Introduction
The core strength of the successful companies are its human resources who possess challenging skill sets and that’s the reason that a high demand exists for such skillful personnel. The talent acquisition by today’s corporate world is undertaken in a very organized and systematic manner, and the set procedures and policies are applicable for their separation too. One such important aspect which is quite common nowadays is the concept of Notice period, where a parting employee has to serve for a period generally ranging from two to three months.
Concept of Short notice recovery
An employee is expected to intimate the company with a formal resignation well in advance and shall serve a period of at least two to three months before quitting the job and shall continue to work in the same role till completion of such period and this period is called as ‘notice period’. In case of employee not serving the mandated notice period, the company could rightfully recover an amount called as short notice period recovery as per the company’s policy or terms of employment contract.
In this article, it is examined, whether service tax is applicable / payable by company on amount collected towards short notice recovery from the parting employees in this article.
Services in course of employment
Under the negative list based taxation, all the services covered under the definition of service wef July 2012 shall be taxable, except the services listed in Negative list or services exempted vide mega exemption notification.
As per Section 65B (44), definition of service reads as under:
“Service” means any activity carried out by a person for another for consideration, and includes a declared service, but shall not include;
- …………………………..
- a provision of service by an employee to the employer in the course of or in relation to his employment;
In other words, the service provided by employee to employer in course of employment is excluded from service tax levy.
Service tax implication on short notice recovery
Now it is clear that, there is no exclusion or exemption to the services provided by employer to employee. The same is also not covered in the exclusion limb of the service definition either and covers declared services in the definition of service, and declared services, as per section 66E (e) sets out as under:
‘agreeing to the obligation to refrain from an act, or to tolerate an act or a situation, or to do an act’
Companies collect money from the resigning employees for tolerating early termination from the employment, without serving notice period and such receipts could be liable to service tax in the hands of company, at the limb – …………..to tolerate an act or a situation and service tax could be demanded.
At same time, it should not be lost sight that under negative list based taxation, the Service tax levy is an activity tax. Service tax is leviable on service being ‘any activity’ for a consideration. Though the company is receiving a consideration, there is no activity done by company to the employee in exchange for consideration of notice period recovery. A view is possible that the fundamental premise of ‘activity for a consideration’ itself is not satisfied, in which case the Service tax levy may not be applicable.
Even though it is not liable, as of date there is no clarification/circular clarifying non applicability of service tax on notice period recovery, erring on caution the service tax could be decided to be paid by the company as under.
Whether service tax can be collected from the employee?
As per Section 68(1), service tax is payable by the provider of taxable services, except in some specified instances where the service receiver is liable. As service tax is destination based levy the service tax could also be collected from the service receiver and paid to Government by the service provider. This view was also held in All India Federation of Tax Practitioners & others v/s Union of India (2007 (7) S.T.R. 625 (S.C.))
An employer, who is recovering amount towards short notice, could collect and pay the service tax at 12.36% from the employee. As a tax planning, company could insert a clause in the employment agreement, stating that service tax payable extra by employee as applicable. If company does not collect service tax extra.
If company does not collect extra service tax, then it shall bear the service tax out of pocket by calculating the service tax on inclusive basis as per Sec 67(2) of the Act.
An illustration is provided below for the benefit of readers for clear understanding of the concept.
Illustration:
Mr. Vijay, a professional software programmer, employed in M/s ABC Software Pvt Ltd having an experience of 2 years, drawing a salary Rs.75,000 p.m. and wish to leave the company as he has got some better opportunity elsewhere. So he decides to leave M/s ABC and as per the terms of employment he shall serve notice period for a period of 3 months. Compute the amount of service tax payable by the company.
Solution:
In the given case assuming that Mr. Vijay has served only one month of notice period and did not serve other two months and agreed to pay off his short notice.
Situation 1:
No separate clause in the employment agreement, with respect to service tax and the company did not collect service tax from Mr. Vijay.
| Amount received as short notice recovery for 2 months | Rs.1,50,000 (Rs.75,000 * 2 months) |
| Service tax included in Rs.1,50,000 | Rs.16,501 (Rs. 150,000*12.36/112.36) |
Therefore in the current situation M/s ABC shall pay a service tax of Rs.16,501 from this receipt.
Situation 2:
A separate clause in the employment agreement is inserted saying ‘that the amount recovered would be in addition to the applicable service tax’
| Amount received as short notice recovery for 2 months | Rs.1,50,000 (Rs.75,000 * 2 months) |
| Service tax on in Rs.1,50,000 | Rs.18,540 (Rs. 150,000 * 12.36%) |
Therefore in the current situation M/s ABC shall pay a service tax of Rs.18,540 from this receipt, which shall be collected from the Employee.
Conclusion
Though there is no activity of service, there is a flow of consideration from employee to employer and also at present there is no clarity in the law. Since, service tax law is new and developing with grey areas, erring on caution the recovery towards short notice could be levied to service tax and it is advisable to remit service tax by the employer either by collecting it from the employee or shall be paid by employer by calculating service tax on inclusive basis as illustrated above.
(Written By – Sushanth Karanth, Articled Assistant, Hiregange & Associates, Chartered Accountants, Bangalore.)
What about the valuation rules 6(2)((vi) which excludes the value of accidental damages due to unforeseen actions not relatable to provision of service.
I strongly argue that notice pay recovery is a compensation for breach of terms of employment contract under provisions of Indian Contract Act 1972 and is not a consideration for contract under the said law. The definition of consideration in Service Tax Law is exactly linked to the said definition in Indian Contract Act, 1972. Meaning thereby, the compensation for breach of a contract not being a consideration, notice pay recovery is not chargeable to Service Tax. This holds true not for an employment contract but for any other contract.
If a canteen operated in office raises bill to company and company in return recovers 50% of the amount from employee and pays 50% by itself, now will company have to charge service tax to employee if it is not eligible for SSP exemption.
Hi There,
Recently I have joined in a software startup company in Hyderabad. They said to me that there will be service tax deduction in salary. I want to know, For what reason I should pay service tax, as my salary is not exceeding 2,50,000/yr?
For what services, they (software companies) have to deduct service tax?
For what level companies, employees have to pay service tax? Please answer me.
Hi There,
Recently I have joined in a software startup company in Hyderabad. They said to me that there will be service tax deduction in salary. I want to know, For what reason I should pay service tax, as my salary is not exceeding 25000/yr?
For what services, they (software companies) have to deduct service tax?
For what level companies, employees have to pay service tax? Please answer me.
section 66E (e) of finance act,1994, Agreeing to the obligation, or to the act to refrain from an act, or to tolerate an act or a situation, or to do an act. Therefore, non-compete fees would be taxable.
In my opinion, on this ground service tax liability will arise.
We are in agreement with Mr. A Wilson on this matter.
In our opinion, no service tax would be chargeable as even at the time of departing no services were provided by the employer to employee. Employer is recovering the extra amount which was paid as salaries to the employee in this matter.
Regards,
YAGAY and SUN
(Management, Business & Indirect Tax Consultants)
Hi Sushanth Karanth,
I appreciate your views on this Topic will be matter of Litigation in future date.
But Here, the Employer is recovering the Excess Compensation paid to the employee due to non-fulfilment of one condition i.e., Short Notice Period. The compensation payable by the employer to the employee got reduced due to Non-fulfilment of one Condition.
As you agreed that No activity done by the employer. Moreover, No Consideration also received by the employer from employee but the employer is recovering the excess compensation paid for earlier Months.
Hence as per my view, No service tax Liability will arise on this.
We invite Tax experts Opinion on this Topic.
Best Regards,
A.Wilson