“Reimbursements and cost recharges” normally ring the bell for corporates from transfer pricing and direct tax perspectives. However, companies should be mindful of indirect tax implications, as mere nomenclature may not be decisive in governing the taxability. There may be an element of service which is subsumed in such transactions.
A service provider ordinarily incurs certain expenses in the course of provision of service such as travelling expenditure, boarding and lodging spend, and mobile expenses, which are recovered from the service recipient. The key requirement under service tax is to derive a taxable value on which the tax can be imposed. So, the question arises, whether the reimbursement of expenses would be included in the value of taxable services and accordingly tax paid on it. Typically, such expenses are not in the nature of remuneration for services rendered and hence should not constitute consideration in the hands of service provider. However, the value on which service tax can be levied has been a debatable subject for long, particularly tax liability on reimbursable expenditures incurred by the service providers.
Examples of “cost recharges” are when a particular expense is incurred by a group company on behalf of the entire group. The cost of these services are, in turn, allocated across beneficiary entities and proportionately recovered from such group entities by way of reimbursements. Evidently, no services are provided and only reimbursements are claimed for expenses incurred.
The history of service tax on reimbursements can be traced to the late 1990s when the ambit of service tax was expanded with introduction of new services, and the Central Board of Excise and Customs (CBEC) issued its instruction on taxability and valuation of services. CBEC then clarified that the amount incurred (such as on travelling, boarding and lodging) by the service provider on behalf of client which is reimbursed on actual basis by the client is excluded from service tax.
In order to overcome the difficulties, the Union government in 2006 introduced the Valuation Rules for Service Tax, and clarified that circulars on valuation issued hitherto including those relating to reimbursement of expenses will have no applicability. The service tax department basis the Valuation Rules of 2006 started asking tax on reimbursable expenditures, i.e. on expenses incurred by one on behalf of another and recovered back.
This invited a new litigation on the issue, which went on seeing multiple courts corridors for constitutional validation of Valuation Rules. The matter was reposed by the Delhi High Court in the noted case of Intercontinental Consultants and Technocrats (P) Ltd in 2012, holding the value as per Section 67 of the Act as the gross amount charged for the taxable service rendered and thus the amount (reimbursable expenditure) must have nexus to taxable services. This lead to an appeal filed by the tax authorities before the Supreme Court. It would be interesting to see the fate of Delhi High Court judgment before the Supreme Court.
Interestingly, the definition of “consideration” was amended effective May 14, 2015. In service tax, “consideration” for the activity is an integral component to be existent for converting the activity into a service. The meaning of “consideration”, as provided in Explanation (a) to Section 67 of the Finance Act 1994, has been expanded with effect from May 14, 2015, to include reimbursements as consideration, for the purpose of taxable value.
The amended law now permits the taxation of these cross-recharges/reimbursements when incurred by the service provider and charged, in the course of providing or agreeing to provide a taxable service. Isolated reimbursements continue to escape the taxability, subject to fulfilment of prescribed conditions. The ones made while providing or agreeing to provide a taxable service are covered within the scope of amendment. Tax authorities, in particular, look for these transactions to be scrutinised in detail, and considering the recent amendment in service tax law, a granular examination is recommended for businesses doing cross-entity reimbursements. These arrangements may obliquely attract 14% additional tax on a unified transaction.
With the introduction of the proposed goods & services tax (GST) regime, it becomes prudent that the government should clearly articulate the legislation to address the issue of reimbursements and cross-recharges. It is an opportunity which the government has and should not be missed. Anyway, one of the mantras of a good GST regime is to have a tax policy which is clear and transparent. Timely action by the government on this issue will help all—tax authorities and taxpayers.
(With inputs from Preetam Singh, associate, Indirect Tax, PwC India)
The author is partner, Indirect Tax, PwC India