Reimbursement of Expenses from Income Tax and Service Tax Standpoint

Reimbursement is a process via which one person is compensated by another for expenses, damages, losses for such other instances. This means, when one person incur expenses for another person out of his own pocket, he gets back his money which is spend as expenses by the another person as the former was not liable for such expenses. Some examples are firm reimbursing his employees provided that their employees have spent their own money on business related expenses.

For better understanding, let us illustrate an example on reimbursement of expense:

Suppose A and B are together visiting a client’s place of business and A pays petrol expenses for B from his own pocket money. Later on B pays back the same amount of money to A. This act is called Reimbursement of Expenses.

But, our main objective in this article is to discuss the implication of Reimbursement of Expenses from Income Tax and Service Tax Standpoint. This is a quite common that in daily day to day operations of a business where employees pay money on behalf of their company, and claims as reimbursements.

Reimbursement of expenses does not indicate the income of the person who is paying the money back and also no service tax on such reimbursement is charged as no services are involved on such reimbursement.

Income Tax Stand Point :

The reimbursement of expenses from Income tax point of view is simply based on the concept that:

Reimbursement of Expenses claimed as deduction: In case any expenses are incurred and the same is charged to Profit and loss; i.e. the expenses are debited to Profit and loss and is claimed as a deduction; but proper TDS compliances has not been followed, then whole of the expense which is claimed as deduction will get added back and would be treated as Deemed Income u/s 41.

In other words, when amount of reimbursement has been claimed as deduction in Income tax; but TDS on such amount has not been deducted, and then it is assumed that no expenses has been incurred and the whole amount is treated as Deemed Income and is liable to tax under IT Act.

Reimbursement of Expenses not claimed as deduction: When reimbursement of expenses has not been claimed as deduction in Income tax, then expenditure reimbursed would not be liable to tax under IT Act.

Some instances as per Income tax Aspect are:

  • Where loss of stock in trade occurs due to fire, then the expenses of such destruction has been allowed as deduction and insurance compensation is received for such losses, then entire insurance amount becomes taxable.
  • Refund of sales tax or excise duty is not chargeable to tax, though the deduction of it is claimed as expenses.
  • If the amount of bad debt is estimated while claiming deduction under IT Act, then the focus is to first check whether the amount of bad debt recovered is more or less than that of estimated one:
    • In case Bad debt Recovery is less than the estimated one, then difference between the amount of debt and bad debt allowed as deduction, will become deductible in the year in the ultimate recovery is made.
    • Whereas, in case Bad debt Recovered is more than the estimated one, then the excess amount i.e. difference between the amount of debt and bad debt allowed as deduction, gets chargeable to tax in the year where ultimate recovery is made.

It was also noticed that the TDS provisions gets applied only to those sums which gets chargeable to tax and there exists no obligation to deduct any TDS, if no element of income is involved in such payments.

Also, in cases of reimbursement of expenses to non-residents, TDS provisions would apply only when such reimbursement is chargeable to income-tax under the IT Act. It was observed that any payment made to foreign nationals not being a foreign company, any sum other than salary, should deduct TDS, at the time of credit or payment whichever is earlier.

Service Tax Standpoint :

We all know the fact that the service tax is charged on the services provided by the service provider. Service provided is required to issue invoice for the sale of services upon which he can charge service tax. The invoice not only indicates the nature of taxable service but also the amount of service tax charged. The invoice also indicates that for claiming reimbursement, expenses should be incurred as an agent and a claim should be raised for reimbursement and not as a charge for the service.

Case when expenditure is incurred by service provider as Pure Agent, on behalf of service receiver:

The service provider often claims reimbursement of expenses called out of pocket expenses incurred by him (like traveling, boarding and lodging etc) while providing a taxable service. These are really charges and are included in such taxable services. Also, it has been proved by the department that out of pocket expenses like traveling, boarding and lodging etc on reimbursable basis are not subject to service tax.

In case the reimbursement of expenses is claimed then care should be taken that CENVAT credit in respect of tax or duty involved, should be claimed only by the service receiver because expenses are incurred on his behalf by the service provider and the agent (service provider) should not claim CENVAT credit for the same.

Taxable services are the total amount of consideration consisting of all components of the taxable service and it is immaterial that details or breakup of individual components is mentioned separately in the invoice or not. Thus, all expenditure incurred by the service provider in the course of providing taxable service forms integral part and is included in the taxable value, immaterial of the fact that whether separate invoices has been made or not. Therefore two situations may arise if our concern is on the invoice issued to the recipient of the service:

If in case, professional service is provided by A to B, say A contracts with B for building a house. During the course of construction B incurs expenses such as telephone expenses, boarding expenses, etc on the behalf of A. Then 2 situations may arise:

Single Invoice is issued: In such a case, if all reimbursable expenses incurred by B is summed up with services provided by him, in a single invoice, then service tax gets charged on full invoice i.e. on total amount including reimbursable expenses too, though as per the service tax rules no service tax is charged on out of pocket expenses like traveling, boarding and lodging etc, which are on reimbursable basis.

Separate Invoice is issued: If two separate invoices are issued, one for taxable service and another for reimbursable expenses then service tax will be applicable only on the invoice of taxable service. No service tax is levied on reimbursed expenses.

Case when expenditure is incurred by service receiver himself: Generally, such cases are met to evade tax. In case, where expenditure are met by service receiver himself directly from his funds, then such costs will be includible in the invoice as such costs can reduce the Assessable value i.e. taxable value on service tax is charged. The illustration of this case is explained below:

A runs beauty parlor and charge normally Rs. 2400 for a hair spa. B visits A and is regular customer of A. A asked B to purchase hair serum (Rs. 600) from outside market, so that A can bill an invoice of Rs. 1800 and not of Rs. 2400. This is simply done to evade service tax. But as per Section 67(1) (ii), i.e. a case of consideration not wholly or partly in money, service tax will be charged on full amount of Rs. 2400, as costs paid by service receiver is also includible.

To conclude: Reimbursement of expenses is out of pocket expense. The concept of reimbursement will arise only when the person actually paying was under no obligation to pay the amount and he pays that amount on behalf of the buyer of the goods and recovers the said amount from the buyer of the goods.

Income tax Stand point, it is first checked whether expenses incurred is claimed as deduction or not. In case, it is deductible and TDS compliances have not been followed, then whole of the expenses will be treated as Deemed Income u/s 41 and is chargeable to tax. Whereas if expenses are not deductible, then it is not chargeable to tax too.

Service tax Stand Point , what matters is whether reimbursable expenses are included in same invoice or separate invoice of taxable service and whether expenses are paid by service receiver or provider.

If expenditure is paid by service receiver and single invoice is issued where amount on which service tax is charged includes both taxable service and reimbursable expense, then service tax gets levied on the whole amount. But, if separate invoices are issued for taxable service and reimbursable expense, then service tax gets charged on the amount of service provided. Moreover, if service receiver pays expenditure then whole of costs gets included in the invoice and cannot be ignored.

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