TDS on Reimbursement of Expenses

Expense reimbursement can be tricky in Indian Tax, as it is confusing due to the difference between pure cost recovery and taxable income. Reimbursements can range from travel and accommodation costs to office supplies and equipment. While reimbursements seem straightforward, the question of whether TDS applies to them is a frequent point of confusion. 

Understanding the basics of TDS on reimbursements is crucial for compliance with Income Tax laws and to avoid penalties. Let’s break down the general principles, specific scenarios and why proper documentation is paramount.

What is Reimbursement of Expenses?

Expense reimbursement occurs when one party covers costs incurred by another on its behalf. Common examples of reimbursement expenses include travel, lodging, meals, courier charges or out-of-pocket expenses. Reimbursement encourages an employee of an organisation to recoup the cost they paid while working for the company. It is, however, crucial to understand the taxation involved in such transactions. 

TDS on Reimbursement of Expenses

As per the Income Tax Act 1961, the fundamental rule governing the TDS on reimbursements relies on the critical distinction: Is the payment a ‘pure reimbursement’ of the expense incurred, or does it involve an element of ‘income’ or ‘profit’ for the recipient?

• Pure Reimbursement

If the payment is the exact repayment of the expense genuinely incurred by a party, with no profit component added, then the TDS is not applicable. This is mainly because a pure reimbursement is not considered income in the hands of the recipient. It is just the repayment of a liability that originally belonged to the company.

• Income/Profit

If the reimbursement includes any service charge or a profit element, then the TDS may be applicable on the entire amount or the portion deemed as income.

Scenarios of TDS on Reimbursement of Expenses

Reimbursement of Expenses to Contractors

Contractors may often incur expenses that later have to be reimbursed. The applicability of TDS on reimbursement to contractors can be explained as

• Pure Reimbursement: TDS is not applicable if the contractor includes all the expenses with proper supporting documentation without involving any profit element.
• Composite Invoice: TDS will be applicable if the contractor issues a composite invoice that includes service charges and expenses without separating them.

Travelling Expenses

If an employee travels for business purposes and submits all the necessary bills to the employer for exact repayment, no TDS is applicable. However, TDS will be applicable if the bills or invoices do not support the entire amount of the invoice.

Reimbursement to Non-Residents

Payments to non-residents that are chargeable to tax in India are subject to TDS under section 195. Suppose the reimbursement is solely for expenses incurred on behalf of the Indian entity and is supported by proper documentation showing no income component. In that case, it may not be subject to TDS. 

Practical Business Implications of TDS on Reimbursement of Expenses

Given the complexities, clarity and robust documentation are not just good practices; they are essential. They are essential for avoiding TDS disputes and disallowances. Here are some practical ways to have a robust policy.

Documentation: Documentation is a critical and essential aspect of successful reimbursement. Only relevant and genuine bills or invoices can prove the reimbursement for pure expenses and remove the income or profit component.

Separate Invoicing: Having a policy for separate invoicing for services rendered and expenses can be of immense help when dealing with pure expense reimbursement.

Expense Reimbursement Policy: Every organisation must have a clear, well-defined expense reimbursement policy. The policy must clearly specify the following:

• What type of expenses are reimbursable
• Spending limits for various categories.
• Required Documentation
• Process of submitting the reimbursement claims and approval timelines

Conclusion

The principle of ‘pure reimbursement’ being exempt from TDS is largely upheld by judicial pronouncements and circulars by the Central Board of Direct Taxes(CBDT). However, the onus is always on the deductor to prove that the payment is indeed a pure reimbursement and not an element of income. This requires meticulous record-keeping, a clear reimbursement policy and vigilance in classifying expenses. Moreover, you can always consult a tax expert to ensure full compliance and avoid any future complications.