With revenue authorities pushing to garner greater taxes, Delhi High Court, in its recent decision in Intercontinental Consultants and Technocrats Pvt Ltd v Union of India & Anr, has ruled that taxing reimbursements for out-of-pocket expenses would lead to double taxation and such reimbursements cannot be taxed.
The court found that rule 5(1) of the Service Tax (Determination of Value) Rules, 2006 (Valuation Rules), which seeks to include within the taxable value expenditures/costs incurred by the service provider “in the course of providing taxable service”, violates the taxing contours prescribed under sections 66 and 67 of the Finance Act, 1994, which only cover consideration received “for such service provided or to be provided by him”. The court ruled that expenditure or costs incurred by the service provider in the course of providing the taxable service could not be considered as the gross amount charged by the service provider “for such service”.
Distinction not mentioned
The distinction between reimbursements in relation to services that are used by the service provider for rendering the final service, as opposed to reimbursements in relation to pass-through services obtained by the service provider on behalf of and directly utilized by the service recipient, was apparently not pointed out or examined by the court. As the Supreme Court held in All India Federation of Tax Practitioners v Union of India, service tax is a value-added tax which is in the nature of a destination-based consumption tax. Conceptually, the value of the services that have been used to provide a service should be included to calculate the taxable value of the service, so that after the set-off of taxes paid for all such services, tax is in effect levied on the value addition provided by the service provider.
Applying the principle of equivalence which equates consumption of goods with consumption of service, as both satisfy human needs, the jurisprudence on taxation of manufacture of goods is pertinent. The Supreme Court inUjjagar Prints and Others v Union of India held that the value of the final goods will include the value of all the raw materials that are used in making the final goods. Costs/expenditures relatable to services used by the service provider for providing the final service should, by analogy, be included in the value of the final service.
The legislative intent to include costs in relation to services used by the service provider and exclude pass-through services emerges on a reading of rule 5(1) with rule 5(2) of the Valuation Rules. While rule 5(1) includes all kinds of reimbursements, rule 5(2) provides for exclusion of reimbursements used by a “pure agent”, who does not own or use such services but procures them on behalf of the service receiver.
The above distinction is supported by the legal position before the Valuation Rules came into effect on 19 April 2006 in that: (1) section 67 (as it was before that date) specifically provided that the value of fares collected by air/rail travel agents was to be excluded from the taxable base; (2) harmonizing the decisions of various benches of the Customs, Excise and Service Tax Appellate Tribunal on the position before 19 April 2006, a larger bench of the tribunal in M/s Shri Bhagavathy Traders v Commissioner of Central Excise, Cochin held that reimbursements were permitted to be excluded only in relation to expenses undertaken on behalf of a service receiver and paid for on actual basis; and (3) clarificatory circulars of the apex board issued for specific services provided for exclusion of costs of services which are pass-through in nature.
The decision does not address questions such as whether a particular component of gross value received is reimbursement or charge “for such service” and what is the “value of service”. It further does not prescribe any condition that may be satisfied or documentary evidence that may be relied on to demonstrate that the consideration is “for such service”. These questions are particularly relevant for taxing “mark-up” businesses, where entire services are outsourced and the cost of the outsourced service plus a mark-up is charged to the final customer.
Since this is the only high court ruling on the issue, the decision is binding on all lower courts and adjudicatory authorities, and may form the basis for applying for refunds of service tax already paid under rule 5(1), provided the other statutory conditions of limitation and unjust enrichment are satisfied.
The impact of the decision may be nullified if the Supreme Court takes a contrary view either in a challenge by the department or in deciding the pending appeal against the decision in the Shri Bhagavathy Traders case.
Economic Laws Practice is a full-service law ﬁrm with headquarters in Mumbai and ofﬁces in New Delhi, Pune and Ahmedabad. Ranjeet Mahtani is a senior associate at the firm and Stella Joseph is an associate.
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