In GST law, there are still few issues like compensatory damages, employee notice period recovery which needs clarity for taxation. In many private organisations, employees would be legally bound to serve for specified period which could vary from 15 days to 3 months or more depending on designation or role of a particular employee during termination of employment contract. If employee fails to serve, then the security amount collected during appointment or amount which could be part of salary would be withheld by the organisation as ‘Notice period pay’. The question of levy of tax on such income started after introduction of negative list concept in service tax. Though GST has replaced the law, the clarity on taxation of such notice period pay continues.
Certain activities have been specifically mentioned in Schedule II to CGST Act 2017 to be treated as goods or services. Agreeing to the obligation to refrain from an act, or to tolerate an act or a situation, or to do an act has been specifically stated to be treated a service in this schedule. Based on plain reading of the entry, it could be contended that notice period pay is the consideration received by employer for tolerating the act of employee who does not serve the notice period.
It is very interesting to note that UK VAT law which is very close to our new GST law does not levy tax on termination of contract subject to condition that the contract originally contains a clause allowing the parties to terminate early in lieu of compensation for losses arising from termination. However, levy could get attracted where no such clause exists in original agreement, and separate agreement reached to terminate. This may not be applicable in India as our GST law does not provide for such exemption.
Services by an employee to employer in course of or in relation to employment would not treated as either supply of goods or as services. There is a school of thought among few professionals that notice period pay is recovered in course of employment and should not be treated as supply liable for GST. It is important to note here that the services are provided by employer to employee by way of tolerating the act. Therefore, this view may not hold good for the simple reason that the exemption is for services by employee to employer and not for services by employer to employee.
Clarification from department in earlier law
Tolerating of an act was considered as ‘declared service’ in earlier service tax law after introduction of negative list taxation system in the year 2012. After this, there were lot of queries raised on applicability of service tax on notice pay recovery. The Director General of Central Excise Intelligence (DGCEI) in November 2015 had made following observation while conducting an audit of an assessee:
1. The activity of entering into an agreement by employer with employee to allow him to forfeit the security deposit or paying some charges/expenses/fee etc., in case of his leaving the employment without giving stipulated notice or completing the bond period, appears to be covered under the declared services of,“agreeing to the obligation to refrain from an act, or to tolerate an act or a situation, or to do an act”.
2. These services are being provided by the employers to its employees and consideration in terms of forfeiture of security deposit or other payments is being received by the employers in lieu of these services. Hence, Service Tax would be leviable on employers for providing these services.
Based on this, many assesses got show-cause notices for payment of service tax.
GST is applicable on supply of taxable goods or services. In terms of schedule II to CGST Act 2017, agreeing to the obligation to refrain from an act, or to tolerate an act or a situation, or to do an act is deemed as service. In case of notice pay policy, there is no such agreement for tolerating the act of employee. Therefore, it can be argued that such recoveries are not subject to tax. Another argument can be that such amounts are recovered for tolerating the act (though there is no agreement) of employee who quits without serving agreed period and therefore, taxable. As this a long pending issue, there is a need for clarification by the government. Another argument can be that there is no positive act and therefore, there is no supply liable for GST.
There are few decisions as well which are in favour of assesses holding that such notice pay recoveries are not subject to service tax. There is an order of Commissioner (Appeals) in case of M/s.Gujarat State Fertilizers & Chemical Ltd (2016) wherein it was held that the cessation of employment should also be treated as employment service not liable for service tax. Very recently, the Allahabad CESTAT in case of M/s. HCL Learning Systems Vs CCE, Noida (service tax appeal no. 70580 of 2018) has held (in November 2019) that when amounts are recovered out of salary already paid, such amounts would not be subject to service tax as salaries are not subject to tax.
Conversely to recovery of notice pay, there could be instances wherein organisations pay amounts to employee for termination of employment contract. Such amounts paid would be “part of salary” and paid as salary. In such cases, there may not be disputes with regard to GST applicability.
Conclusion: Tax payers could rely on these decisions and also could content that there is no supply of any service to the employees in case of notice pay recoveries. Representations could also be made from the industrial associations to seek clarity from the government on this subject as it is very common to recover amounts in service industries. This could provide some respite to such employees who otherwise may have to bear the burden of GST.
Suggestions or feedback at [email protected]