Rule 5(i) requires that certain expenses and costs incurred by the service provider in the course of providing taxable services should be included in the value of service for the calculation of service tax
In a recent ruling, the Delhi High Court, in Intercontinental Consultants and Technocrats Pvt Ltd v Union of India & Anr. (2012-TIOL-966-HC-DEL-ST) held that the rule 5(i) of service tax valuation rules is ultra vires the charging provisions laid under section 66 and section 67 of the chapter V of the Finance Act, 1994.
Rule 5(i) requires that certain expenses and costs incurred by the service provider in the course of providing taxable services should be included in the value of service for the calculation of service tax. As per the court, this seeks to include reimbursement of expenses such as lodging, boarding, air travel expenses, etc incurred by the service provider in the course of providing services which goes beyond the consideration for taxable services brought to charge by the relevant provisions of the Act.
Additionally, the high court has also observed that the reimbursable expenses could have already suffered the tax at time of original purchase by the service provider and addition to the value of output service would lead to double taxation.
At one level, this judgment is sound. The court based its decision largely on the section covering valuation, section 67. Section 67 broadly provides that service tax would be charged on the consideration charged for the service that is provided. While there are many aspects covered by section 67, the overall thrust is that the value of services is comprised of the gross amount charged for the services that are provided. The Delhi High Court has duly examined whether the expenses charged in the case, air travel, hotel stay and the like were amounts charged for the services that were provided. Overall, the court concluded that the expenses charged to the client could not be considered as part of the amount charged “for such service”.
Accordingly, the court held that the provisions of rule 5(1) of the valuation rules travel beyond the limits laid down by section 67.
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On the face of it, many expenses that are charged to the client would not qualify as a part of the gross amount charged “for such service”. This is presumably because the expense is reimbursed by the client because it is incurred by the service provider and is not specifically for providing such service.
However, there may be some expenses which are closely linked to the provision of the service. An example of such an expense could be a leased line cost charged by a provider of software or back-office services. The question that could possibly arise is, do we need to apply this extremely subjective test to every expense billed to a client.
Even for expenses such as hotel and airfare costs, one can easily imagine another court taking a broader view of the concept. One could quite reasonably argue that all amounts paid by the client to the service provider are a part of the consideration “for such service”. If the contract envisages that there is a fixed consideration plus a reimbursement of certain expenses, the whole consideration is broadly, towards the provision of service.
The argument that this would lead to double taxation can also be rebutted, in most cases. Any service tax on the hotel or airfare expense would be available as a credit to the service provider, who incurs the hotel and airfare cost. In turn, service provider would invoice the out-of-pocket cost to the client and charge service tax.
Therefore, it seems unlikely that we have heard the last word on this issue. The department still has the option to challenge this judgement before the Apex court. We would have to wait and see whether the Supreme Court agrees with the Delhi High Court, or whether it chooses to have a different view of the matter.
This leaves the assessees who have been paying service tax on all the reimbursement receipts believing the validity of rule 5(i), in some confusion. The dilemma is whether they should consider this judgment and stop paying tax on reimbursements. The problem with this option is that if this case is overturned by the Apex court, there would be a demand for short payment of service tax from the service provider and also interest, if not penalty.
There is also the possibility of there being an amendment to section 67 that puts the issue beyond doubt. In the past several years, the government has found it prudent to effect many such changes through retrospective amendments.
Given all of the scenarios, it would seem that many service providers would opt for a safer course of action, and continue to charge service tax on all out of pocket costs billed to their clients.
(Supported by Tajinder Singh)
The Author is Leader, Indirect Tax Practice ,PwC India Email: pwctls.nd@in.pwc.com