CA Mansi Goel
Recently, a single judge bench of Madras High Court rendered its judgement on taxability of notice pay (GE T&D India Ltd. reported at 2020-TIOL-183-HC-MAD-ST). The Court held that the recovery of notice pay by the employer from employee does not amount to any service by the former to latter. The department was seeking to tax the notice pay received by the employer under the category ‘agreeing to the obligation to refrain from an act, or to tolerate an act or a situation, or to do an act’.
While migrating to negative list regime in Service Tax in 2012, Government had introduced a new service namely, ‘agreeing to the obligation to refrain from an act, or to tolerate an act or a situation, or to do an act’ (‘toleration of act service’). Under Service tax regime, the said service was covered under Section 66E of Finance Act, 1994 as ‘declared service’. In GST, the said service finds explicit mention in Schedule II of CGST Act 2017 as ‘supply of service’. Thus, the Government has amplified its intention that the activity of tolerating an act or refraining from an act will be treated as service.
After introduction of toleration of act service, doubts arose regarding the purview of the said service; what type of activities would be covered therein; when does one tolerate an act and so on. While explaining the scope of the toleration of act service, Education guide mentioned only one example of amount received under non-compete agreement. Apart from this, the Service tax law or GST law do not provide any guidelines or parameters for classifying an activity as toleration of act/refraining from an act.
In this background, the judgement of Hon’ble Madras High Court holds greater importance since it is the first judgement pronounced by a High Court which deals with the scope of toleration of act service.
While dealing with the notice pay, the Hon’ble Court was concerned with the question whether the employer tolerated the act of the employee by letting him exit early on payment of notice pay. The Court observed that a contract of employment has to be read as a whole; there may be situations within a contract that constitute rendition of service such as breach of a stipulation of noncompete. Notice pay, in lieu of sudden termination however, does not give rise to the rendition of service either by the employer or the employee. The Court held that the employer merely ‘facilitated’ the exit of the employee upon payment of a cost for the sudden exit. The Court however, did not give any reasoning as to why such facilitation cannot be treated as toleration by the employer.
On the similar issue, Allahabad bench of CESTAT also ruled in favour of the assessee (HCL Learning Ltd. reported at 2019-TIOL-3545-CESTAT-ALL). In the said judgement, the Tribunal was concerned with the taxability of amount recovered by the employer from employee in case the employee leaves the company before completion of fixed term of employment. The Hon’ble Tribunal held that the amount recovered by the employer is out of salary which is not covered by the provisions of service tax. Accordingly, it was held that the said amount would not be chargeable to service tax.
Basis the above judgements, one can argue that notice pay is not subject to GST/service tax. However, these judgements do not particularly give the reasoning that why the recovery of notice pay cannot be termed as toleration by the employer. The department can still argue that against recovery of notice pay, the employer tolerates the early exit of the employee. It is this main argument which has not been discussed by the Hon’ble High Court and Tribunal in their judgements. In view of this, it is unlikely that the issue of taxability of notice pay is going to settle in near future.