INTRODUCTION:
Incurring of reimbursable expenditure by service provider during the course of providing his services and service receiver subsequently reimbursing them is the inevitable business expediency in certain service sectors. Inclusion of this expenditure in the value of taxable service for the purpose of paying service tax seems to be never ending litigation between Revenue and taxpayer. With the recent judicial pronouncements, it appeared that this issue is settling in a manner acceptable to taxpayer and Revenue. But Revenue has come up with a heavy punch by amending the definition of ‘Consideration’ in the explanation to Section 67 to seek the last laugh in this regard. Let us analyze how distorting the amendment is capable of!
LEGAL POSITION PRIOR TO FINANCE ACT, 2015 AMENDMENT:
(a) Legislative Framework:
Section 67 of the Finance Act, 1994 provides that value of taxable service shall be the gross amount charged by the service provider to service receiver in a case where the consideration for the taxable service is received in money. ‘Consideration’ for this purpose is defined in the explanation to Section 67 to include any amount that is payable for the taxable services provided or to be provided.
Rule 5(1) of the Service Tax (Determination of Value) Rules, 2006 provides that where any expenditure or costs are incurred by the service provider in the course of providing taxable service, all such expenditure or costs shall be treated as consideration for the 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.
Rule 5(2) provides that where any expenditure or costs incurred by the service provider as a pure agent of the recipient of service shall be excluded from the value of taxable service subject to satisfaction of certain specified conditions.
(b) Rule 5(1) Ultra Vires Section 67:
In the case of Intercontinental Consultants & Technocrats Pvt Ltd vs. UOI, 2012-TIOL-966-HC-DEL-ST, wherein it was held that Section 67 authorizes the determination of the value of the taxable service as the gross amount charged by the service provider for such service provided or to be provided by him, in a case where the consideration for the service is in money. It is only the value of such service that can be brought to charge and nothing more. The quantification of the value of the service can therefore never exceed the gross amount charged by the service provider for the service provided by him. (Para 10)
On the said premise, the Delhi High Court has struck down Rule 5(1) stating it travels beyond Section 66 and 67 by requiring inclusion of reimbursable expenditure incurred by service provider in the value of taxable service for the purpose of charging service tax. Thus the rule is ultra vires Section 66 and 67 of the Finance Act (Para 11).
(c) Reimbursable Expenditure vis-à-vis Consideration:
In view of the above Delhi High Court decision, it is well established that reimbursable expenditure is not subject to service tax. How what constitutes reimbursable expenditure is not being discussed by the Delhi High Court. There is a thin line of difference between reimbursable expenditure and other expenditure having the characteristics of consideration. The following judgments throw light in this regard.
The Larger Bench of the Bangalore Tribunal in the case of Sri Bhagawathy Traders vs CCE, Coachin, 2011(24)STR290(Tri-LB) wherein it was held that the concept of 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 goods and recovers the said amount from the buyer of the goods. Similar is the situation in the transaction between a service provider and service recipient. 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.
In the case of Naresh Kumar & Co vs CCEx, 2008(11)STR 578, wherein the Kolkata Tribunal has held that expenditure which is indispensable or inevitable to provide a service, such costs cannot be considered as reimbursable expenditure and the same will essentially forms part of the cost of the service. Expenditure incurred being incidental or ancillary to perform an act, shall essentially make value addition to service.
Further in the case of Rolex Logistics Pvt Ltd vs CCEx, 2009(13)STR147, has held that service tax liability in terms of section 67 is only on the gross amounts received towards the service rendered. If the service provider in the course of rendering service has to make such payment on behalf of 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 avoiding delay.
In Nutshell:- Reimbursable expenditure is nothing but the expenditure incurred by service provider but the legal or contractual obligation to incur such expenditure is on service receiver. Such expenditure should not be of indispensable/incidental/ancillary to the services provided by service provider. Normally, the requirement to incur such expenditure by service provider arises out of business expediency for quicker rendering of services. There are several other decisions which more or less advocate the above proposition only.
(d) Examples for Better Understanding:
X, a clearing and forwarding agent located in Hyderabad has entered into an agreement with his client located in Delhi to provide services receiving the goods from the factory of the client, warehousing the goods in the warehouse, dispatching of goods as per the directions of the client, maintaining of records in this regard. The agreement detailed that the rent for warehouse is the obligation of the Client but is paid by X. X has also incurred loading and unloading charges from a contract labour. X wants to claim the rent and loading charges as reimbursable expenditure.
In the above example, there is a clear contractual obligation on client to incur rent for the warehouse. The same cannot be consideration by any means to X. Therefore, the same can be claimed as reimbursable expenditure. Coming to loading charges, receiving of goods, storing and dispatching them is the contractual obligation of X, service provider. In such case, the expenses of loading are ancillary/incidental to the services provided by X. They may not acquire the character of reimbursable expenditure and are required to be included in the value of taxable service for the purpose of payment of service tax.
If the expenditure incurred is on behalf of service receiver (legal or contractual obligation) then the same do not take the character of consideration but is of reimbursable expenditure. Hence, it is not includible in the value of taxable service. Similarly, where the expenditure incurred is merely incidental or ancillary to provide services, then it would partake the character of artificial offloading/bi-furcation of costs to reduce the incidence of service tax, hence includible in the value of taxable service. Thus the issue of reimbursable expenditure has almost settled in an acceptable/justifiable manner protecting the interests of both service provider and Revenue.
LEGAL POSITION AFTER FINANCE ACT, 2015 AMENDMENT:
Now the word ‘Consideration’ for the purpose of Section 67 as appearing in the Explanation to Section 67 is amended as follows;
‘Consideration’ includes—
i. Any amount that is payable for the taxable services provided or to be provided;
ii. 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.
iii. ……………………..
In light of the above amendment (clause ii), it is targeted to include reimbursable expenditure incurred by service provider in the course of providing a taxable within the ambit of consideration thereby nullifying the impact of Intercontinental case in so far as the proposition that reimbursable expenditure would not partake the character of consideration. Simultaneously, the Rule 5(1) and consequently Rule 5(2) are given re-birth by creating an exception in the said clause to exclude the certain expenditure incurred by service provider in specified circumstances and subject to prescribed conditions.
It has been clarified in TRU Circular (F.No.334/5/2015-TRU), that the intention of the legislature has always been to include reimbursable expenditure in the value of taxable service. However in some cases, courts have taken a contrary view thus requiring the intention clearly being stated in Section 67.
With the present amendment read with Rule 5(1), all reimbursable expenditure is required to be included in the value of taxable service for payment of service tax. The only way in which they can be kept out of service tax is by claiming that the said expenditure is incurred as Pure Agent in terms of conditions laid down in Rule 5(2). This sub-rule provides that a service provider is required to satisfy four conditions in order to qualify as ‘pure agent’. Apart from this, eight other conditions are required to be cumulatively satisfied in order to exclude reimbursable expenditure from the value of taxable service. The eight conditions details out the manner in which the transaction of reimbursable expenditure should be effected by service provider after being satisfied as pure agent. But the real difficulty is in satisfying the conditions of pure agent which are reproduced as follows;
a. enters 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 intends to hold nor holds any title to the goods or services so procured or provided as pure agent of the recipient of service;
c. does not use such goods or services so procured; and
d. receives only the actual amount incurred to procure such goods or services.
The essential conditions to be satisfied are that the service provider incurring reimbursable expenditure relating to services should not own any title and should not use these services. Owning of title to the services or usage of services is of very subjective nature because of their intangible character.
Usage of service may either be perceived in terms of immediate benefits or in terms of their ultimate motive. In the above example, considering the legal position prior to the amendment, it is concluded that warehouse rent incurred by service provider being clearing and forwarding agent qualifies to be a reimbursable expenditure. After the amendment, if the said conditions of pure agent are applied, a view may be taken that the service by way of renting of warehouse is used by the clearing and forwarding agent for storing of goods and forwarding the same as per the directions of service receiver. However it can also be viewed that the access of warehouse by service provider is merely to provide his services to service receiver and it is the service receiver who has used the renting of warehouse services. Thus title and usage of services is the determinative factor for a service provider to qualify as pure agent. This is very subjective and requires judicial examination.
Thus the amendment distorts the possibility of not including in the value of taxable service, certain expenditure incurred by service provider on behalf of service receiver under clear contractual terms.
CONCLUSION:
In view of the above discussion, it can be said that Finance Act, 2015 amendment has given wide scope to Pro Revenue officers to take a stand that a particular reimbursable expenditure is includible in the value of taxable service though in clear contractual terms such expenditure is the obligation of service receiver but is incurred by service provider and is over and above the services provided by him. Thus paradox rejuvenated.
About the author: The author is a Hyderabad Based Practicing Chartered Accountant. He can be reached at camanindar@icai.org
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