LEGAL ISSUE: Whether reimbursable expenses incurred by a service provider can be included in the value of taxable services for the purpose of service tax.
CASE TYPE: Service Tax
Case Name: Union of India & Anr. vs. M/s. Intercontinental Consultants and Technocrats Pvt. Ltd.
[Judgment Date]: 7 March 2018
Date of the Judgment: 7 March 2018
Citation: (2018) INSC 194
Judges: A.K. Sikri, J. and Ashok Bhushan, J.
Can the government tax expenses that a service provider incurs and is later reimbursed for? The Supreme Court of India recently addressed this question, which has significant implications for businesses across various sectors. This judgment clarifies that service tax cannot be levied on expenses that are merely reimbursed to the service provider, as these are not part of the value of the service itself. The ruling was delivered by a two-judge bench comprising Justice A.K. Sikri and Justice Ashok Bhushan, with Justice A.K. Sikri authoring the opinion.
Case Background
M/s. Intercontinental Consultants and Technocrats Pvt. Ltd. (the respondent) provides consulting engineering services, specializing in infrastructure projects. They were engaged by the National Highway Authority of India (NHAI) for various highway projects. In the course of their work, they incurred expenses like air travel and hotel stays, which were then reimbursed by NHAI. The respondent paid service tax on the fees for their services but not on the reimbursed expenses.
The Service Tax Department initiated an audit for the financial years 2002-03 to 2006-07, asserting that service tax was due on the gross value, including the reimbursed expenses. Consequently, a show cause notice was issued on March 17, 2008, demanding service tax on these reimbursements, citing Rule 5(1) of the Service Tax (Determination of Value) Rules, 2006.
The respondent challenged the show cause notice and the validity of Rule 5 in the High Court of Delhi, arguing that it was unconstitutional and ultra vires Sections 66 and 67 of the Finance Act, 1994.
Timeline
| Date | Event |
|---|---|
| 2002-03 to 2006-07 | Respondent provides consulting engineering services and gets reimbursed for expenses. |
| 19.10.2007 | Superintendent (Audit) Group II (Service Tax), New Delhi issues a letter to the petitioner regarding service tax audit. |
| 17.03.2008 | Show cause notice issued by Commissioner, Service Tax, demanding service tax on reimbursed expenses. |
| 2008 | Respondent files Writ Petition No. 6370 of 2008 in the High Court of Delhi challenging Rule 5. |
| 30.11.2012 | High Court of Delhi declares Rule 5 ultra vires Sections 66 and 67 of the Finance Act, 1994. |
| 07.03.2018 | Supreme Court upholds the High Court’s decision, dismissing the appeals. |
Course of Proceedings
The High Court of Delhi, in its judgment dated November 30, 2012, ruled in favor of the respondent, declaring Rule 5 of the Service Tax (Determination of Value) Rules, 2006 as ultra vires Sections 66 and 67 of the Finance Act, 1994. The High Court held that the rule, which included reimbursed expenses in the taxable value, went beyond the scope of the Act.
The Union of India, the appellant, appealed this decision to the Supreme Court of India, arguing that Rule 5 was a valid interpretation of Section 67, which deals with the valuation of taxable services.
Legal Framework
The core of the dispute revolves around the interpretation of Section 67 of the Finance Act, 1994, which deals with the valuation of taxable services for charging service tax, and Rule 5 of the Service Tax (Determination of Value) Rules, 2006.
Section 66 of the Finance Act, 1994, is the charging section that imposes service tax on the value of taxable services. It states:
“there shall be levy of tax (hereinafter referred to as the service tax) @ 12% of the value of taxable services referred to in sub-clauses …..of Section 65 and collected in such manner as may be prescribed.”
Section 67 of the Finance Act, 1994, as it stood before amendment on May 1, 2006, stated:
“For the purposes of this Chapter, the value of any taxable service shall be the gross amount charged by the service provider for such provided or to be provided by him.”
After the amendment on May 1, 2006, Section 67 reads:
“(1) Subject to the provisions of this Chapter, where service tax is chargeable on any taxable service with reference to its value, then such value shall,
(i) in a case where the provision of service is for a consideration in money, be the gross amount charged by the service provider for such service provided or to be provided by him;
(4) Subject to the provisions of sub sections (1), (2) and (3), the value shall be determined in such manner as may be prescribed.”
Rule 5 of the Service Tax (Determination of Value) Rules, 2006, states:
“5. Inclusion in or exclusion from value of certain expenditure or costs.
(1) Where any expenditure or costs are incurred by the service provider in the course of providing taxable service, all such expenditure or costs shall be treated as consideration for the taxable service provided or to be provided and shall be included in the value for the purpose of charging service tax on the said service.”
The core issue is whether Rule 5, which includes reimbursed expenses in the value of taxable services, is consistent with Section 67 of the Finance Act, 1994. The High Court held that the rule went beyond the scope of the Act and was therefore ultra vires.
Arguments
Appellant’s Arguments (Union of India):
-
The appellant argued that the term “gross amount charged” in Section 67 includes all amounts received by the service provider, not just the remuneration for the service.
- They contended that essential input costs, such as transportation, office rent, and equipment, should be included in the gross amount charged.
- They argued that Rule 5 was a valid interpretation of Section 67, as it merely clarified what constitutes the “gross amount charged.”
- The appellant relied on the principle in excise law, stating that the same principles apply to service tax matters, and therefore, all costs incurred in providing the service should be included in the taxable value.
- They argued that Section 67, which deals with valuation, should be considered independently of Section 66, the charging section.
Respondent’s Arguments (M/s. Intercontinental Consultants and Technocrats Pvt. Ltd.):
-
The respondent argued that Section 66, the charging section, levies tax only on the “value of taxable services,” and Section 67 refers to the “gross amount charged for such service.”
- They contended that any amount collected that is not directly for providing the taxable service cannot be taxed.
- They argued that the term “such service” in Section 67 limits the taxable value to the consideration for the service itself.
- The respondent pointed out that the Finance Act, 2015, amended Section 67 to include reimbursement of expenses, which implies that such reimbursements were not taxable before the amendment.
- They referred to a circular from 1997 which clarified that reimbursable expenses should not be included in the value for computing service tax.
- The respondent relied on the principle that a tax statute must clearly define the subject of the tax, the person liable, and the rate of tax, and any ambiguity is fatal to its validity.
[TABLE] of Submissions
| Main Submission | Sub-Submissions (Appellant) | Sub-Submissions (Respondent) |
|---|---|---|
| Interpretation of “Gross Amount Charged” |
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| Validity of Rule 5 |
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| Impact of Amendment to Section 67 |
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| Reliance on Excise Law |
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Innovativeness of the argument: The respondent’s argument that the amendment to Section 67 by the Finance Act, 2015, which explicitly included reimbursement of expenses, was innovative. It suggested that prior to the amendment, the law did not permit the inclusion of such reimbursements, thereby supporting their claim that Rule 5 was ultra vires.
Issues Framed by the Supreme Court
The Supreme Court framed the following issue for determination:
- Whether Rule 5 of the Service Tax (Determination of Value) Rules, 2006, which includes reimbursable expenses in the value of taxable services, is ultra vires Sections 66 and 67 of the Finance Act, 1994.
Treatment of the Issue by the Court
| Issue | Court’s Decision | Reason |
|---|---|---|
| Whether Rule 5 is ultra vires Sections 66 and 67 of the Finance Act, 1994 | Rule 5 is ultra vires Section 67. | Section 67 specifies that the value of taxable service is the gross amount charged for “such service,” and reimbursed expenses are not part of this value. The amendment to Section 67 in 2015, which included reimbursements, was a substantive change and not a clarification. |
Authorities
The Supreme Court considered the following authorities:
On the interpretation of statutes and rules:
- Central Bank of India & Ors. v. Workmen, etc., [(1960) 1 SCR 200] – Supreme Court of India: Rules cannot override or overreach the provisions of the main enactment.
- Babaji Kondaji Garad v. Nasik Merchants Co-operative Bank Ltd., [(1984) 2 SCC 50] – Supreme Court of India: If there is any conflict between a statute and subordinate legislation, the statute prevails.
- State of U.P. & Ors. v. Babu Ram Upadhya, [(1961) 2 SCR 679] – Supreme Court of India: Rules should be in conformity with the statute.
- CIT v. S. Chenniappa Mudaliar, [(1969) 74 ITR 41] – Supreme Court of India: A rule that conflicts with the main enactment has to give way to the provisions of the Act.
- Bimal Chandra Banerjee v. State of M.P. & Ors., [(1971) 81 ITR 105] – Supreme Court of India: Rules are meant to carry out the provisions of the Act and cannot take away what is conferred by the Act.
- CIT, Andhra Pradesh v. Taj Mahal Hotel, [(1971) 82 ITR 44] – Supreme Court of India: Rules cannot whittle down the effect of the Act.
- Commissioner of Customs and Excise v. Cure and Deeley Ltd., [(1961) 3 WLR 788 (QB)] – Queens Bench of England: Principles of statutory interpretation.
On the nature of taxation:
- Jain Brothers v. Union of India, [(1970) 77 ITR 107] – Supreme Court of India: Double taxation is permissible only if categorically provided for and intended, not by implication.
- Mathuram Agrawal v. State of Madhya Pradesh, [(1999) 8 SCC 667] – Supreme Court of India: A tax statute must clearly define the subject of the tax, the person liable, and the rate of tax.
- Govind Saran Ganga Saran v. Commissioner of Sales Tax & Ors., [(1985) Suppl. SCC 205] – Supreme Court of India: The components of a tax must be clearly and definitely ascertainable.
On the interpretation of Section 67 of the Finance Act, 1994:
- Union of India & Ors. v. Bombay Tyre International Limited & Ors., [(1984) 1 SCC 467] – Supreme Court of India: Valuation of a taxable service has to be taken into consideration and no assistance can be taken from the charging section.
On the retrospective application of laws:
- Commissioner of Income Tax (Central)-I, New Delhi v. Vatika Township Private Limited, [(2015) 1 SCC 1] – Supreme Court of India: Unless a contrary intention appears, a legislation is presumed not to be intended to have a retrospective operation.
Relevant Legal Provisions:
- Section 66 of the Finance Act, 1994: Charging section for service tax.
- Section 67 of the Finance Act, 1994: Valuation of taxable services.
- Rule 5 of the Service Tax (Determination of Value) Rules, 2006: Inclusion or exclusion of certain expenditures in the value of taxable services.
[TABLE] of Authorities Considered by the Court
| Authority | Court | How Considered |
|---|---|---|
| Central Bank of India & Ors. v. Workmen, etc. | Supreme Court of India | Followed – Rules cannot override the main enactment. |
| Babaji Kondaji Garad v. Nasik Merchants Co-operative Bank Ltd. | Supreme Court of India | Followed – Statute prevails over subordinate legislation. |
| State of U.P. & Ors. v. Babu Ram Upadhya | Supreme Court of India | Followed – Rules must conform to the statute. |
| CIT v. S. Chenniappa Mudaliar | Supreme Court of India | Followed – Rules must give way to the Act. |
| Bimal Chandra Banerjee v. State of M.P. & Ors. | Supreme Court of India | Followed – Rules cannot take away what is conferred by the Act. |
| CIT, Andhra Pradesh v. Taj Mahal Hotel | Supreme Court of India | Followed – Rules cannot whittle down the effect of the Act. |
| Commissioner of Customs and Excise v. Cure and Deeley Ltd. | Queens Bench of England | Referred – Principles of statutory interpretation. |
| Jain Brothers v. Union of India | Supreme Court of India | Followed – Double taxation must be explicit. |
| Mathuram Agrawal v. State of Madhya Pradesh | Supreme Court of India | Followed – Tax statute must be clear. |
| Govind Saran Ganga Saran v. Commissioner of Sales Tax & Ors. | Supreme Court of India | Followed – Tax components must be ascertainable. |
| Union of India & Ors. v. Bombay Tyre International Limited & Ors. | Supreme Court of India | Followed – Valuation is separate from charging section. |
| Commissioner of Income Tax (Central)-I, New Delhi v. Vatika Township Private Limited | Supreme Court of India | Followed – Laws are generally prospective. |
Judgment
How each submission made by the Parties was treated by the Court?
| Party | Submission | Court’s Treatment |
|---|---|---|
| Appellant | “Gross amount charged” includes all amounts received, including reimbursements. | Rejected – Court held that “gross amount charged” refers only to the consideration for the service itself. |
| Appellant | Rule 5 is a valid interpretation of Section 67. | Rejected – Court held that Rule 5 goes beyond the mandate of Section 67. |
| Appellant | Principles of excise law apply to service tax. | Rejected – Court held that the context was entirely different. |
| Respondent | Section 67 refers to “gross amount charged for such service,” limiting the taxable value. | Accepted – Court agreed that “such service” limits the taxable value to the consideration for the service itself. |
| Respondent | Amendment to Section 67 in 2015 implies that reimbursements were not taxable before. | Accepted – Court agreed that the amendment was a substantive change and not a clarification. |
| Respondent | Reimbursable expenses should not be included in the value for computing service tax. | Accepted – Court agreed that reimbursements are not part of the value of the service. |
How each authority was viewed by the Court?
- The Court relied on Central Bank of India & Ors. v. Workmen, etc. [CITATION], Babaji Kondaji Garad v. Nasik Merchants Co-operative Bank Ltd. [CITATION], State of U.P. & Ors. v. Babu Ram Upadhya [CITATION], CIT v. S. Chenniappa Mudaliar [CITATION], Bimal Chandra Banerjee v. State of M.P. & Ors. [CITATION], and CIT, Andhra Pradesh v. Taj Mahal Hotel [CITATION] to emphasize that rules cannot go beyond the statute.
- The Court used Jain Brothers v. Union of India [CITATION] to support the view that double taxation must be explicit and not by implication.
- The Court cited Mathuram Agrawal v. State of Madhya Pradesh [CITATION] and Govind Saran Ganga Saran v. Commissioner of Sales Tax & Ors. [CITATION] to highlight that a tax statute must be clear and unambiguous.
- The Court referred to Union of India & Ors. v. Bombay Tyre International Limited & Ors. [CITATION] to clarify that the valuation of a taxable service should be considered independently of the charging section.
- The Court relied on Commissioner of Income Tax (Central)-I, New Delhi v. Vatika Township Private Limited [CITATION] to assert that laws are generally prospective unless explicitly stated otherwise.
The Supreme Court held that Section 66 of the Finance Act, 1994, refers to service tax on the ‘value of taxable services’. The Court emphasized that the expression ‘such’ in Section 67 is crucial, meaning that the gross amount charged must be for providing ‘such’ taxable services.
The Court reasoned that any amount collected not for providing such taxable service cannot be part of the valuation. The Court stated that the valuation of taxable service cannot be more or less than the consideration paid for rendering the service.
The Court noted that Section 67(4) empowers the rule-making authority to determine the manner of valuation, but this is subject to Section 67(1), which limits the tax to the services actually provided by the service provider.
The Court reiterated the principle that rules cannot go beyond the statute, citing Babaji Kondaji Garad [CITATION], Chenniappa Mudaliar [CITATION], and Taj Mahal Hotel [CITATION].
The Court highlighted that the legislature amended Section 67 in 2015 to include reimbursable expenses, indicating that such expenses were not included before the amendment. The Court held that this amendment was a substantive change and not a clarification and therefore, has to be prospective in nature.
The Court concluded that Rule 5 of the Service Tax Rules was ultra vires Section 67 of the Finance Act, 1994, and therefore, the appeals were dismissed.
“In this hue, the expression ‘such’ occurring in Section 67 of the Act assumes importance. In other words, valuation of taxable services for charging service tax, the authorities are to find what is the gross amount charged for providing ‘such’ taxable services.”
“As a fortiori, any other amount which is calculated not for providing such taxable service cannot a part of that valuation as that amount is not calculated for providing such ‘taxable service’.”
“Mandate of sub-section (1) of Section 67 is manifest, as noted above, viz., the service tax is to be paid only on the services actually provided by the service provider.”
The Court did not have any dissenting opinions.
The Court’s decision means that service providers are not liable to pay service tax on expenses that they incur and are reimbursed for by their clients. This decision has implications for various sectors where service providers incur expenses on behalf of their clients.
The Court’s reasoning was based on a strict interpretation of Section 67, which it held limited the taxable value to the consideration for the service itself. The Court rejected the argument that the term “gross amount charged” included all amounts received by the service provider.
The Court’s decision also means that Rule 5 of the Service Tax Rules, which included reimbursed expenses in the value of taxable services, was ultra vires.
The Court’s decision has potential implications for future cases involving the interpretation of tax statutes and the relationship between primary legislation and subordinate rules.
What weighed in the mind of the Court?
The Supreme Court’s decision was primarily influenced by a strict interpretation of the legal provisions, particularly Section 67 of the Finance Act, 1994. The Court focused on the phrase “for such service,” emphasizing that the value of taxable services should only include the consideration for the service itself and not reimbursements. The Court was also influenced by the principle that rules cannot go beyond the statute and that tax laws should be clear and unambiguous.
The Court also considered the legislative intent behind the amendment to Section 67 in 2015, which explicitly included reimbursements, suggesting that such reimbursements were not intended to be taxed prior to the amendment.
Sentiment Analysis of Reasons
| Reason | Percentage |
|---|---|
| Strict Interpretation of Section 67 | 40% |
| Rules cannot go beyond the Statute | 30% |
| Legislative intent behind the 2015 amendment | 20% |
| Tax laws should be clear and unambiguous | 10% |
Fact:Law Ratio
| Consideration | Percentage |
|---|---|
| Fact | 20% |
| Law | 80% |
Logical Reasoning:
Key Takeaways
- Service providers are not liable to pay service tax on expenses that are reimbursed by their clients.
- Rule 5 of the Service Tax (Determination of Value) Rules, 2006, has been declared ultra vires Section 67 of the Finance Act, 1994.
- The amendment to Section 67 of the Finance Act, 1994, in 2015, which explicitlyincluded reimbursement of expenses, was a substantive change and not a clarification.
- The judgment reinforces the principle that tax laws must be clear and unambiguous, and that rules cannot go beyond the scope of the primary legislation.
- The decision provides clarity for businesses that incur reimbursable expenses, ensuring they are not taxed on amounts that are not part of their service value.
- This case highlights the importance of carefully interpreting tax statutes and the relationship between primary legislation and subordinate rules.
Future Implications
This judgment has set a precedent for how reimbursable expenses are treated under service tax law. It reinforces the principle that tax laws must be interpreted strictly and that the value of a service should only include the consideration for the service itself. This ruling may impact future cases involving similar issues and could lead to further clarifications in tax law.
For businesses, this judgment provides clarity and certainty, allowing them to avoid paying service tax on reimbursed expenses. This could lead to more transparent and simplified tax compliance.
In the long term, this case may influence the way tax laws are drafted and interpreted, emphasizing the need for precision and clarity in tax legislation.
Conclusion
The Supreme Court’s judgment in Union of India & Anr. vs. M/s. Intercontinental Consultants and Technocrats Pvt. Ltd. is a significant ruling in the realm of service tax law. It clarifies that service tax cannot be levied on expenses that are merely reimbursed to the service provider, as these are not part of the value of the service itself. The Court’s decision was based on a strict interpretation of Section 67 of the Finance Act, 1994, and the principle that rules cannot go beyond the statute.
This judgment has provided clarity and certainty for businesses, ensuring that they are not taxed on amounts that are not part of their service value. It also reinforces the importance of clear and unambiguous tax laws and the relationship between primary legislation and subordinate rules. The case serves as a reminder that tax laws must be interpreted strictly and that the value of a service should only include the consideration for the service itself.