears that value of supply shall be the transaction value and it shall include all incidental expenses, such as commission, packaging incurred in respect of supply at the time of or before supply of goods or services. Accordingly, in the GST law, the value of supply has been clearly defined to be the transaction value and inclusions have also been clearly defined in the act itself. However, further rules have been prescribed in exercise of the powers of provision of section 15, which can be referred if criteria for referring to the rules have been fulfilled. Now, when we refer the judgment of the hon'ble Supreme Court in case of Intercontinental in the context of GST law, it is imperative to note that the hon'ble apex court has upheld the ruling of the hon'ble Delhi High Court majorly on the ground that since rule 5(1) was enlarging the scope of consideration which was given in the law, and accordingly rule 5(1) is ultra vires to the Finance Act, 1994, hence there cannot be any tax on the reimbursement. Further, since, in GST era, the provision of valuation given in Act itself includes the all expenses in value of supply, in the humble opinion of the author, the ratio of judgement of Intercontinental (supra) may not be applicable in GST regime. Henceforth, reimbursement of expenses should be includible in value for the purpose of Levying GST until & unless covered by specific provisions of 'Pure Agent'. Rule 33 of the Central Goods and Services Tax Rules, 2017, provides for the exclusion of expenses incurred in the capacity of pure agent from value of supply if condition prescribed therein is duly fulfilled. Explanation to said rule also defines the pure agent who enters into contractual agreement to act as the pure agent in addition to the other services which he was asked to provide at the first place. The understanding may also be borrowed from the CST Act, 1956, in which sale price (Sec. 2(h)) is defined in such a manner that it includes all expenses incurred at the time or before the delivery of goods other than freight or cost of installation and tax is payable on sale. Accordingly, apart from basic value of goods under sales, CST is/was applicable on the expenses incurred at the time or before delivery of goods.

Conclusion:

Ergo, from the above exposition, in the humble view of the author, the ratio of the verdict held by hon'ble apex court in Intercontinental (Supra) will not be applicable into the GST Era and out of pocket expenses are includible into the value of supply in terms of section 15(2) unless it is specifically covered by the purview of pure agent.

(The author is Partner, J. Harjai & Associates, Chartered Accountants and the views expressed are strictly personal.)