Recent judgments settling the pending cases under Section 66E(e) of the Finance Act 1994JAN 18, 2021
Recent judgments settling the pending cases under Section 66E(e) of the Finance Act 19940
There are many ongoing litigations pertaining to erstwhile Service Tax regime where Revenue is of the view that Service Tax shall be charged on various receipts in the nature of penalty, like, compensation charged on account of late delivery, poor/deficient supply of services, notice pay recovery, etc. under clause (e) of Section 66E of the Finance Act 1994 (“Declared Service”) which read as “agreeing to the obligation to refrain from an act, or to tolerate an act or a situation, or to do an act.”
In the earlier regime, taxability of liquidated damages has always been a matter of debate. However, many recent judicial pronouncements have settled some disputes in this regard wherein it was held that these charges in the nature of compensation do not qualify as service. Below cited decisions may help businesses in taking decision on taxability of various damages recovered under an original contract of supply of goods or services.
A summary of some recent rulings is as below –
Facts of the case – In this matter, the Appellant is engaged in manufacture of confectionaries falling under Chapter 17 of the Central Excise Tariff Act, 1985 for and on behalf of the principal manufacturer, M/s Parle Biscuits Pvt. Ltd. As per the terms of contract, in case the quantum of goods provided by M/s Parle Biscuits Pvt. Ltd is less than standard mutually agreed upon quantum, the Appellant are entitled ex-gratia job charges to cover up the loss or deficiencies in normal job charges to be received by the Appellant. Revenue is of the view that such Ex-gratia job charges amounts to providing services under Section 66E(e) of the Finance Act 1994.
Decision – The Hon’ble Allahabad CESTAT, while setting aside the demand of Service Tax, held that the ex gratia charges paid by principal manufacturer to Appellant were towards making good the damages, losses or injuries caused due to breach of terms of contract and does not emanate from any obligation on the part of any of the parties to tolerate an act or a situation and cannot be considered to be the payments for any services.
Facts of the case – In this matter, the Appellant is an electricity distribution company engaged in transmission or distribution of utility covered under Negative List of Services (Section 66D). The Appellant in the present case was deducting the penalty from their suppliers and contractor’s bills due to various reasons, like, delay in commencing the work, stopping the work or delay in completing the work. Also, some penalties were levied by Appellant for delay in supply of goods or services by a contractor. The revenue is of the view that such receipt of penalty is covered under clause (e) of Section 66E of the Finance Act,1994, thus taxable.
Decision – The Hon’ble Delhi CESTAT, while setting aside the demand of Service Tax, inter-alia held that the amount received by Appellant is not towards any service rendered as given under Section 66E(e) ibid.
Facts of the case – The Appellant is engaged in the business of mining and selling of coal, which is an excisable good. The Appellant, during the period July 2012 to March 2016, collected an amount towards compensation/penalty from the buyers of coal on the short lifted/un-lifted quantity of coal; collected amount towards compensation/penalty from the contractors engaged for breach of terms and conditions; and collected amount in the name of damages from the suppliers of material for breach of the terms and conditions of the contract.
The above stated compensation/penalties collected by the Appellant were alleged by the revenue to be covered under Section 66E(e) for the reason that by collecting the said amount, the Appellant had agreed to the obligation to refrain from an act or to tolerate the non-performance of the terms of the contract by the other party and thus, treated as taxable in nature.
Decision – The Hon’ble Delhi CESTAT, while setting aside the demand of Service Tax, inter-alia observed that there is a marked distinction between “conditions to a contract” and “considerations for the contract”. The recovery of liquidated damages/penalty from other party cannot be said to be towards any service per se, since neither the Appellant is carrying on any activity to receive compensation nor can there be any intention of the other party to breach or violate the contract and suffer a loss. The purpose of imposing compensation or penalty is to ensure that the defaulting act is not undertaken or repeated and the same cannot be said to be towards toleration of the defaulting party.
Hon’ble CESTAT while holding that the amount received by the Appellant is not a ‘consideration’ for ‘tolerating an act’ observed that the activities that are contemplated under Section 66E(e), when one party agrees to refrain from an act, or to tolerate an act or a situation, or to do an act, are activities where the agreement specifically refers to such an activity and there is a flow of consideration for this activity. Accordingly, it was observed that in this case there was no specific obligation as per the agreement which has been cast upon the Appellant to refrain from an act or tolerate an act or a situation.
NOTICE PAY RECOVERY
There is a standard practice in industry wherein employment contract is drafted in such a way to include terms that where any employee wishes to leave the organization, he/she has to serve a notice period, like, fifteen days, one month, two months, etc. varying from organization to organization. Now, if any employee does not serve such notice period and chooses to leave the organization immediately upon resignation, an option is provided that certain salary (as per the terms of contract) shall be payable by the outgoing employee to employer for covering the losses incurred on account of not serving the notice period. Revenue in this case is of the view that such ‘notice pay recovery’ by employers shall be taxable under Section 66E(e) ibid. since employer has tolerated the act of outgoing employee of not serving the notice period.
Note – Here it is pertinent to mention that a recent advance ruling under GST pronounced by AAR, Gujarat in Re: M/s Amneal Pharmaceuticals Pvt. Ltd., Advance Ruling no. GUJ/GAAR/R/51/2020 dated 30 July 2020 ruled that notice pay recovery is taxable under GST (Clause 5(e) to Schedule II of CGST Act) as the employer has tolerated the act of employee of not serving the notice period which was employee’s contractual obligation. Further, all the above decisions were disregarded by the AAR as the same pertains to Service tax regime and not GST.
However, Gujarat AAR failed to appreciate the fact that Entry 5(e) to Schedule II of CGST Act is akin to Section 66E(e) of Finance Act, 1994 and thus, those decisions and observations of various Tribunals and High Courts still holds valid under GST regime. Furthermore, Advance Rulings does not form precedent and are applicable only to the Applicant who sought such Advance Ruling. Thus, based on the observations (in extenso) of various Courts under Service tax era, the Advance Ruling pronounced by Gujarat AAR does not seem valid and must not be followed.
Facts of the case – The Appellant, in the course of their business of running a hotel has offered advance booking to its customers, on payment of rent or deposit. In the event of cancellation or of no show, i.e. if the guest does not come for stay, the Appellant retains the full or part of the amount towards cancellation charges. The revenue demanded Service tax on the amount retained by the Appellant under Section 66E(e) ibid. by holding that such amount is received by the Appellant for not availing the said services by the customers, which the Appellant has tolerated.
Decision - The Hon’ble CESTAT observed that the customers pay an amount to the Appellant in order to avail the hotel accommodation services, and not for agreeing to the obligation to refrain from an act, or to tolerate an act or a situation, or to do an act. It was held that the retention amount (on cancellation made) by the Appellant does not undergo a change after receipt and thus, not taxable under Section 66E(e).
CONCLUSION (SERVICE TAX VIS -À-VIS GST REGIME)
A similar entry as that in Sec 66E(e) of Finance Act, 1994 (erstwhile Service tax regime) also exists under GST law vide Entry No. 5(E) of Schedule II of Central Goods and Services Tax Act, 2017. Accordingly, the aforesaid judgements shall also be applicable in GST Law. The ratio of rulings supra provides with clear understanding as to what all components must be considered while determining the taxability of a transaction under this particular entry.
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