KJS Cement Ltd Vs Commissioner of CGST (CESTAT Delhi)
Summary: M/s KJS Cement Ltd filed Service Tax Appeal No. 51642 of 2018 before the Principal Bench of the Customs, Excise & Service Tax Appellate Tribunal, New Delhi, challenging the order dated 08.03.2018 passed by the Commissioner, Central GST, Central Excise & Customs, Jabalpur, confirming recovery of service tax of Rs.3,95,60,896/- with interest and penalty. The appeal was heard and decided on 07.12.2023 by a Bench comprising Justice Dilip Gupta, President, and P.V. Subba Rao, Member (Technical).
The appellant was engaged in manufacture of cement clinker and cement and obtained raw materials and inputs from various suppliers. Following an audit, the Department alleged that service tax had not been discharged on certain amounts treated as “declared services” under Section 66E(e) of the Finance Act, 1994. A show cause notice dated 17.10.2017 covered the period from 01.07.2012 to 31.03.2017 and alleged that the appellant had recovered penalties from raw-material suppliers for poor quality of materials through adjustments in supplier ledger accounts, recovered cheque-return penalties, recovered notice pay from staff and recovered liquidated damages, without paying service tax.
The four activities forming the subject matter of the demand were: (i) debit notes raised to offset excess credit in the supplier ledger account; (ii) notice pay recovery; (iii) cheque return penalty; and (iv) liquidated damages.
The Tribunal examined the statutory framework. Section 65B(22) of the Finance Act defines “declared service” as an activity carried out by one person for another for consideration and declared as such under Section 66E. Section 66E(e) covers agreeing to the obligation to refrain from an act, to tolerate an act or a situation, or to do an act. The Tribunal observed that there has to be a flow of consideration from one person to another when such an obligation is undertaken. The agreement must therefore specify the relevant activity as well as the consideration for agreeing to refrain from an act, tolerate an act or situation, or do an act.
The Tribunal considered the decision of the Delhi Bench in South Eastern Coalfields Ltd. vs. Commissioner of Central Excise and Service Tax, Raipur, 2021 (55) G.S.T.L. 549 (Tri.-Del.). In that decision, the Tribunal had held that penal clauses in commercial agreements were safeguards for commercial interests and that recovery of penalty or liquidated damages for breach could not be regarded as consideration for a service. The intention of the parties was to perform the contract, rather than to breach it and pay a penalty. The Tribunal also held that the recovery of liquidated damages or penalty could not be said to be towards any service where the amount was intended to ensure compliance with contractual obligations.
The Tribunal also referred to the Circular No. 214/1/2023-Service Tax dated 28.02.2023 issued by the Board. The Circular stated that the activity contemplated by Section 66E(e) requires an agreement specifically referring to the activity and a flow of consideration for that activity. It also referred to the jurisprudence concerning liquidated damages and related contractual payments.
On the debit notes, the appellant explained that the quality and quantity of raw materials were checked through laboratory inspection after delivery. The supplier ledger was initially credited with the invoice value, and after inspection the actual value was determined under the pre-agreed computation algorithm. Where the material did not meet the promised quality or quantity, the differential price was adjusted by raising a debit note. The appellant contended that the debit notes were merely book adjustments and involved no consideration.
The Tribunal accepted this submission. It held that the debit notes were mere book adjustments to balance the ledger and that the appellant had followed a price-reduction method with its suppliers. The price of the goods was reduced where the delivered goods fell short in quantity or quality. The Tribunal found that no consideration was paid. It also referred to Futura Polyster Ltd. vs. Commissioner of Central Excise, Chennai for the proposition that service tax could not be levied merely because of entries made in books of account.
On notice pay recovery, the appellant submitted that there was no consideration paid for tolerating termination of the employment contract. The amount recovered was not for tolerating the employee’s act of quitting within the notice period, but for preventing breach of the employment contract. The Tribunal accepted the submission.
The Tribunal referred to the Education Guide dated 20.06.2012 issued by CBIC, which had clarified that provision of service by an employee to the employer is outside the ambit of service and that amounts paid in relation to premature termination of a contract of employment were not chargeable to service tax. The Tribunal also relied on the Madras High Court decision in GE T & D India Limited vs. Deputy Commissioner of Central Excise, 2020 (35) G.S.T.L. 89 (Mad.), which held that the employer could not be said to have rendered a taxable service by facilitating the employee’s exit upon imposition of a cost for the sudden exit. The Madras High Court also held that notice pay in lieu of sudden termination does not give rise to rendition of service by either the employer or the employee.
The Tribunal noted that this view had also been upheld in Shriram Pistons And Rings Ltd. vs. Commissioner of C.T., Ghaziabad.
With regard to cheque bounce penalties, the appellant submitted that the amount was a penalty intended to deter cheque dishonour and was not consideration for tolerating the activity. The Tribunal found force in the submission. It referred to Circular No. 178/10/2022-GST dated 03.08.2022, which clarified that cheque dishonour fines or penalties are imposed for not tolerating, penalising and deterring such conduct and therefore are not consideration for any service. The Tribunal also relied upon Rohan Motors Ltd. vs. Commissioner of Central Excise, Dehradun, 2021 (45) G.S.T.L. 315 (Tri.-Del.), which held that cheque dishonour amounts were deterrent in nature and not consideration for any service.
Regarding liquidated damages, the appellant submitted that the amount recovered for delay in the delivery schedule was a penalty intended to deter delay and did not constitute consideration for tolerating the delay. The Tribunal relied upon its earlier decision in South Eastern Coalfields Ltd.. The Tribunal further noted that the Department had filed Civil Appeal No. 2372 of 2021 against that decision before the Supreme Court, but the appeal was dismissed as withdrawn on 11.07.2023 in view of the Circular dated 28.02.2023 issued by CBIC.
Ultimately, the Tribunal held that none of the four demands could be sustained. The order dated 08.03.2018 passed by the Commissioner was set aside and the appeal was allowed.
Cases Discussed
- South Eastern Coalfields Ltd. vs. Commissioner of Central Excise and Service Tax, Raipur, 2021 (55) G.S.T.L. 549 (Tri.-Del.) — relied upon for the proposition that penalties and liquidated damages recovered for breach of contractual obligations are not consideration for a service under Section 66E(e).
- Futura Polyster Ltd vs. Commissioner of Central Excise, Chennai, [2013 (29) S.T.R. 371 (Tri.-Chennai) — relied upon for the proposition that service tax cannot be levied merely because of entries made in the books of account.
- GE T & D India Limited vs. Deputy Commissioner of C.Ex. Chennai, 2020 (35) G.S.T.L. 89 (Mad.) — relied upon for the proposition that notice pay recovery does not constitute consideration for a taxable service.
- Shriram Pistons And Rings Ltd. vs. Commissioner of C.T., Ghaziabad, 2020 (42) G.S.T.L. 79 (Tri.-All.) — noted as having upheld the view that notice pay recovery is not subject to service tax.
- Rohan Motors Ltd. vs. Commissioner of Central Excise, Dehradun, 2021 (45) G.S.T.L. 315 (Tri.-Del.) — relied upon for the proposition that cheque dishonour amounts are deterrent in nature and not consideration for a service.
- M/s Dy. GM (Finance), Bharat Heavy Electricals Ltd., Appeal No. ST/50080 of 2019 — referred to in the Circular reproduced by the Tribunal in relation to the interpretation of Section 66E(e).
- M/s Western Coalfields Ltd., Order A/85713/2022 dated 12.08.2022 — referred to in the Circular reproduced by the Tribunal in relation to the treatment of activities under Section 66E(e).
- M/s Paradip Port Trust, Dy. No. 24419/2022 dated 08.08.2022 — referred to in the Circular reproduced by the Tribunal in relation to the Department’s decision concerning appeals on the issue.
- M/s Neyveli Lignite Corporation Ltd., CA No. 0051-0053/2022 — referred to in the Circular reproduced by the Tribunal in relation to the Department’s decision concerning appeals on the issue.
FULL TEXT OF THE CESTAT DELHI ORDER
M/s KJS Cement Ltd1 has filed this appeal to assail the order dated 08.03.2018 passed by the Commissioner, Central GST, Central Excise & Customs2 ordering recovery of service tax amounting to Rs. 3,95,60,896/- with interest and penalty.
2. The appellant is engaged in the manufacture of cement clinker and cement and obtains raw materials and inputs from various suppliers. An audit was carried out by the department and it was noticed by the audit team that tax liability against ‘declared services’ had not been discharged by the appellant.
3. A show cause notice dated 17.10.2017 was, accordingly, issued to the appellant alleging that for the period from 01.07.2012 to 31.03.2017 the appellant recovered penalty from raw material suppliers against poor quality of materials by adjustment in the ledger account of the supplier. The appellant also recovered penalty amount on cheque return, recovery from notice pay from staff. However, service tax was not paid for these services, though the services that were rendered were ‘declared services’ under section 66E (e) of the Finance Act, 19943.
4. The appellant filed a reply denying the allegations made in the show cause notice but the Commissioner, by the order dated 08.03.2018, confirmed the demand with penalty and interest.
5. The four activities on which service tax has been demanded from the appellant by treating them to be “declared services” under section 66E(e) of the Finance Act are as follows:
(i) Debit notes raised to offset the excess credit in the ledger account
(ii) Notice pay recovery
(iii) Cheque return penalty
(iv) Liquidated damages
6. ‘Declared service’ has been defined under section 65B(22) of the Finance Act as follows:
“65B(22) “Declared service” means any activity carried out by a person for another person for consideration and declared as such under section 66E.”
7. Section 66E(e) of the Finance Act is reproduced below:
“66E. Declared services:
The following shall constitute declared service, namely:-
(e) agreeing to the obligation to refrain from an act, or to tolerate an act or a situation, or to do an act;”
8. The aforesaid four activities on which service tax has been demanded have been described by the appellant.
Debit Notes
In the business of the appellant, the quality and quantity of the raw materials supplied by the suppliers are checked at the time of taking delivery, but since the raw materials are natural minerals, their quality and quantity can only be determined by laboratory inspection. As soon as the delivery of raw materials is obtained, the sample is sent to laboratory for inspection and the appellant credits the ledger account of the supplier with the value specified in the invoice raised by the supplier. Once the inspection report is received, the appellant actually computes the value in terms of the pre-agreed computation algorithm and determines the actual value of the raw material supplied by the supplier. If the delivered raw material are not upto the mark as promised in the invoice, then the differential in price is adjusted by raising a debit note on the supplier. The debit note is book entry passed for adjustment of the ledger entries. The actual payment for the raw material supplied happens later.
Liquidated Damages
This is the amount recovered from suppliers on account of their not adhering to the agreed delivery schedule. Such non-adherence leads to stalling of manufacturing activities of the appellant. To recover the cost of such stalling, the suppliers are charged liquidated damages.
Notice Pay
Employees of the appellant are governed by the employment contract where they work with the appellant for a pre-designated period. In cases where it is not possible for the employees to adhere to the said requirement, the employment is cut short and payment of notice pay by the employees is waived.
Cheque Bounce Penalty
Whenever there is a case of cheque bounce on the cheques deposited into the bank account of the appellant, the banker charges a penalty on the appellant. The appellant passes on this penalty to the person who issued the cheque since it is their fault.
9. Section 65B(44) of the Finance Act defines ‘service’ to mean any activity carried out by a person for another for consideration and includes a declared service. One of the declared services contemplated under section 66E is a service contemplated under clause (e), which service is agreeing to the obligation to refrain from an act, or to tolerate an act or a situation, or to do an act. There has, therefore, to be a flow of consideration from one person to another when one person agrees to the obligation to refrain from an act or to tolerate an act, or a situation or to do an act. In other words, the agreement should not only specify the activity to be carried to by a person for another person but should specify the:
(i) consideration for agreeing to the obligation to refrain from an act; or
(ii) consideration for agreeing to tolerate an act or a situation; or
(iii) consideration to do an act.
10. Thus, a service conceived in an agreement where one person, for a consideration, agrees to an obligation to refrain from an act, would be a ‘declared service’ under section 66E(e) read with section 65B(44) and would be taxable under section 68 at the rate specified in section 66B. Likewise, there can be services conceived in agreements in relation to the other two activities referred to in Section 66E(e).
11. The provision of section 66E(e) of the Finance Act were analysed by a Division Bench of this Tribunal in South Eastern Coalfields Ltd vs. Commissioner of Central Excise and Service Tax, Raipur4 and the relevant portion of the decision is reproduced below:
“27. It is trite that an agreement has to be read as a whole so as to gather the intention of the parties. The intention of the appellant and the parties was for supply of coal; for supply of goods, and for availing various types of services. The consideration contemplated under the agreements was for such supply of coal, materials or for availing various types of services. The intention of the parties certainly was not for flouting the terms of the agreement so that the penal clauses get attracted. The penal clauses are in the nature of providing 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. It is not the intention of the appellant to impose any penalty upon the other party nor is it the intention of the other party to get penalized.
28. It also needs to be noted that Section 65(44) defines “service” to mean any activity carried out by a person for another for consideration. Explanation (a) to Section 67 provides that “consideration” includes any amount that is payable for the taxable services provided or to be provided. 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. The expectation of the appellant is that the other party complies with the terms of the contract and a penalty is imposed only if there is non-compliance.
29. The situation would have been different if the party purchasing coal had an option to purchase coal from ‘A’ or from ‘B’ and if in such a situation ‘A’ and ‘B’ enter into an agreement that ‘A’ would not supply coal to the appellant provided ‘B’ paid some amount to it, then in such a case, it can be said that the activity may result in a deemed service contemplated under Section 66E(e).
30. The activities, therefore, 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 an there is a flow of consideration for this activity.”
12. The Circular dated February 28, 2023 issued by Board also provides that service tax cannot be levied on the amount collected towards liquidated damages. It is reproduced below:
“4. As can be seen, the said expression has three libs: – i) Agreeing to the obligation to refrain from an act, ii) Agreeing to the obligation to tolerate an act or a situation, iii) Agreeing to the obligation to do an act. Service of agreeing to the obligation to refrain from an act or to tolerate an act or a situation, or to do an act is nothing but a contractual agreement. A contract to do something or to abstain from doing something cannot be said to have taken place unless there are two parties, one of which expressly or impliedly agrees to do or abstain from doing something and the other agrees to pay consideration to the first party for doing or abstaining from such an act. Such contractual arrangement must be an independent arrangement in its own right. There must be a necessary and sufficient nexus between the supply (i.e. agreement to do or to abstain from doing something) and the consideration.
5. The issue also came up in the CESTAT in Appeal No. ST/50080 of 2019 in the case of M/s Dy. GM (Finance) Bharat Heavy Electricals Ltd in which the Hon’ble Tribunal relied on the judgment of divisional bench in case of M/s South Eastern Coal Fields Ltd Vs. CCE Raipur (2021 (55) G.S.T.L 549(Tri-Del)). Board has decided not to file appeal against the CESTAT order ST/A/50879/2022-CU[DB] dated 20.09.2022 in this case and also against Order A/85713/2022 dated 12.8.2022 in case of M/s Western Coalfields Ltd. Further, Board has decided not to pursue the Civil Appeals filed before the Apex Court in M/s South Eastern Coalfields Ltd. supra (CA No. 2372/2021), M/s Paradip Port Trust (Dy. No. 24419/2022 dated 08-08-2022), and M/s Neyveli Lignite Corporation Ltd (CA No. 0051-0053/2022) on this ground.
6. In view of above, it is clarified that the activities contemplated under section 66E(e), i.e. when one party agrees to refrain from an act, or to tolerate an act or a situation, or to do an act, are the activities where the agreement specifically refers to such an activity and there is a flow of consideration for this activity. Field formations are advised that while taxability in each case shall depend on facts of the case, the guidelines discussed above and jurisprudence that has evolved over time, may be followed in determining whether service tax on an activity or transaction needs to be levied treating it as service by way of agreeing to the obligation to refrain from an act, or to tolerate an act or a situation, or to do an act. Contents of Circular No. 178/10/2022-GST dated 3rd August, 2022, may also be referred to in this regard.”
(emphasis supplied)
13. It is in the light of the aforesaid that each of the four issues would have to be examined.
14. In regard to the issue relating to debit notes, Shri Arjun Raghavendra M, learned counsel for the appellant, submitted that there is no consideration paid at all as the debit notes are mere book adjustments to balance the ledger. Learned counsel also placed reliance upon a decision of the Tribunal in Futura Polyster Ltd vs. Commissioner of Central Excise, Chennai5 to contend that no service tax can be levied merely because of the entries made in the books of account.
15. Shri Harshvardhan, learned authorized representative appearing for the department has, however, supported the impugned order.
16. The submissions advanced by the learned counsel for the appellant deserve to be accepted as no consideration is paid. The debit notes are mere book adjustments to balance the ledger. The appellant has merely followed the price reduction method with the suppliers. In terms of the agreement price is agreed upon on the commitment by the supplier to supply the goods. However, upon delivery, the price of the delivered goods is reduced if it falls short in quantity or quality. Such price reduction is effected through debit notes issued by the appellant to the suppliers. It is apparent that no consideration is paid. The Tribunal in Futura Polyster also held that no tax can be levied merely because of the entries made in the books of account. In the present case, there is no separate agreement and the provisions of section 66E(e) have been applied in terms of the purchase order, as is clear from paragraph 3 of the show cause notice.
17. Regarding the notice pay recovery, learned counsel for the appellant submitted that there is no consideration paid for tolerating the termination of the contract. The amount recovered is not for tolerating the act of quitting employment within the notice period but is for preventing the breach of contract.
18. This submission advanced by the learned counsel for the appellant also has substance.
19. The Education Guide dated 20.06.2012 issued by CBIC has clarified that such notice pay recovery is not subject to service tax and the relevant extract is as follows:
“2.9 Provision of service by an employee to the employer is outside the ambit of service.
2.9.3 Would amounts received by an employee from the employer on premature termination of contract of employment be chargeable to service tax?
No. Such amounts paid by the employer to the employee for premature termination of a contract of employment are treatable as amounts paid in relation to services provided by the employee to the employer in the course of employment. Hence, amounts so paid would [not] be chargeable to service tax. However any amount paid for not joining a competing business would be liable to be taxed being paid for providing the service of forbearance to act.”
20. The Madras High Court in GE T & D India Limited vs. Deputy Commissioner of C.Ex. Chennai6, in no uncertain terms, also held that notice pay recovery is not subject to service tax and the relevant portion of the judgment is as follows:
“11. The query raised relates to a contra situation, one, where amounts have been received by an employee from the employer by reason of premature termination of contract of employment, and the taxability thereof. The Board has answered in the negative, pointing out that such amounts would not be related to the rendition of service. Equally, so in my view, the employer cannot be said to have rendered any service per se much less a taxable service and has merely facilitated the exit of the employee upon imposition of a cost upon him for the sudden exit. The definition in Clause (e) of Section 66E as extracted above is not attracted to the scenario before me as, in my considered view, the employer has not ‘tolerated’ any act of the employee but has permitted a sudden exit upon being compensated by the employee in this regard.
12. Though normally, a contract of employment qua an employer and employee has to be read as a whole, there are situations within a contract that constitute rendition of service such as breach of a stipulation of non-compete. Notice pay, in lieu of sudden termination however, does not give rise to the rendition of service either by the employer or the employee.”
21. The Tribunal has also upheld this view in Shriram Pistons And Rings Ltd. vs. Commissioner of C.T., Ghaziabad7.
22. Regarding cheque bounce penalty, learned counsel for the appellant submitted that there is no consideration for tolerating the activity of cheque bounce. According to the learned counsel, it is a penalty to deter the possibility of cheque bounce.
23. There is force in this submission advanced by the learned counsel for the appellant. Circular No. 178/10/2022-GST dated-3-8-2022 has clarified that cheque bounce penalty is not subject to Goods and Service Tax and the reasoning would also be applicable to service tax. The relevant extract of the Circular is as follows:
“Cheque dishonor fine/penalty
7.3 No supplier wants a cheque given to him to be dishonoured. It entails extra administrative cost to him and disruption of his routine activities and cash flow. The promise made by any supplier of goods or services is to make supply against payment within an agreed time (including the agreed permissible time with late payment) through a valid instrument. There is never an implied or express offer or willingness on part of the supplier that he would tolerate deposit of an invalid, fake or unworthy instrument of payment against consideration in the form of cheque dishonour fine or penalty. The fine or penalty that the supplier or a banker imposes, for dishonour of a cheque, is a penalty imposed not for tolerating the act or situation but a fine or penalty imposed for not tolerating, penalizing and thereby deterring and discouraging such an act or situation. Therefore cheque dishonor fine or penalty is not a consideration for any service and not taxable.”
24. The Tribunal in Rohan Motors Ltd vs. Commissioner of Central Excise, Dehradun8 also held that cheque dishonour amount is deterrent in nature and not towards consideration for any service.
25. Regarding liquidated damages, learned counsel for the appellant submitted that there is no consideration for tolerating the activity of delay in delivery of schedule and it is in fact a penalty to deter the delay.
26. This issue was examined by the Tribunal in South Eastern Coalfields and the relevant portions of the decision have been reproduced above.
27. Though the department had filed Civil Appeal No. 2372 of 2021 before the Supreme Court to assail the decision of the Tribunal rendered in South Eastern Coalfields but in view of the Circular dated 28.02.2023 issued by the CBIC, the Civil Appeal was dismissed as withdrawn on 11.07.2023.
28. Thus, as none of the four demands can be sustained, the order dated 08.03.2018 passed by the Commissioner is set aside and the appeal is allowed.
(Dictated and Pronounced in the open Court)
Notes:
1 the appellant
2 the Commissioner
3 the Finance Act
4 2021 (55) G.S.T.L. 549 (Tri.-Del.)
5 [2013 (29) S.T.R. 371 (Tri.- Chennai)
6 2020(35) G.S.T.L.89 (Mad.)
7 2020 (42) G.S.T.L.79 (Tri. All.)
8 2021 (45) G.S.T.L. 315 (Tri.-Del)
