“It is only a reimbursement of actual expense incurred….please do not deduct tax on our payments “.  An oft repeated request from a payee.  Let us see in the context of non-salary payments whether this statement hold true.

What is a reimbursement?

Reimbursement is an act of compensating someone else for an expense which he incurs for the payer.  

The expression ‘reimbursement’ presupposes previous payment and follows incurrence of expenditure.  Typically reimbursement should have an evidence that the documentation is for the expense incurred and is done at actual cost i.e, without any markup.

The payee’s viewpoint is that these expenses are incurred for the payer and is being recouped without any markup.  If the payee has not made any income out of the same, why should there be any withholding.

The tax technical position would depend on the underlying characterization of the said payment which would drive the withholding treatment.  A reimbursement could range from an expense of the payer which has been met by the payee and is being recouped to an expense incurred in providing a service which is recovered by the payee from the payer.

Legislative and judicial landscape

The legislation (i.e, the Income tax Act and the Rules) do not specifically deal with reimbursement and its treatment.  The tax legislation provides withholding tax treatment on different characterization of income streams. 

The issue of reimbursement and its withholding tax treatment has been the subject matter of several rulings and will continue to be so as each business situation can throw up a unique fact pattern which governs the characterization.

The matter gets confounded on the several rulings which have emanated on this space some in favour and some against.  There have been instances wherein on similar facts or fact pattern there have been conflicting rulings.

Whether reimbursement constitutes an income for the recipient is as much a question of fact as application of legal principles. 

Rulings have also held that if the transaction is one of rendering services then one cannot articulate that expenses incurred to render the service is a reimbursement and therefore to this extent does not represent income element (Timken India Ltd in re [TS-5032-AAR-2004-O]).  

Courts have also held that the taxpayer cannot be allowed to show some part of the contract price as ‘reimbursement of expenses’ and claim as non-taxable when incurring of the expenses is towards performance of the contract itself.  It is the substance of the transaction which matters and the real character of the transaction cannot be cloaked under the nomenclature of ‘reimbursement’. 

Therefore determining the nature of the transaction becomes very important. 

Let’s look at some examples:

1) Boarding and lodging expenses incurred by a foreign affiliate for an Indian tax payer

It is common in multi-national corporations that personnel of one entity in a country may travel to another entity located in a different country for official purposes.  In such a case, the overseas entity typically may initially incur certain expenses like accommodation, local travel etc which are subsequently charged back. 

Under such circumstances, it can be argued that the remittances were purely reimbursement of expenses with no element of income embedded in such payments and these were expenses of the payer which was incurred by the payee and consequently not liable to withholding under the Indian domestic tax laws (Mahindra & Mahindra Ltd [TS-5212-ITAT-2009(Mumbai)-O]).  

2) Engaging a Group entity to carry out routine activities

In this case the tax payer engaged its group company to carry out certain activities like maintenance of books of account, getting the accounts audited, maintenance of secretarial records, filing with statutory authorities etc. The group company was to use third party vendors for the above.  The consideration to the Group Entity was 5 % of the total expenditure incurred.  

The consideration of 5% was liable for withholding.  However the third party vendor expenditure which the Group Entity got it reimbursed from the tax payer was held (CIT vs DLF Commercial Project Corporation [TS-5618-HC-2015(DELHI)-O]) as not being subject to withholding as the same does not have any income element in it. 

It also helped that the Group Entity had discharged withholding tax obligations when making the expenditure payment to the third party vendors.

3) Whose expenditure is it that is being reimbursed

In a case where the taxpayer reimbursed the C&F agent expenses incurred by him on behalf of the tax payer towards transportation and other costs and also paid him his charges, the Court in CIT vs Gujarat Narmada Valley Fertilizers Co. Ltd [TS-5478-HC-2013(GUJARAT)-O] and ACIT vs Minpro Industries [TS-5665-ITAT-2011(JODHPUR)-O] upheld the principle that the reimbursement of expenses is not subject to withholding more so as the withholding tax obligation on such expenditure was complied with by the C&F agent.

Observation:

Courts have consistently taken a view that if the taxpayer’s expenditure has been incurred by the payee which is sought to be reimbursed then there is no income element for the payee as contrasted with an expenditure incurred during the course of rendering of service.

In business situations often the distinction between whether an amount is towards service or recoupment of expenditure could blur in several cases which adds to the ambiguity in the position on reimbursement.

4) Training programme conducted centrally in one country and recharged back

If positioned as a service rendered by the Group company then withholding tax would apply. On the other hand if positioned as an expense of the Indian taxpayer which is incurred by the Group company and recharged, then the reimbursement articulation can be advanced.

The reimbursement principle in this case would depend on the underlying facts as to whether the Group company provided the training itself, was there a third party cost, etc.

5) Ownership of services

a) If the payee is acting as an agent and is incurring expenses on behalf of the tax payer, then predominantly courts have held that such expenditure is the expenditure of the taxpayer and not of the agent and hence no withholding.

b) Often Courts have relied upon the discharge of the agent’s withholding obligations when payments are made to third party vendors.

c) On a particular transaction whether the payee is acting as an agent i.e, whether he is incurring expenditure on behalf of the taxpayer or is incurring expenses in providing services to the taxpayer thus becomes crucial

- This depends on the transactions and facts and the form and substance plays a crucial role

- In several live business transactions this could be a thin line

6) Deputation / secondment of personnel

Typically, a secondment arrangement would have a foreign enterprise (“Home Entity”) deputing its employee to its associated entity in India (“Host Entity”) and the Host Entity reimburses wholly or partly the cost incurred by Home entity being the salary cost of the deputed employee.

In case of a secondment arrangement, taxability of the payment made by the Host Entity to the Home Entity would depend on nature of relationship between the Host Entity and the seconded employee.

If the seconded employee is viewed in substance as an employee of Host Entity the payments to the Home Entity by Host Entity may be characterized as a mere reimbursement (Abbey Business Services (India) (P) Ltd vs Dy CIT [TS-6745-ITAT-2012(BANGALORE)-O] and Dy DIT vs Tekmark Global Solutions LLC [TS-5164-ITAT-2010(Mumbai)-O]) and accordingly no further tax implications arise on the payment thereof.

On the other hand, for any reason whatsoever if there is no employer-employee relation between the Host Entity and seconded employee, transaction could be viewed as rendering of services through its personnel by the Host Entity, in which case, the payments to Host Entity could be viewed as not mere reimbursements but as service fees.

In case of domestic secondment arrangements, the Hyderabad Tribunal in Bhagyanagar Gas Limited vs ACIT [TS-6170-ITAT-2012(HYDERABAD)-O] and Delhi Tribunal in United Hotels Limited vs ITO [TS-5672-ITAT-2004(Delhi)-O] Tribunals held that payments representing the actual salary cost of seconded employees by Host Entity to Home Entity amounts to mere reimbursements as there is no income element involved therein.  Presumably on facts there was no service characterization here. 

7. ESOPs

In case of multinational enterprises which have entities across the globe, it is common that such enterprises offer their shares under an Employee Stock Option (“ESOP”) scheme to employees of its subsidiary entities. In such scenario, ESOP cost (accounting charge in the Parent’s books) is cross charged to the Indian subsidiary as the employees work for the Indian subsidiary.

ESOP charge on shares of foreign company issued to employees of Indian subsidiary which is borne by Indian subsidiary is a tax deductible expenditure in its hands, as expenditure incurred is for retaining, motivating and rewarding its employees which is akin to salary costs. (Novo Nordisk India (P) Ltd vs DCIT [TS-524-ITAT-2013(Bang)-O] and Dy CIT vs Accenture Services (P) Ltd [I.T. Appeal No. 4540 of 2008 (ITAT) (Mum.)

Arguably, proportionate ESOP charge cross charged by foreign company to Indian subsidiary based on number of participating employees is not taxable in the hands of foreign company as it is mere reimbursement.  Also in this case one can argue that no service are rendered and this is a cost of the Indian taxpayer who has the employees on its rolls which is recharged by the overseas parent. 

One can extend the above argument to cross charge of actual expenses associated with ESOP scheme such as legal or consultancy charges etc., by the foreign company based on allocation keys (i.e. number of employees, number of shares granted).  

8) Cost Sharing arrangements

There could be situations where a facility/service is enjoyed by two or more persons but payment is initially made by one of them to the ultimate beneficiary. Later, the total cost would be allocated amongst the persons and each one of them would reimburse their portion of actual cost to the first mentioned payer who has initially settled the payment with the beneficiary. Such reimbursement of cost by one party to other does not attract withholding, provided taxes are withheld on the whole consideration by the person making the payment to the beneficiary/service provider. (Onward e-Services Ltd vs ACIT [TS-315-ITAT-2012(Mum)-O], Karnavati Co-op Bank Ltd [TS-5636-ITAT-2011(Ahmedabad)-O] and ITO vs Vishinda Diamonds [TS-6761-ITAT-2012(Mumbai)-O]. 

9) Centralised Group Procurement Arrangements

Multinational Corporations generally prefer to have a single arrangement with a third party (global) vendor to obtain certain services/software etc which are enjoyed by all other group entities across the globe. The same is done to enjoy the cost efficiency that a particular jurisdiction offers and to enjoy the benefit of a common infrastructure and uniform services across all entities. The cost incurred by the group entity is recharged to all the participating entities in pre-determined ratio or based on actual usage.

Some of the common centralized group procurement services are software licenses, bandwidth services, risk and legal advisory services, centralized procurement of materials etc.

In the past, various Courts held that reimbursement of actual cost incurred which has no profit element embedded in it being pure reimbursements would not be subject to tax (CSC Technology Singapore Pte Limited vs ADIT [TS-94-ITAT-2012(DEL)-O]) and accordingly withholding tax would not be applicable on such payments.

However, it would be pertinent to note that the Mumbai Tribunal C.U Inspection India Private Limited vs DCIT [TS-132-ITAT-2013(Mum)-O] held that merely routing of a transaction through a related party cannot be held as being a reimbursement to avoid tax in India. In other words, under such circumstances, the withholding tax obligation in the hands of the Indian entity must be looked at, as if such cost been directly paid to the third party by the Indian entity.

Here again the principles of whether the Cross Charging entity is rendering a service or merely acting as an agent for the Indian tax payer would be of relevance in determining withholding tax applicability.

Key takeaways

i) A position of reimbursement should always be backed up by actual third party documentation

ii) Form (Agreement etc) and substance should clearly evidence that the expenditure is that of the payer which is being reimbursed to the payee

iii) Evaluation is required on whether the expenses were incurred in the provision of any service or whether it was an expenditure of the tax payer which was incurred and recouped by the payee

iv) Position of reimbursement and hence no withholding is likely to be litigative with the tax authorities.

v) Useful to back up the reimbursement principle for a nil withholding with other arguments. For example Tax Treaty benefits (make available clause) etc.