In this world nothing can be said to be certain, except death and taxes - Benjamin Franklin. This quote holds good as far as payment of taxes is concerned, nonetheless amount of taxes to be deposited is anything but certain in India.

Interestingly, although the levy of tax depends upon the happening of a particular event, the taxable base for payment of taxes may include an amount which otherwise has no connection with the taxable event in any way. For instance, excise duty is a tax on manufacture of an article in India, however excise duty is levied on clearance price of goods, which not only includes the manufacturing cost but also the manufacturer’s sales margin. Government is vested with full freedom to decide the tax base. Consequently, ‘valuation’ has been an area of constant litigation in Indian indirect taxes and service tax provisions are no different.

A service provider ordinarily incurs certain expenses in the course of provision of service such as traveling expenses, boarding and lodging expense, mobile expenses which are recovered from the service recipient. Rationally, reimbursements for such expenses are not in the nature of remuneration for services rendered and hence should not constitute consideration in the hands of service provider. Yet in service tax arena, much of the controversy is centered around the taxability of such out-of-pocket expenses and reimbursements recovered by the service providers from the service recipients.

There can be many such scenarios, where certain charges are recovered by way of reimbursements by service providers apart from the remuneration towards the services. A typical example of this is services rendered by a Chartered Accountant, who assists a client with statutory filings. Many a times while assisting the client, Chartered Accountants deposit statutory filing fee on behalf of clients or incur travel expenses rendering their professional services. While billing for his services the Chartered Accountant recovers these pay-outs / expenses as out-of-pocket expenses from the client. These charges are purely in the nature of reimbursements and have no ostensible connection with the services provided by the Chartered Accountant. On the other hand there are certain services, such as media agency services, services of clearing and forwarding agents wherein the remuneration is typically under a cost plus margin basis only. In such cases in fact the reimbursement forms major part of the cost of services rendered.

Another avenue of ambiguity in this context is the arrangements where only reimbursements are charged. A classic example of this is when certain services such as brand promotion services are availed by one of the group entities on behalf of the entire group. The cost of these services are in-turn allocated across the 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.

Previously, there was no specific provision to this effect and constant doubts remained as to the taxability of reimbursements for service tax purposes. But with the introduction of specific rules in this regard, the government made its intentions clear that service tax is indeed recoverable on out-of-pocket expenses and reimbursements.

After the introduction of these Rules, entire industry started paying service tax on these reimbursements until when Delhi High Court in the case of Intercontinental Consultants held that no service tax can be recovered on expenses as the Rules framed by the Government are beyond the powers imparted by statutory provisions. To overcome this decision of the Delhi High Court, the Government eventually through Union Budget 2015 amendment introduced enabling provision under the governing statute for levy of service tax on expense reimbursements. After this amendment, there is little scope of any dispute and all reimbursements or costs incurred by the service provider in the course of providing taxable service are liable to service tax.

Taxation of reimbursements has been a plaguing issue and has presented challenges in other countries as well. Thus, taking a cue from the European VAT laws, the Government has carved an exception to the applicability of service tax on these reimbursement and out of pocket expenses. This is when the person requesting reimbursements is merely acting as a ‘pure agent’. In service tax, 'pure agent' means a person who procures services on behalf of his client, while providing his own taxable service. A pure agent acts merely as a mediator between some service provider and his client. Value of services procured by pure agent is not taxable, when (i) service provider charges the client directly, (ii) pure agent does not hold tittle to such services, and (iii) pure agent receives the actual amount of such service from the client. The criteria of pure agent is therefore very stringent which most service providers find difficult to satisfy and remains another source of constant litigation.

It is also interesting to note that charging service tax on reimbursements many a time may lead to anomalies. For instance, if travel expenses of the service provider are paid by the client directly, the same are not taxable. On the contrary, while taking reimbursements it becomes a part of the value of taxable service and hence service tax becomes payable even on those charges. Importantly, under the income tax provisions, no withholding tax is to be deducted on mere cost reimbursements. Given this disconnect between the income tax and service tax treatment many business entities inadvertently end up missing payment of service tax on reimbursements and get into unwarranted litigation.

The impending introduction of Goods and Services Tax (‘GST’) regime presents itself as an opportunity for the government to address the ambiguity prevailing in the present regime. However, the matter is a double edged sword and needs to be addressed with due diligence. On one hand, certainly pure reimbursements of costs should ideally be out of scope of levy pf GST. However at the same time a straight jacket exclusion towards cost reimbursements under GST regime may result in opening avenues for unique ways of tax evasion.