Question: Whether the tax is payable on recovery made by company from the employees

It is submitted that applicability of tax on the notice pay recovery is not free from doubt uptill now since there is no precedent judgement which clarifies that the notice pay is taxable or not.

I hereby discuss the following points based on which it can be argued that no tax is payable on the notice pay recovery:

1. Favourable order of Commissioner (A) holding that notice pay recovery is not liable to service tax.

Commissioner (Appeals) in case of M/s. QX KPO Services Pvt Ltd vide Order in Appeal no. AHM-EXCUS-001-APP-0107-17-18 dated 29.09.2017 has held that no service tax is payable on notice pay recovery. The relevant para of the said judgement reads as follows:

9. At the onset, I will discuss the first issue; stating that as per the definition of service as envisaged under Section 65B(44)(b) of the Finance Act, 1994, the activity was carried out by one person to another for a consideration which is tolerating the act of the employees to leave the job without giving notice for the stipulated period and allowing the employees to leave the job. In view of the above, I find that the adjudicating authority has towed to the lines as prescribed in the amendments made in the Act w.e.f. 01.07.2012. in the new system, the word ‘service’ has been redefined under Section 65B(44) of the Finance Act, 1994. However, CBEC, in the month of June 2012, had introduced as ‘Education Guide’ in light of the new system. The said guide clarifies many queries that were supposed to erupt at the time of the amendments made in the Act w.e.f. 01.07.2012. I would like to quote below a concerned paragraph from the said guide for clarification; 

2.9 Provision of service by an employee to the employer is outside the ambit of service

2.9.1 Are all services provided by an employer to the employee outside the ambit of services?

No. Only services that are provided by the employee to the employer in the course of employment are outside the ambit of services. Services provided outside ambit of employment for a consideration would be a service. For example, if an employee provides his services on. contract basis to an associate company of the employer, then this would be treated as provision of service.

2.9.2 Would services provided on contract basis by a person to another be treated as services in the course of employment?

No. Services provided on contract basis i.e. principal-to-principal basis are not services provided in the course of employment.

2.9.3 Would amounts received by an employee from the employer on premature termination of contract of employment be chargeable to service tax?

No. Such amounts paid by the employer to the employee for premature termination of a contract of employment are treatable as amounts paid in relation to services provided by the employee to the employer in the course of employment.

Hence, amounts so paid would not be chargeable to service tax. However, any amount paid for not joining a competing business would be liable to be taxed being paid for providing the service of forbearance to act.

In view of the above, it now very clear that any payment made by either of the party to the other one would not be changeable to service tax. Thus, from the above, conclude that the process of payment made by the employees to the appellants, for termination of job before the completion of the agreed upon period, is not to be treated as a service has any act of consideration for retraining from any act or tolerating any act.

Therefore, I hold that demand of Rs. 86,576/- should be set aside in the interest of justice and the appellants should be given relief  from payment of Service Tax along with interest and penalty.

Further, the Commissioner (Appeals) Order-in-Appeal No. VAD-EXCUS-003-APP-392/2016-17 dated 20.10.2016 in the case of Gujarat State Fertilizers & Chemicals Ltd Vs Assistant Commissioner, Central Excise & Customs, Service Tax, Division-IV, Anand Commissionerate has held no service tax is leviable on notice pay recovery. However, in the said judgement the Commissioner (A) has not given specific finding as to why tax is not payable.

2. The amount of notice pay recovery is treated as “salary” by Income Tax Authorities and thus Service tax department of same ministry cannot take contrary view.

Hon’ble Ahmedabad Tribunal in the case of Nandinho Rebello v. Deputy Commissioner of Income-tax [2017] 80 taxmann.com 297 (Ahmedabad – Trib.) has interpreted that notice pay recovery is nothing but an adjustment of salary and does not tantamount to any service thus service tax is not leviable.

3. Without prejudice to the above, it is renegotiation of contract.

It has been consistently held that when recovery of the amount is specified in the contract, the recovery reduces the value of the service which is provided in the contract. In this case, the employee has provided the service to the employer, as per the contract of the employment.  Therefore, the value of services provided by the employee has reduced, as the part of the amount has been recovered by the employer. The amount received by the employer is not chargeable to tax. Therefore, it is possible to argue that this amount is not taxable.

4. Notice pay recovery is part of the employment contract and thus there is employer and employee relationship

Hon’ble Delhi High Court in case of SATYA DEVELOPERS PVT. LTD. reported in 2017 (3) G.S.T.L. 325 (Del.) has held that contract /document as a whole has to be looked into and its meaning has to be what parties intended to give. Therefore, it is evident that the employment contract shall be read as whole. Thus, it can be said that the notice pay recovery is separate contract and it can be concluded that notice pay recovery is the part of the contract and hence tax is not payable.

5. One clause of the contract does not create separate contract.

One of the clause of the employment contract provides that if employee does not serve notice period, the amount shall be recovered from him. In this regard, it is pertinent to advert that entire contract was employment contract and thus the relationship was employee and employer. Further, one clause which provides that if the employee does not serve for notice period does not create separate contract. Therefore, in my view no tax is payable on notice.

However, as mentioned above that the said issue is not free from litigation. Therefore, if the amount involved substantial, then the company may contest based on the above grounds on the contrary if the amount involved is not high then the company may pay to buy piece of mind.

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