Rajeev Kumar Agarwal, Advocate, Kolkata
In this article, I will discuss various situations having taxability implications under a deeming fiction. For the first time with the introduction of Negative List based Service Taxation, effective from 1st July 2012, a separate class of service, termed as ‘Declared Service‘, was introduced under Section 66E. Clause (e) therein, reads as “Agreeing to the obligation to refrain from an act, or to tolerate an act or a situation, or to do an act.” Identical provision has been made in the GST regime, which is appearing in Schedule II, Entry No. 5(e) of the CGST Act, 2017, which is a deemed supply of services under Section 7 in the said Act.
The objective of introducing the above entry, in my view, is to tax an activity which is intended to be carried out by the parties to the transaction for a ‘consideration’. We may envisage a situation where there is an arrangement entered by the parties by way of “non-compete agreement” which probably would be one of such situations that may become the subject matter of levy under the said entry.
Taking note of the above taxing entry, the Revenue Authorities are taking a view that even in case of a receipt of an amount which is of penal nature, generally known as Liquidated Damages (LD) or penalty or compensation, for non-fulfilment of the terms of the contract by other party would be liable to service tax/GST. It is the contention of the Revenue Department that by collecting the amount of LD or Penalty, the assessee is tolerating the act of non-performance by the other party who is incurring the said LD/Penalty amount. To support their stand, it is stated by the authorities that the LD amount is a “consideration” in the hands of the assessee. Notices are being issued for raising demand of service tax/GST on the LD/Penalty amount. Several adverse decisions have already been passed by the Advance Ruling Authorities, after the introduction of GST, wherein the Authorities have taken a view that GST would be applicable on such Liquidated Damages or compensation amount.
A similar matter came up for consideration before the Hon’ble CESTAT, Principal Bench, New Delhi in case of South Eastern Coalfields Limited vs. Commissioner of Central Excise & Service Tax, Raipur (Final Order No. 51651/2020 dated 22.12.2020). In the said case, the assessee was engaged in mining and selling of coal and had coal supply agreements with the coal buyers. There was a clause in the agreement that in the event the coal buyer fails to lift below the specified quantity of coal, penal clauses would be attracted as specified therein. There were also similar penal clauses in the purchase order issued by the assessee for receiving various goods and services, which stated that LD would be charged in case of delayed supply of goods or delay in carrying out the projects as specified in the work orders. There were also clauses enabling the assessee to forfeit the Earnest Money Deposits (EMD) made by the vendors and coal buyers. The issue before the Tribunal was whether the receipt of LD/Penalty or forfeiture of EMD would be liable to service tax under Section 66E(e). The Tribunal after detailed examination of the subject agreement observed that the intention of the parties to the agreement was a first and foremost factor to decide the taxability. It observed that in the said case the assessee, engaged in the business of supply of coal, had the intention to supply of coal and to receive various goods and services from vendors. Further, the intention of the parties on the other side was to purchase coal or to supply various goods and services to the assessee. The intention of the parties certainly was not for flouting the terms of the agreement so that the penal clauses get attracted. The purpose of such penal clauses was to safeguard commercial interest of the contracting parties. The Tribunal categorically noted that there is a marked difference between the “conditions to the contract” and the “consideration for the contract”. There was no intention of the assessee to impose any penalty upon the other party nor is it the intention of the other party to get penalized. The sole 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 assessee is that the other party complies with the terms of the contract and the penalty is imposed only if there is a non-compliance of the terms of the underline subject contract.
Another interesting case was before the Hon’ble CESTAT, Principal Bench, New Delhi, in the case of Madhya Pradesh Poorv Kshetra Vidyut Vitaran Company Limited vs. Pr. Commissioner, CGST & Central Excise, Bhopal (Final Order No. 51024/2021 dated 14.01.2021). The assessee being a State Government company engaged in the business of electricity transmission and distribution, collected “Theft Charges” for unauthorized usage of electricity from the consumers. It was the contention of the Revenue Department that by collecting the said ‘theft charges”, the assessee was tolerating the act of unauthorized electricity usage and therefore, demand was raised by invoking Section 66E(e). The Tribunal following the decision in the case of South Eastern Coalfields Limited (SECL) quashed the entire demand.
On reading of the above, one would observe that the Authorities is invoking the above taxing entry in all cases wherever any amount is received by the assessee on account of penalty or compensation, without considering the true intent of the assessee for invoking such penal clauses.
I would further discuss one more interesting case that came up for consideration before the CESTAT, Kolkata Bench in MNH Shakti Ltd vs. Commissioner, CGST, Rourkela (Final Order no. 75689 dated 10.11.2021). In that case, the Authorities had issued demand notices on the amount of compensation received by the assessee from the Government consequent to cancellation of coal blocks by the Hon’ble Supreme Court in 2014. About 218 coal blocks, which were initially allocated to several large companies, were subsequently cancelled by the said Supreme Court Order. Prior to such cancellation of the coal blocks, those companies had incurred substantial expenditure for developing the coal block. Subsequent to the cancellation of coal block as above, a separate statute was enacted namely Coal Mines (Special Provision) Act, 2015 in terms of which compensation amount was paid to the prior allottees (incl. the assessee) by the Government on which the demand of service tax was raised by the Authorities. Setting aside the said demand, the Tribunal held that the compensation was received by the assessee in terms of the statute enacted pursuant to the Supreme Court Order and the assessee cannot be presumed to have tolerated any Act inasmuch as the assessee do not have any option or choice whether to tolerate or not and accordingly, held that the stand taken by the Department was not correct.
There can be several other situations where compensation amount is received by the assessee, e.g. compensation received for out of Court settlement, compulsory acquisition of land by the Government, compensation for loss or damage, compensation for delayed handing over the immovable property to the buyer, etc. If the view of the Revenue is accepted, all above cases would be subject to levy of tax, which do not appear to be legally correct. It has to be appreciated that every such cases may not be towards provision or supply of service for a consideration. The taxability in each such cases must be examined independently by ascertaining the intention of the parties who receives or pays such compensation. It must be understood that, neither in the pre-GST nor in GST regime, every flow of money from one party to another may not necessarily be towards supply of goods or services and that tax can be levied only in such cases which strictly falls within the ambit of the taxing entry.
The author can be reached at – rajeev@carajeev.in
Author Bio
