This is to update you
on a recent judgment pronounced by CESTAT, New Delhi in the case of M/s South
Eastern Coalfields Limited (‘Appellant’) wherein it has been held that no
service tax shall be levied on liquidated damages, earnest money deposit &
penalty charged for breach of contract.
A brief synopsis of
the judgment is highlighted below for your ready reference:
1.
Background
·
The
Appellant, a subsidiary of Coal India Limited, entered into commercial
contracts during the course of its business which include certain clauses
towards penalty on non-observance/breach of the terms of contract.
·
Under
such clauses, the Appellant collected amount towards compensation/penalty from
buyers on short lifted/un-lifted quantity of coal, compensation/penalty from
contractors for breach of terms and conditions and damages from suppliers of
material for breach of terms and conditions of the contract.
·
The
department held such compensation received to be a consideration received
towards a ‘declared service’ under Section 66E(e) of the Finance Act, 1994 and
accordingly leviable to service tax. Section 66E(e) provides for the following:
‘agreeing
to the obligation to refrain from an act, or to tolerate an act or a situation,
or to do an act’
2.
Ruling pronounced
·
The
Hon’ble Tribunal, on referring to the landmark decisions in the case of M/s
Commissioner of Service Tax vs. M/s Bhayana Builders [2018 (2) TMI 1325]
and M/s Union of India vs. Intercontinental Consultants and Technocrats
[2018 (10) GSTL 401 (SC)] and the TRU Circular dated 20 June 2012
issued by CBIC, held that “consideration” must flow from the service recipient
to the service provider and should accrue to the benefit of the service
provider. Further, the amount charged must necessarily be a consideration for
the taxable service provided under the Finance Act.
·
The
Tribunal further elucidated on the clear demarcation between the phrase ‘conditions
to a contract’ and ‘considerations for the contract’ and held that a
service recipient may be required to fulfil certain conditions contained in the
contract. However, such conditions would not necessarily mean that the value of
compensation would form part of the taxable value of services provided.
-
In
the instant case, the intention of the parties under the contracts was for
supply of coal, supply of material and availment of services from contractors
for which a pre-agreed consideration is mentioned in the contract.
-
The
penal clauses provide a safeguard to the commercial interest of the Appellant
and it cannot, by any stretch of imagination, be said that recovering any sum
by invoking the penalty clauses is the reason behind the execution of the
contract for an agreed consideration.
·
The
Tribunal also inferred that the ‘declared service’ under Section 66E(e) is an
activity which is specifically required to be mentioned in the agreement
executed between the parties. In the instant case, agreements did not specify
what precise obligation has been cast upon the Appellant to refrain from an act
or tolerate an act or a situation.
·
Basis
the above grounds, it was held that in the absence of any specified intention
or activity agreed between the parties to tolerate an act or a situation, there
is no agreed service rendered between the parties and therefore, compensation
received by the Appellant shall not be liable to service tax.
3. Comments
·
Taxability
of liquidated damages has always been a matter of debate. The Hon’ble CESTAT,
Allahabad, in the case of M/s K. N. Food Industries
(2019-VIL-731-CESTAT-ALH-ST), had held that liquidated damages are
received to make good the losses or injuries from unintended events and these
damages do not emanate from any obligation on part of any of the parties.
Hence, the same cannot be considered as the payments for any service.
·
The said rulings could be referred in the context of GST
regime as well as similar activities of agreeing to an obligation to refrain
from or to tolerate an act are treated as supply under GST laws as well.
However, given the ambiguity associated with the tax treatments of such
payments, the same may not be free from litigation.
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