With the introduction of Valuation Rules as of April 2006, the concept of ‘pure agent’ was introduced. This means that any expenditure incurred by a service provider are not liable to service tax, where such expenses have been incurred as a pure agent of the service recipient.
Further, a service provider would be construed as a pure agent of a service recipient if certain conditions were fulfilled. However, these conditions are rather stringent and practically difficult to fulfill. As a result, since April 2006, businesses have tended to pay service tax on out-of-pocket expenses which are charged from the client.
In the recent landmark case of Intercontinental Consultants and Technocrats Pvt Ltd (2012-TIOL-966-HCDel- ST), the Delhi High Court held that, under Section 67 of the service tax law (this section defines the ‘value’ on which service tax would be chargeable), service tax can be levied only on the gross amount charged for services. Reimbursements are not part of the gross amount charged for services and so the relevant provision of the Valuation Rules is outside the service tax law. No service tax can therefore be levied on reimbursements.
This ruling could lead to a number of further questions, such as:
- what is the impact on inter-company cross-charges done on a cost-to-cost basis
- can assessees claim a refund of service tax already paid on such reimbursements
- what is the impact on the on-going litigation on this issue.
Given the considerable revenue implications of this ruling, it is likely that the tax authorities will seek to appeal the decision in the Apex Court. Until this happens, the issue will remain the focus of much heated discussion. It will also be interesting to see whether the Government seeks to amend the relevant provisions retrospectively, a policy it has applied in the recent past on transactions such as renting.
Assessees who have been paying service tax on reimbursement receipts now face a dilemma over whether to stop paying tax on reimbursements in light of this ruling. The problem being that if this case is overturned by the Apex Court, or the Government makes a retrospective amendment, there could be a demand for tax as well as interest, if not a penalty.
In the meantime, it will be interesting to see whether businesses take the risk of not charging service tax on the recovery of out-of-pocket expenses. Developments need to be monitored closely.