In the context of employment transactions, an employee renders services while the employer compensates with a salary along with additional non-monetary benefits (perquisites). Consequently, there is a supply from both parties, which should therefore be subject to taxation under GST. This article aims to provide a comprehensive understanding of the GST treatment concerning employee remuneration and the recovery of notice pay.
What is Notice Pay Recovery?
Whenever an employee enters or exits an organization, they are obligated to adhere to the terms of their employment. Typically, an employee must fulfill the stipulated notice period prior to resigning. Nevertheless, the majority of employment contracts include a provision indicating that if an employee wishes to depart from the company without completing the designated notice period, they must compensate an amount equivalent to the unfulfilled notice period. This process is referred to as notice pay recovery, which can either be collected from the employee directly or subtracted from their due salary.
Treatment of GST on Employee Remuneration
Under the CGST Act, the provision of goods and services is subject to GST. This tax is applicable to the consideration charged by a registered taxable individual during the course of conducting business. Nevertheless, Schedule I of the CGST Act encompasses transactions that are regarded as supplies, even when conducted without consideration between related parties, provided they occur in the course of business operations. Furthermore, Section 15 of the CGST Act indicates that the employer and employee are considered related persons.
Consequently, supplies made by an employer to an employee are subject to GST, even if provided without consideration (with the exception of gifts valued at up to Rs. 50,000). However, Schedule III of the CGST Act specifies that ‘services rendered by an employee to the employer in the course of or related to his employment’ are not classified as the supply of goods or services. Therefore, GST is not applicable to employee remuneration.
Applicability of GST on Notice Pay Recovery
As previously mentioned, employment services are exempt from GST. Nevertheless, employers allocate resources towards recruiting and training employees, anticipating that they will remain for a minimum duration or at least complete their notice period, in order to prevent any work disruptions. When employees leave early or do not fulfill their notice period, it leads to unnecessary interruptions and unfavorable circumstances for the organization. Consequently, the majority of employment contracts incorporate a salary forfeiture or bond recovery clause to discourage non-committed candidates. This practice is commonly referred to as notice pay recovery.
To determine the applicability of GST on notice pay recovery, it is essential to first ascertain whether it qualifies as a ‘supply’ under the GST legislation. Serial 5(e) of Schedule II of the CGST Act outlines specific activities that are considered a supply of goods or services. These activities encompass ‘Agreeing to the obligation to refrain from an act, or to tolerate an act or a situation, or to do an act.’ However, does notice pay recovery fit into this classification?
To eliminate any ambiguity, CGST Circular No. 178/10/2022-GST provides clarification that-
1. An examination of Serial 5(e) of Schedule II indicates that it consists of three distinct categories of activities, namely:
1. The duty to abstain from an action,
2. The duty to endure an action or circumstance,
3. The duty to perform an action.
2. It should not be assumed that an agreement to perform or abstain from an action exists. In simpler terms, unless there is a clear or implied commitment from the recipient of funds to either perform or refrain from performing an action, it cannot be inferred that the payment was made for performing an action, refraining from an action, or tolerating an action or circumstance.
3. In this context, the forfeiture of salary or the recovery of notice pay for an early departure does not constitute payments for tolerating actions; rather, they serve as a deterrent against violations by other employees. These are contractual repercussions, not considerations of service. Moreover, the employee does not receive any benefit from the employer in exchange for such payments.
4. Consequently, payments made in the form of salary forfeiture or notice pay recovery do not qualify as a ‘consideration’ unless they are made under a distinct agreement specifically for tolerating an action. Absent this, such activities do not meet the criteria of a ‘supply’ under the CGST Act.
Therefore, amounts recovered by the employer are not subject to taxation as consideration for the service of agreeing to tolerate an action or circumstance.
Case Laws on Notice Pay Recovery Under GST
There have been a few crucial decisions in the past made in favour of the assessees stating that notice pay recoveries are not subject to GST:
1. Order of Commissioner (Appeals) in case of M/s.Gujarat State Fertilisers & Chemical Ltd – It was held that cessation of employment is treated as employment service not liable for GST.
2. Allahabad CESTAT in case of M/s. HCL Learning Systems Vs CCE, Noida – It was held that the amount recovered out of salary already paid is not subject to GST.
3. Manappuram Finance Ltd. v. Assistant Commissioner of Central Tax and Excise, Kerala – It was held that the amounts recovered by an employer not as consideration for tolerating an act of such premature quitting of employment but as penalties and therefore the employer would not be liable to pay GST on notice pay.
4. In re Piaggio Vehicles Pvt Ltd (GST AAR Maharashtra)- It is now clarified by the CBIC circular No. 178/10/2022-GST dated 3rd August 2022 that the notice pay recoveries are not taxable. In view of this clarification, notice pay recoveries made from the employees are not liable to levy of tax under CGST Act, 2017.
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