Friday 8 January 2021

No service-tax on liquidated damages, earnest money, deposit & penalty for contract breach – CESTAT New

 

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.

No comments:

Whether Pre-deposit can be made post filing of Appeal

  Recently, the Hon’ble Punjab & Haryana High Court, in the case of Sumat Gupta & CO. v. UOI, 2024-VIL-416-P&H , held that pre-d...