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.

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Employment services exempted from GST

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 on notice pay recovery

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 mahadev@hiregange.com

Author Bio

Qualification: CA in Practice
Company: Hiregange & Associates
Location: Bangalore, Karnataka, IN
Member Since: 25 Nov 2019 | Total Posts: 3

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8 Comments

  1. vivek says:

    Good compilation on a truly relevant and burning topic. CAs recommending GST payment or making observations on the amount because dept audit teams demand tax on it without fail and most auditees accept demand because they don’t want to litigate. And, scope of deemed service of “tolerate an act” is very wide as well. Thanks for pulling out relevant cases.
    The topic is relevant for an organisation because they are liable to pay taxes out of own pocket. Employees don’t pay the amount of tax because that is not part of contract and they do not consider this as a service.

  2. HARIOM SHARMA says:

    Notice pay recovery is not a service by employer to employee, but recovery of notice pay is the part of salary which was supposed to be paid to employee but due to break in continuity of service salary paid have been more because employee was required to intimate decision prior to a certain period(1/2/3 months) in such circumstances recovery of notice pay should have been part of the pay that employee have already got. Considering this interpretation GST chargeability not applicable(employee and employer relation of salary give/take are not covered under GST.)

  3. HPaudit says:

    With due respect to subject, it is quite understandable that employees and employer relationship is clear and distinct itself and NOT any business Nexus. Taxes should be on business transactions,why CAs are making it more complicated

    1. mahadevr says:

      Are CAs demanding taxes? Does it mean that if CAs don’t interpret, department will not demand or dispute? Analysis can be a tool for tax payers to use.

  4. Cecily A says:

    I do not understand the logic behind this article. When an Employee is willing to pay Rs 100/-, why cant the employee pay another Rs 18/- . The organizations should fight their tax battles not battles of their Ex -Employees who have not even bothered to work for minimum period agreed upon , GST consultants should advise their clients to fight true battles not challenge Wind Mills.

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