No Service Tax on Reimbursement of Expenses

The service tax will easily qualify as the legislation which has witnessed the maximum changes over the last 16 years. What started off as a simple tax on three services, has now turned into a cash cow for the Government with revenues expected to cross Rs 100 million soon. The negative list introduced in 2012 is expected to be a game-changer for service tax law as it is touted as a pre-cursor to the Goods and Service Tax (GST) - if and when it does arrive. The Delhi High Court is turning out to be a good place to turn to for consultation on service tax. Take for instance, its landmark judgement in the case of Home Solution Retail that base rent from property cannot be subject to service tax. But the Government reversed this ruling with its Brahmastra - amending the Act to accommodate the levy. In a recent case of Intercontinental Consultants and Technocrats Pvt Ltd, the Delhi High Court has rendered another quality landmark judgement that reimbursement of expenses is not subject to service tax. Rule 5 (1) The Court pronounced that Rule 5 (1) of the Service Tax Valuation Rules which provides for inclusion of the expenditure or costs incurred by the service provider in the course of providing the taxable service in the value for the purpose of charging service tax is ultra vires of Section 66 and 67 of the Finance Act, 1994. It added that the Rule travels much beyond the scope of these two sections and to this extent, it has to be struck down as a bad law. The expenditure or costs incurred by the service provider, in the course of providing the taxable service, can never be considered as the gross amount charged by the service provider 'for such service' provided by him, it said. It appears that the decision to integrate central excise and service tax was not a very reasoned one. Valuation and cenvat credit are both integrally connected with central excise law, but alien to service tax Illustration 3 given below Rule 5 (1) amplifies what is meant. In the illustration given, the architect who renders the service incurs expenses such as telephone charges, air travel tickets, hotel accommodation, among others, to enable him to effectively perform the services. The illustration says that these expenses are to be included in the value of the taxable service. The illustration clearly shows how the Rule breaches the boundaries of Section 67. The High Court opined that apart from travelling beyond the scope and mandate of the Section, the Rule may also result in double taxation. If the expenses on air travel tickets are already subject to service tax and is included in the bill, to charge service tax again on the expense will certainly amount to double taxation. It is true that there can be double taxation, but it is equally true that it should be clearly provided for and intended; at any rate, double taxation cannot be enforced by implication. Delhi High Court decision Section 66 levies service tax at a particular rate on the value of taxable services. Section 67 (1) makes the provisions of the section subject to the provisions of Chapter V, which includes Section 66. This is a clear mandate that the value of taxable services for charging service tax has to be in consonance with Section 66 which levies a tax only on the taxable service and nothing else. There is thus an in built mechanism to ensure that only the taxable service shall be evaluated under the provisions of 67. Clause (i) of sub-section (1) of Section 67 provides that the value of the taxable service shall be the gross amount charged by the service provider 'for such service'. Reading Section 66 and Section 67 (1) (i) together and harmoniously, it seems clear to us that in the valuation of the taxable service, nothing more and nothing less than the consideration paid as quid pro quo for the service can be brought to charge. Sub-section (4) of Section 67 which enables the determination of the value of the taxable service 'in such manner as may be prescribed' is expressly made subject to the provisions of sub-section (1). The thread which runs through Sections 66, 67, and 94, which empowers the Central Government to make rules for carrying out the provisions of Chapter V of the Act is manifest, in the sense that only the service actually provided by the service provider can be valued and assessed to service tax. We are, therefore, undoubtedly of the opinion that Rule 5 (1) runs counter and is repugnant to Sections 66 and 67 of the Act and to this extent it is ultra vires. It purports to tax not what is due from the service provider under the charging Section, but it seeks to extract something more from him by including in the valuation of the taxable service the other expenditure and costs which are incurred by the service provider "in the course of providing taxable service". What is brought to charge under the relevant Sections is only the consideration for the taxable service. By including the expenditure and costs, Rule 5(1) goes far beyond the charging provisions and cannot be upheld. Budget 2013 could provide a clue as to whether the Government intends to amend the taxing provisions that impose service tax on reimbursement of expenses It is no answer to say that under sub-section (4) of Section 94 of the Act, every rule framed by the Central Government shall be laid before "The fact that the rules framed under the Act have to be laid before each House of Parliament would not confer validity on a rule if it is made not in conformity with Section 40 of the Act." Thus Section 94 (4) does not add any greater force to the Rules than what they ordinarily have as species of subordinate legislation. Impact While the jurisdiction of this decision will be restricted to the jurisdiction of the Delhi High Court, it will trigger a number of similar writs in High Courts across the country probably leading to a reference to the Apex Court too. In hindsight, it appears that the decision to integrate central excise and service tax was not a very reasoned one. Valuation and Cenvat Credit are both integrally connected with central excise law but alien to service tax. Manufacture and service are totally different in nature and envisaging a common law for both is not going to be easy. Since inception, service tax law has used the term gross amount charged to determine the value of the service. This can be taken to mean the amount that one charges for rendering a service – for instance a charge by a lawyer at a rate per hour based on the number of hours spent. Logically, one charges only for the value of services rendered but expenses are claimed as a reimbursement. Rule 5(1) of the Valuation Rules did not make this distinction between a charge and a claim and included all expenses in the value except expenses incurred as a pure agent. The concept of a pure agent may not be valid in the service industry as it can be claimed that one always acts as a pure agent of a client irrespective of the number of clients being serviced. Striking down Rule 5 (1) under the pretext of double taxation may not hold water for long as double taxation as a concept has been accepted in the country and has been blessed by the Apex Court too. The difference between a charge and a claim should be the reason for not levying service tax on expenses reimbursement. The Government should take this decision in its right spirit and not reuse the Brahmastra and amend Rule 5 (1) to retrospectively include all reimbursements as has been its want. The law should state that as long as there is a one-to-one correspondence between the claim and the expense and there is no profit being made by the service provider out of the expense claim, it should not be eligible to tax. Doing anything different will only tempt a litigious tax-payer to knock on the comforting chambers of the Delhi High Court frequently. What should tax-payers do? History has shown us that the Department does not accept stances taken on the basis of judgments other than the jurisdictional High Court. Hence, tax-payers who agree with the decision of the Delhi High Court will be well-advised to get together and file a writ in their jurisdictional High Court. However, Budget 2013 could provide a clue as to whether the Government intends to nip this issue in the bud by amending the taxing provisions. Tax-payers could wait for this event to pass before filing their writs.