Payment of GST for Recovery of Notice Pay- An Enigma

Notice pay is the consideration received when an employee resigns without notice and puts an end to his contract of employment, allowing the company from which he is resigning to recover a part of his salary, ranging from one to a few months, which is adjusted against his final settlement amount and the net amount payable to the outgoing employee, and is treated as his remuneration for provision of his services and accordingly accounted for in the books of accounts.

While the payment of GST on this recovery of notice pay has been some subject of debate, it must be understood that any adjustment or deduction on any account arising out of contract of employment, is nothing but integral part of salary and wages.

The levy under the CGST Act, 2017 is on “supply” of goods or services or both. In order to attract the levy under Sec.9 of the CGST Act, 2017, the taxable event of “supply” must have taken place. Section 7 of the CGST Act, 2017 defines the scope of “supply” i.e. the scope and ambit of the word “supply.” In a given case if there is no “supply” within the meaning of Section 7, there is no levy under Section 9.

The Clause (a) of sub-Section (1) of Section 7 Of the CGST Act, 2017 envisages that the expression “supply” includes all forms of supply of goods or services or both such as sale, transfer, barter, exchange, license, rental, lease or disposal made or agreed to be made for a consideration by a person in the course or furtherance of business.

The word “such as” preceding the words sale, transfer, barter, exchange, etc. indicates that the forms of supply shall be those which are enumerated therein or of similar character but not other dissimilar forms of supply. The expression “such as” indicates the character of the transactions.

Through application of the subsidiary rules of interpretation of noscitur a sociis words are known by the company it keeps and they take their color from their companion.

While dealing with notice pay, it must be noted that it does not fit into the scope of “supply” under clause (a) of sub-Section (1) of Section 7. Furthermore, the  CGST (Ammendment) Act, 2018 dated 30-08-2018 inserted sub- Section (1A) to Section 7 of the CGST Act, 2017 with retrospective effect 01-07-2017 in place of clause (d) of sub-Section (1) of Section 7, which seeks to levy tax on certain declared “supply” of goods or services referred to in Schedule II of the CGST Act, 2017.

The provisions of Section 7 of the CGST Act, 2017 and the relevant portion of Schedule II now stipulate as follows:
“Section 7. Scope of Supply- For the purposes of this Act, the expression “supply” includes-

(a) All forms of supply of goods or services or both such as sale, transfer, barter, exchange, licence, rental, lease or disposal made or agreed to be made for a consideration by a person in the course or furtherance of business;

(b) Import of services for a consideration whether or not in the course or furtherance of business; [and]

(c) The activities to be treated as supply of goods or supply of services as referred to in Schedule II.

(1A) Where certain activities or transactions constitute a supply in accordance with the provisions of sub-section (1), they shall be treated either as supply of goods or supply of services as referred to in Schedule II.”

The relevant portions of Clause 5(e) of schedule (II), stipulate as follows:

“The following shall be treated as supply of services, namely: –

(d) Agreeing to the obligation to refrain from an act, or to tolerate an act or a situation, or to do an act;”

The said newly inserted sub-Section (1A) envisages that where certain activities or transactions constitute a supply in accordance with the provisions of sub-Section (1), they shall be treated either as supply of goods or supply of services as referred to in Schedule II.

A perusal of sub-Section (1A) shows that the forms of supplies set out under sub-Section (1) is the condition precedent for attracting the levy on declared supply of goods or services enumerated under Schedule II. The form of supply must be one of those listed therein or similar.

Thus, under Sub-Section (1A), in order to attract the levy, the activities or transactions must constitute a “supply” in the similar form as mentioned in sub-Section (1) i.e sale, transfer, barter, exchange, etc and if the transactions do not fall in any of such form of supply, it is not a supply at all and hence, cannot be subject matter of levy under Section 9 of the CGST Act, 2017.

Mere presence of an activity or transaction in Schedule II per se, cannot attract the levy unless the ingredients of form of supplies such as sale, transfer, barter, exchange, license, rental, lease or disposal etc for a consideration by a person in the course or furtherance of business, is also satisfied.

Prior to omission of Clause (d) of Sec.7(1), the existence of any form of supply was not a condition precedent and mere meeting the requirement of Clause 5(e) of Schedule II was enough which is intentionally done away with retrospective effect.Therefore, in cases of declared services the twin test set out under sub-Section (1A) and those set out under Schedule II must be satisfied.

As notice pay recovery does not fall within the forms of supply i.e. sale, transfer, etc. set out under sub-Section (1) of Section 7, hence the primary conditions of sub-Section (1A) is not satisfied and for that reason the transaction in question in the instant case cannot be termed a “supply” within the meaning of Section 7 and therefore, cannot be subjected to levy.

Support of this view may be found from the subsequent omission of clause (d) of sub-Section (1) of Section 7 with retrospective effect from 01-07-2017 and retrospective insertion of sub-Section (1A) in its place.

A comparison of omitted clause (d) vis-à-vis the newly inserted sub-Section (1A) in juxtaposition, clearly shows that the Legislature intended that the activities or transactions under Schedule II must also satisfy the test that they constitute supply under sub-Section (1) i.e sale, transfer, lease etc. whereas under the omitted clause (d) this ingredient was absent.

Thus, in view of the omission of clause (d) and insertion of sub-Section (1A) it can be safely said that even in respect of cases falling under Clause 5(e) of Schedule II, the declared transactions must be result of supply i.e sale, transfer etc set out under sub-Section (1) of Section 7.

In the instant case since, the transaction in question is neither a case of sale, transfer, barter, licence etc. or connected or similar thereto, no tax can be levied thereon.

While examining whether the activities or transactions in question can be said to be covered under clause 5(e) of Schedule II which seeks to declare agreeing to the obligation to refrain from an act or tolerate an act or a situation or to do an act, as declared supply of services. The said clause 5(e) has the following ingredients: –

(i) one party is under obligation, as agreed, to refrain from an act;

(ii) one party is under obligation, as agreed, to tolerate an act or situation;

(iii) one party is under obligation, as agreed, to do an act; all against consideration

The clause 5(e) treats an act of forbearance (refrain) or tolerating an act or situation where one of the parties is under obligation, as agreed upon, to forbear, refrain or tolerate an act or situation, against consideration. Section 2(31)(b) defines consideration in relation to supply of goods and services or both and includes the monetary value of any act or forbearance.

The word “Service” defined under Section 2(104) of the CGST Act, 2017 means anything other than goods, money and securities

In the instant case any attempt to bring the transactions in question within the ambit of sub-Section (1) of Section 7 of the CGST Act, 2017 and for that matter sub-Section (1A) of Section 7 and Clause 5(e) of Schedule II, would amount to stretching the provision too far which is clearly impermissible in law.

Now a question arises whether the receipt or deduction of pay in lieu of notice by an employee can be said to be consideration for an act of forbearance and whether the act of accepting the resignation without one month’s notice from an employee can be said to be an act of toleration.

It must be noted here, that there is no consideration within the meaning of Sec.2(31)(b) of the CGST Act, 2017 flowing from an act of forbearance in as much as there is no breach of contract, as a question of any consideration for forbearance would arise in case of breach of contract.

When an employee leaves his service without prior notice or payment of amount equivalent to one month’s salary, there will be a breach of the conditions of the contract making the employee liable for damages, which may fall under Clause 5(e) of Schedule II and would be subjected to levy if form of supply under sub-Section (1) of Section 7 are also satisfied. The employee opting to resign by paying amount equivalent to one month’s salary in lieu of notice, has acted in accordance with the contract and that being the case no question of any forbearance or tolerance does arise. Further, as per the agreement, the resignation by the employee is not subject to any acceptance or approval. The employee is free to tender his resignation, make payment of one-month salary and quit. Hence, there is neither any active nor any passive role played by the employer.

The primary condition for invoking Section 73 or Section 74 of the Contract Act, 1872 for damages/penalty, is breach of the conditions of the contract.

Section 73 of the Contract Act, 1872 provides for: “Compensation for loss or damage caused by breach of contract”. Section 74 of the Contract Act, 1872 provides for “Compensation for breach of contract where penalty stipulated for”. In both the cases, breach of contract is must and then comes consideration or damages or penalty for such breach for it’s forbearance or toleration. In the instant case, since, there is no breach of contract, there is no question of any forbearance or toleration within the meaning of Clause 5(e) of the Schedule II.

Hence, as the activities or transactions in question do not satisfy the test of “supply” under sub-Section (1A) read with sub-Section (1) of Section 7 of the CGST Act, 2017, levy under S.9 should not be attracted. Further, as there is no breach of the conditions of the contract, no question of any forbearance or tolerance or damages/penalty does arise, and the activities or transaction in question do not fall within the ambit of Clause 5(e) of Schedule II clearly and the amount received cannot be said to be consideration within the meaning of Section 2(31)(b) of the CGST Act, 2017 and Clause 5(e) of Schedule II for any forbearance or tolerance and there sould be no taxability on the amount.

Despite this, the tax authorities have initiated scrutiny of transactions of major Information Technology (IT) and Information Technology Enabled Services (ITeS) companies where employees have paid money for not serving the full notice period while quitting. This scrutiny has followed after issuance of advance ruling in the case of M/s Caltech Polymers Pvt. Ltd.[TS-110-AAR-2018-NT], wherein it was held that recovery of food expenses from the employees for the canteen services provided by the Company would come under the definition of ‘outward supply’ and taxable as a supply of service under GST. Applying the same logic, it has been contended by authorities that GST must be levied on notice pay.

However, a clear perusal of the sections indicate that GST must not be levied upon the same, and hence, a clear clarification to this effect is essential in employer-employee relationships in the present era.