The Principal Bench of Hon’ble CESTAT set aside the Service Tax demand of Rs. 32.76 Crores approx., plus equal penalty and applicable interest, on the amount of Liquidated Damages / Forfeiture of EMD / Penalty recovered from the various contractors & suppliers / Coal buyers under FSA and coal e-Auction scheme. The said demand was raised by invoking the provisions contained in Section 66E(e) as ‘Declared Service’ which reads as “agreeing to an obligation or to refrain from an act or to tolerate an act or a situation or an act”.
It was held that it not possible to sustain the view taken by the Principal Commissioner that penalty amount, forfeiture of earnest money deposit and liquidated damages have been received by the appellant towards “consideration” for “tolerating an act” leviable to service tax under section 66E(e) of the Finance Act.
FULL TEXT OF THE CESTAT JUDGEMENT
This appeal has been filed by M/s South Eastern Coalfields Ltd.1 to assail the order dated December 18, 2018 passed by the Chief Commissioner, officiating as the Principal Commissioner, by which the demand of service tax has been confirmed with interest and penalty by invoking the extended period of limitation contemplated under the proviso to section 73 of the Finance Act, 19942.
2. The appellant is a public sector undertaking and is a subsidiary of Coal India Ltd. It is primarily engaged in the business of mining and selling of coal, which is an excisable good. It operates from 18 different mines/offices. In commercial contracts entered during the course of business, certain clauses providing penalty for non-observance/breach of the terms of contract have been stipulated. According to the appellant, these clauses have been provided to safeguard the interest of the appellant.
3. A show cause notice dated April 10, 2017 was issued to the appellant under section 73(1) of the Finance Act mentioning therein that the appellant had collected an amount towards compensation/penalty from the buyers of coal on the short lifted/un-lifted quantity of coal; collected amount towards compensation/penalty from the contractors engaged for breach of terms and conditions; and collected amount in the name of damages from the suppliers of material for breach of the terms and conditions of the contract. According to the Department this amount charged by the appellant during the period from July 2012 to March, 2016 appeared to be taxable as a ‘declared service‘ under section 66E (e) of the Finance Act. The relevant portion of the show cause notice is reproduced below:-
”5. M/s SECL is charging & collecting amount in the name of compensation/penalty from the buyers of coal on the short-lifted/un-lifted quantity of coal & non-compliance of terms & conditions of coal supply agreements including forfeiture of EMD/SD. M/s SECL is also collecting amount in the name of compensation/penalty from the contractors engaged by them for providing various types of services viz. transportation, OBR removal, etc. for breach of terms & conditions of the respective contracts. It is also noticed that SECL were also recovering/claiming amount in the name of liquidated damages from the material suppliers for breach of terms & conditions of the contracts. Accordingly, in terms of provisions of Section 65B of the Finance Act, 1994 read with Section 66E(e) ibid, such amount charged by SECL from the buyers of coal/service providers etc. under the respective agreements appears pertain to the declared services under clause (e) of Section 66E attracting levy of service tax. M/s SECL and its coal producing areas have recovered Rs. 265,99,46,400/-towards EMD forfeitures, penalty & liquidated damages respectively from the buyers of coal, contractors and material suppliers during the period from July‘2012 till March‘2016. The location-wise details of amount collected under the above heads and the tax liability payable thereon by M/s SECL are tabulated as per Annexure C-1 to C-16, D-1 to D-17 & E-1 to E-18. The details of year-wise & area-wise are consolidated in Annexure A&B appended herewith. It therefore, appears that SECL & its coal producing areas had collectively evaded payment of Service Tax amounting to Rs. 35,26,59,837/- (incl. Cess) and the same appears liable to be recovered from them under Section 73 of the Finance Act, 1994 alongwith interest under Section 75 ibid.‖
4. The show cause notice involved branches of the appellant that were scattered over various Commissionerates. Therefore, by order dated November 7, 2017, the Principal Commissioner of Central Excise, Customs and Central Tax, Raipur3 was directed to act as a common adjudicating authority. During the course of adjudication proceedings, it was noticed that certain other show cause notices had been issued to the appellant on identical issues.
In such circumstances, such six show cause notices were also tagged.
5. The appellant submitted a reply to the show cause notice contending that penalty clauses were provided in the contract so that the parties to the contract did not breach the clauses repeatedly as financial consequences flow and that such penal clauses were invoked only in cases where party to the contract did not adhere to the terms of the contract. It was also stated that the appellant collects penalty (compensation) and forfeits security deposit/earnest money deposit for non-compliance of the terms of contract from buyers of coal on the quantity of un-lifted/short lifting of coal in terms of paragraph 3.6 of Coal Supply Agreement and not for tolerating any act or situation. The appellant also pointed out that penalty is charged from the vendors if there was a delay in supply of goods ordered by the appellant and that penalty is charged if the contractor also does not execute the terms of the contract in time. Such amount received by the appellant is shown in the books of the appellant under the head ―Liquidated Damages & Penalty Recovered.‖ The appellant also stated that the extended period of limitation could not have been invoked in the facts and circumstances of the case and neither interest or penalty was imposable.
5. The Principal Commissioner, however, did not accept the contentions advanced on behalf of the appellant and confirmed the demand of service tax holding that the amount received by the appellant towards penalty, earnest money deposit forfeiture and liquidated damages would tantamount to a consideration ―for tolerating an act‖ on the part of the buyers of coal/contractors, for which service tax would be levied under section 66 E(e) of the Finance Act. The relevant portion of the order is reproduced below:
”10. I find that the main allegation based on which the demands of Service Tax have been made, in all the cases is non-payment of Service Tax on the amount of EMD forfeitures, penalty & liquidated damages recovered by M/s. SECL from the buyers of coal, contractors and material suppliers. I find that the proposition of the Revenue is simple, that the impugned activity falls under the category of „Declared service‟ and shall be taxable, while on other hand, M/s. SECL has contested the levy of Service Tax on the above on different grounds.
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13. Before initiating the examination of the facts of the case, I would first like to discuss the provisions and legality in regard to the activity of ‘agreeing to the obligation to refrain from an act, or to tolerate an, act or a situation, or to do an act‘.
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13.1 As per the declared service entry, the scope of levy of service tax would apply to even a situation where the actual activity is nonexistent and consequently a person would be required to pay tax even for not doing anything. Even if a person refrains from doing a particular activity for which a consideration is received or receivable, such consideration would be taxed.
Thus, it is evident that as per the law, the action of restraining oneself with financial gain would constitute a service under the perception of ‘Declared Service‘.
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14.4 Thus, it is clear that the essence of service is not required in case of Declared Service relating to the activity of „agreeing to the obligation to refrain from an act, or to tolerate an act or a situation, or to do an act‟. M/s SECL is therefore not right in claiming that there is no element of service in the contract and which is for sale only. M/s SECL is also not correct when it says that there is specifically no clause in the contract regarding ‘agreeing to refrain from any act or tolerating any act for a defined consideration‘, because it says that penal clauses, are provided in the contracts so that the parties to the contract do not breach the clauses repeatedly as financial consequences are involved.
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17. Thus, as per the law of ad seriatim, invoking of first clause provided relief to the suppliers inasmuch as they continued to work under the said contract, without being made to lose the contract or bear further losses.
Thus, buy charging certain penalty/liquidated damages, a monetary consideration, M/s. SECL has refrained itself from taking any consequential steps detrimental to the interest of the suppliers. By simple evaluation, the relevant instances clearly fall within the activity of „agreeing to the obligation to refrain from an act, or to tolerate an, act or a situation, or to do an act‟.
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23.2 In view of the facts as discussed in proceedings paras, I am of considered opinion that, Penalty, EMD forfeiture amount and Liquidated damages would tantamount to a consideration payable for ―tolerating an act” on the part of Buyers of Coal/Contractors of M/s. SECL. Therefore, Service Tax is leviable to be paid by M/s. SECL under section 66E(e) of the Finance Act, 1994.”
7. Shri Rajeev Agarwal, learned authorized representative for the appellant made the following submissions:
(i) The Principal Commissioner committed an error in holding that by collecting the amount, the appellant has agreed to the obligation to refrain from an act or that the appellant tolerated the non-performance of the terms of the contract by the other party. In support of this contention, learned authorized representative placed reliance upon the following decisions:
(a) M/s K.N. Food Industries Pvt. Ltd. vs. Commissioner of CGST and Central Excise Kanpur4.
(b) M/s Lemon Tree Hotel Commissioner, Goods and Service Tax5.
(c) Commissioner of Service Tax, Chennai M/s Repco Home Finance Ltd.6
(d) GE T & D India Limited vs. Deputy Commissioner of C. Ex., Chennai7;
(ii) The Commissioner committed an error in holding that the scope of levy of service tax would also apply to a situation where the actual activity is non-existent;
(iii) It cannot be urged that the recovery of any sum by invoking penal clauses was a term of the contract for an agreed consideration;
(iv) The extended period of limitation could not have been invoked in the facts and circumstances of the case; and
(v) Penalty could not have been imposed.
8. Shri J.P. Singh and Shri Vivek Pandey learned authorized representatives of the Department, however, supported the impugned order and made the following submissions:
(i) Declared service is a deeming provision enacted by Parliament and as per definition, it need not be an activity carried out by one person for another;
(ii) In the alternative, activity includes both active and passive sense. Tolerating the short lifting of coal is a passive activity on the part of the appellant;
(iii) At the time of signing the contract, both the parties planned and agreed to tolerate any breach of contract through the payment of liquidated damages. Hence, the consideration is both intentional and at the desire of the parties;
(iv) The Constitution Bench of the Supreme Court in Fateh Chand Balkishan Das8 held that reasonable compensation for a breach of contract has to be proportionate to the actual injury suffered, which means injury tolerated since the word “suffering” is synonymous to “tolerating”.
(v) A case of compensation or damages for breach of a contract always involves one party tolerating/suffering an injury. Hence, the claim of the appellant in the present case that their contract is not for tolerating anything is fundamentally wrong;
(vi) The aim of compensation is to place the person in the same position as without breach, thereby allowing him to tolerate the situation arising out of breach of contract; and
(vii) The decision of the Tribunal in N. Foods runs contrary to the judgment of the Supreme Court in Fateh Chand.
9. The submissions advanced by the learned authorized representative of the appellant and the learned authorized representatives of the Department have been considered.
10. The issue that is involved is whether the appellant is providing a “declared service” contemplated under section 66E(e) of the Finance Act, which service became taxable w.e.f July 1, 2012. The period of dispute in the present appeal is from July 2012 to March 2016.
11. Section 65B(44) of the Finance Act defines “service” to mean any activity carried out by a person for another for consideration, and includes a declared service, but does not include what is mentioned in “a,b and c”. The relevant portion of the definition of “service” is reproduced below:
“service” means any activity carried out by a person for another for consideration, and includes a declared service, but shall not include-
(a) an activity which constitutes merely,-
(i) a transfer of title in goods or immovable property, by way of sale, gift or in any other manner; or
(ii) such transfer, delivery or supply of any goods which is deemed to be a sale within the meaning of clause (29A) of article 366 of the Constitution; or
(iii) a transaction in money or actionable claim;
(b) a provision of service by an employee to the employer in the course of or in relation to his employment;
(c) fees taken in any Court or tribunal established under any law for the time being in force.”
12.”Declared services” have been defined in section 66E and sub-section(e) of section 66E, which is involved in this appeal, is as follows :
“66E. Declared services
The following shall constitute declared services, namely:-
(e) agreeing to the obligation to refrain from an act, or to tolerate an act or a situation, or to do an act;”
13. The show cause notice and the impugned order indicate that the appellant was charging and collecting an amount under the following three heads:
(i) Compensation/penalty from the buyers of coal on the short-lifted/un-lifted quantity of coal and noncompliance of the terms and conditions of the Coal Supply Agreement, including forfeiture of earnest money deposit/security deposit;
(ii) Compensation/penalty from the contractors engaged by the appellant for providing various types of services for breach of the terms and conditions of the contract; and
(iii) Liquidated damages from the suppliers of materials for breach of the terms and conditions of the contract.
14. Liability has been fastened upon the appellant under section 65B read with section 66E(e) of the Finance Act for the period from July 2012 till March 2016 for the reason that by collecting the said amount the appellant had agreed to the obligation to refrain from an act or to tolerate the non-performance of the terms of the contract by the other party.
15. Section 65B (44) defines ‗service‘ to mean any activity carried out by a person for another person for consideration, and includes a declared service. Under section 66E (e), a declared service shall constitute agreeing to the obligation to refrain from an act, or to tolerate an act or situation, or to do an act. Section 66 B provides that service tax shall be levied at the rate of 12 per cent on the value of all services, other than those services specified in the negative list, provided or agreed to be provided in the taxable territory by one person to another and collected in such manner as may be prescribed. Section 66D contains a negative list of services, while section 66E contains a list of declared services.
16. Section 67 of the Finance Act deals with valuation of taxable service for charging service tax. It is reproduced below:-
67. (1) Subject to the provisions of this Chapter, where service tax is chargeable on any taxable service with reference to its value, then such value shall,-
(i) in a case where the provision of service is for a consideration in money, be the gross amount charged by the service provider for such service provided or to be provided by him;
(ii) in a case where the provision of service is for a consideration not wholly or partly consisting of money, be such amount in money, with the addition of service tax charged, is equivalent to the consideration;
(iii) in a case where the provision of service is for a consideration which is not ascertainable, be the amount as may be determined in the prescribed manner.
Explanation.—For the purposes of this section,—
(a) ”consideration” includes
17. Section 68 provides that every person providing taxable service to any person shall pay service tax at the rate specified in section 66B in such manner and within such period as may be prescribed.
18. It is, thus, clear that where service tax is chargeable on any taxable service with reference to its value, then such value shall be determined in the manner provided for in (i), (ii) or (iii) of subsection (1) of section 67. What needs to be noted is that each of these refer to “where the provision of service is for a consideration”, whether it be in the form of money, or not wholly or partly consisting of money, or where it is not ascertainable. In either of the cases, there has to be a “consideration” for the provision of such service. Explanation to sub-section (1) of section 67 clearly provides that only an amount that is payable for the taxable service will be considered as “consideration”. This apart, what is important to note is that the term “consideration” is couched in an “inclusive”
19. A Larger Bench of the Tribunal in Bhayana Builders (P) Ltd. vs Commissioner of Service Tax9 observed that implicit in the legal architecture is the concept that any consideration, whether monetary or otherwise, should have flown or should flow from the service recipient to the service provider and should accrue to the benefit of the latter. In the said decision, the Larger Bench made reference to the concept of “consideration‟, as was expounded in the decision pertaining to Australian GST Rules, wherein a categorical distinction was made between “conditions‟ to a contract and “consideration for the contract”. It has been prescribed under the said GST Rules that certain “conditions‟ contained in the contract cannot be seen in the light of “consideration‟ for the contract and merely because the service recipient has to fulfil such conditions would not mean that this value would form part of the value of the taxable services that are provided.
20. The Supreme Court in Commissioner of Service Tax M/s Bhayana Builders10 , while deciding the appeal filed by the Department against the aforesaid decision of the Tribunal, also explained the scope of Section 67 of the Act. The Supreme Court observed that any amount charged which has no nexus with the taxable service and is not a consideration for the service provided does not become part of the value which is taxable under Section 67. The observations are:
“The amount charged should be for “for such service provided”: Section 67 clearly indicates that the gross amount charged by the service provider has to be for the service provided. Therefore, it is not any amount charged which can become the basis of value on which service tax becomes payable but the amount charged has to be necessarily a consideration for the service provided which is taxable under the Act. By using the words “for such service provided” the Act has provided for a nexus between the amount charged and the service provided. Therefore, any amount charged which has no nexus with the taxable service and is not a consideration for the service provided does not become part of the value which is taxable under Section 67. The cost of free supply goods provided by the service recipient to the service provider is neither an amount “charged” by the service provider nor can it be regarded as a consideration for the service provided by the service provider. In fact, it has no nexus whatsoever with the taxable services for which value is sought to be determined.”
21. The aforesaid view was reiterated by the Supreme Court in Union of India Intercontinental Consultants and Technocrats11 and it was observed that since service tax is with reference to the value of service, as a necessary corollary, it is the value of the services which are actually rendered, the value whereof is to be ascertained for the purpose of calculating the service tax payable thereupon.
22. In this connection it would also be pertinent to refer to TRU Circular dated 20 June, 2012 issued by the Central Board of Excise and Customs as an Education Guide when the Negative List based taxation regime was introduced from July 2012 to clarify various aspects of the levy of service tax. The Board dealt with “consideration” in paragraph 2.2 of this Circular and pointed out that since the definition was inclusive, it will not be out of place to refer to the definition of “consideration” as given in section 2(d) of the Indian Contract Act, 187212. The relevant portion of the aforesaid Circular is reproduced below:
2.2.1 The phrase “consideration” has not been defined in the Act. What is, therefore, the meaning of “consideration”?
As per Explanation (a) to section 67 of the Act “consideration”‖ includes any amount that is payable for the taxable services provided or to be provided.
Since this definition is inclusive it will not be out of place to refer to the definition of “consideration” as given in section 2(d) of the Indian Contract Act, 1872 as follows-
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23. It would, therefore, be appropriate to examine the definition of “consideration” in section 2(d) of the Contract Act, as the Contract Act deals with all kinds of contracts and predates the Finance Act. The definition of “consideration”‖ is as follows:-
“2(d) When, at the desire of the promisor, the promisee or any other person has done or abstained from doing, or does or abstains from doing, or promises to do or to abstain from doing, something, such act or abstinence or promise is called a consideration for the promise.‖”
24. What follows from the aforesaid decisions of the Supreme Court in Bhayana Builders and Intercontinental Consultants, and the decision of the Larger Bench of the Tribunal in Bhayana Builders is that “consideration” must flow from the service recipient to the service provider and should accrue to the benefit of the service provider and that the amount charged has necessarily to be a consideration for the taxable service provided under the Finance Act. Any amount charged which has no nexus with the taxable service and is not a consideration for the service provided does not become part of the value which is taxable. It should also be remembered that there is marked distinction between “conditions to a contract” and “considerations for the contract”. A service recipient may be required to fulfil certain conditions contained in the contract but that would not necessarily mean that this value would form part of the value of taxable services that are provided.
25. It is in the light of what has been stated above that the provisions of section 66E(e) have to be analyzed. Section 65B(44) defines service to mean any activity carried out by a person for another for consideration and includes a declared service. One of the declared services contemplated under section 66E is a service contemplated under clause (e) which service is agreeing to the obligation to refrain from an act, or to tolerate an act or a situation, or to do an act. There has, therefore, to be a flow of consideration from one person to another when one person agrees to the obligation to refrain from an act, or to tolerate an act, or a situation, or to do an act. In other words, the agreement should not only specify the activity to be carried out by a person for another person but should specify the:
(i) consideration for agreeing to the obligation to refrain from an act; or
(ii) consideration for agreeing to tolerate an act or a situation; or
(iii) consideration to do an act.
26. Thus, a service conceived in an agreement where one person, for a consideration, agrees to an obligation to refrain from an act, would be a ‗declared service‘ under section 66E(e) read with section 65B (44) and would be taxable under section 68 at the rate specified in section 66B. Likewise, there can be services conceived in agreements in relation to the other two activities referred to in section 66E(e).
27. It is trite that an agreement has to be read as a whole so as to gather the intention of the parties. The intention of the appellant and the parties was for supply of coal; for supply of goods; and for availing various types of services. The consideration contemplated under the agreements was for such supply of coal, materials or for availing various types of services. The intention of the parties certainly was not for flouting the terms of the agreement so that the penal clauses get attracted. The penal clauses are in the nature of providing a safeguard to the commercial interest of the appellant and it cannot, by any stretch of imagination, be said that recovering any sum by invoking the penalty clauses is the reason behind the execution of the contract for an agreed consideration. It is not the intention of the appellant to impose any penalty upon the other party nor is it the intention of the other party to get penalized.
28. It also needs to be noted that section 65B(44) defines “service” to mean any activity carried out by a person for another for consideration. Explanation (a) to section 67 provides that “consideration” includes any amount that is payable for the taxable services provided or to be provided. The recovery of liquidated damages/penalty from other party cannot be said to be towards any service per se, since neither the appellant is carrying on any activity to receive compensation nor can there be any intention of the other party to breach or violate the contract and suffer a loss. The purpose of imposing compensation or penalty is to ensure that the defaulting act is not undertaken or repeated and the same cannot be said to be towards toleration of the defaulting party. The expectation of the appellant is that the other party complies with the terms of the contract and a penalty is imposed only if there is non-compliance.
29. The situation would have been different if the party purchasing coal had an option to purchase coal from ‘A‘ or from ‘B‘ and if in such a situation ‘A‘ and ‘B‘ enter into an agreement that ‘A‘ would not supply coal to the appellant provided ‘B‘ paid some amount to it, then in such a case, it can be said that the activity may result in a deemed service contemplated under section 66E (e).
30. The activities, therefore, that are contemplated under section 66E (e), when one party agrees to refrain from an act, or to tolerate an act or a situation, or to do an act, are activities where the agreement specifically refers to such an activity and there is a flow of consideration for this activity.
31. In this connection, it will be useful to refer to a decision of the Supreme Court in Food Corporation of India Surana Commercial Co. and others12. The Supreme Court pointed out that if a party promises to abstain from doing something, it can be regarded as a consideration, but such abstinence has to be specifically mentioned in the agreement. The relevant portion of the judgment is reproduced below:
”Under the main agreement, a party had contracted for the conversion of whole arhar grain into dal. Subsequently, by another supplemental agreement, the party agreed to upgrade the dal. It was held that as soon as the first agreement was complied with and dal was delivered, the contract came to an end and the supplemental agreement, which was made subsequently, was a separate and independent agreement. In this agreement, there was no consideration to be given to the promissor and thus that agreement could not be enforced in law. It was claimed that in the supplemental agreement consideration was that the bank guarantees were not to be encashed, but it was found that there was no mention of such a consideration in the supplemental agreement. Although if a party promised to abstain from doing something, it could be regarded as consideration for the contract, but in the present case there was no such case of abstinence and there was no consideration for supplemental contract.”
32. In the present case, the agreements do not specify what precise obligation has been cast upon the appellant to refrain from an act or tolerate an act or a situation. It is no doubt true that the contracts may provide for penal clauses for breach of the terms of the contract but, as noted above, there is a marked distinction between ‘conditions to a contract‘ and ‘considerations for a contract‘.
33. It would be apt to refer to a judgment of the European Court of Justice (First Chamber) in Case C-277/2005, in Societe Thermale d‘Eugenic-les-Bains Ministere de I‘Economie, des Finances et de I‘Industrie as it deals with the issue whether an obligation to refrain from an act or to tolerate an act or situation would result in supply of services when a sum paid as a deposit by a client to a hotelier, where the client exercises the cancellation option available to him and that sum is retained by the hotelier, can be regarded as consideration for the supply of a reservation service. Under Article 2(1) of the Sixth Directive, ‘the supply of goods or services effected for consideration within the territory of the country by a taxable person acting as such‘ is subjected to VAT. Article 6(1) of the Sixth Directive provides that ―supply of services‖ shall mean any transaction which does not constitute a supply of goods within the meaning of Article 5 and that such transactions may include inter alia an obligation to refrain from an act or to tolerate an act or situation. Under Article 11(A) (1) (a) of the Sixth Directive, the taxable amount in respect of supplies of services is to be ‗everything which constituted the consideration which has been or is to be obtained by the supplier from the customer or a third party for such supplies‘.
34. The question referred for preliminary hearing, in essence, in the aforesaid decision was whether a sum paid as a deposit by a client to a hotelier, where the client exercises the cancellation option available to him and that sum is retained by the hotelier, can be regarded as consideration for the supply of a reservation service, which is subject to VAT, or as a fixed compensation for cancellation, which is not subject to VAT. The Court found that there has to be a direct link between the service rendered and the consideration received. The sum paid must constitute a genuine consideration for an identifiable service supplied in the context of a legal relationship for which performance is reciprocal. It is in this context that Court observed:
”26. Since the obligation to make a reservation arises from the contract for accommodation itself and not from the payment of a deposit, there is no direct connection between the service rendered and the consideration received (Apple and Pear Development Council, paragraphs 11 and 12; Tolsma, paragraph 13; and Kennemer Golf, paragraph 39). The fact that the amount of the deposit is applied towards the price of the reserved room, if the client takes up occupancy, confirms that the deposit cannot constitute the consideration for the supply of an independent and identifiable service.
27. Since the deposit does not constitute the consideration for the supply of an independent and identifiable service, it must be examined, in order to reply to the referring Court, whether the deposit constitutes a cancellation charge paid as compensation for the loss suffered as a result of the client‗s cancellation.
28. In that regard, it should be noted that the contracting parties are at liberty – subject to the mandatory rules of public policy – to define the terms of their legal relationship, including the consequences of a cancellation or breach of their obligations. Instead of defining their obligations in detail, they may nevertheless refer to the various instruments of civil law.
29. Thus the parties may make contractual provision – applicable in the event of non-performance – for compensation or a penalty for delay, for the lodging of security or a deposit. Although such mechanisms are all intended to strengthen the contractual obligations of the parties and although some of their functions are identical, they each have their own particular characteristics.
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32. Whereas, in situations where performance of the contract follows its normal course, the deposit is applied towards the price of the services supplied by the hotelier and is therefore subject to VAT, the retention of the deposit at issue in the main proceedings is, by contrast, triggered by the client„s exercise of the cancellation option made available to him and serves to compensate the hotelier following the cancellation. Such compensation does not constitute the fee for a service and forms no part of the taxable amount for VAT purposes (see, to that effect, as regards interest applied on account of late payment, Case 222/81 BAZ Bausystem  ECR 2527, paragraphs 8 to 11).”
35. Reference can also be made to a decision of the Tribunal in Lemon Tree Hotel. The issue that arose for consideration was whether forfeiture of the amount received by a hotel from a customer on cancellation of the booking would be leviable to service tax under section 66E(e). The Tribunal held that the retention of the amount on cancellation would not attract service tax under section 66E (e) and the relevant portion of the decisions is reproduced below:
”3. So far as the first issue is concerned, the appellant, in the course of their business of running a hotel, offers advance booking to its customers, on payment of rent or deposit. Sometimes in the event of cancellation or of no show i.e. if the guest does not come for stay, the appellants retains the full or part of the amount towards cancellation charges. It is admitted that the appellant have paid service tax under Accommodation Services as and when they receive advance, availing the permissible abated value. It is the case of the Revenue that upon cancellation by the customers, the gross amount received by the appellant qualifies the receipt under Section 66 E (e).
4. Commissioner (Appeals) in confirming the demand under this head has observed that retention of such cancellation charges is not against the provisions of intended services but for not availing the said services by the customers, which the appellant has tolerated.
5. Having considered the rival contentions, I find that the aforementioned observation of the Commissioner (Appeals) are erroneous and have no legs to stand. Admittedly, the customers pay an amount to the appellant in order to avail the hotel accommodation services, and not for agreeing to the obligation to refrain from an act, or to tolerate an act or a situation, or to do an act; and chargeable on full value and not on abated value. The amount retained by the appellant is for, as they have kept their services available for the accommodation, and if in any case, the customers could not avail the same, thus, under the terms of the contract, they are entitled to retain the whole amount or part of it. Accordingly, I hold that the retention amount (on cancellation made) by the appellant does not undergo a change after receipt. Accordingly, I hold that no service tax is attracted under the provisions of Section 66 E(e) of the Finance Act. Accordingly, this ground is allowed in favour of the appellant.”
36. A Division Bench of the Tribunal in K.N. Food Industries examined the provisions of section 66E(e) in the context of an assessee manufacturing for and on behalf of M/s Parley and clearing the same upon payment of central excise duty. In a situation when the capacity of the assessee was not fully utilized by M/s Parley, ex-gratia charges were claimed so as to compensate the assessee from financial damage or injury. The Department invoked the provisions of 66E(e) to levy tax on the amount so received. The Tribunal held that the ex-gratia charges were for making good the damages due to the breach of the terms of the contract and did not emanate from any obligation on the part of any of the parties to tolerate an act or a situation and cannot be considered to be towards payment for any services. The relevant portion of the decision is reproduced below:
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We find that appellant is admittedly manufacturing confectionaries for and on behalf of the M/s Parle and is clearing the same upon payment of Central Excise duty on the basis of MRP declared by M/s Parle. It is only in situation when the appellants capacity, as a manufacturer, is not being fully utilized by M/s Parle, their claim of ex-gratia charges arises so as to compensate them from the financial damage/injury. As such, ex-gratia amount is not fixed and is mutually decided between the two, based upon the terms and conditions of the agreement and is in the nature of compensation in case of low/less utilization of the production capacity of the assessee.
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In the present case apart from manufacturing and receiving the cost of the same, the appellants were also receiving the compensation charges under the head ex-gratia job charges. The same are not covered by any of the Acts as described under Section 66E (e) of the Finance Act, 1994. The said Sub-clause proceeds to state various active and passive actions or reactions which are declared to be a service namely; to refrain from an act, or to tolerate an act or a situation, or to do an act. As such for invocation of the said clause, there has to be first a concurrence to assume an obligation to refrain from an act or tolerate an act etc. which are clearly absent in the present case. In the instant case, if the delivery of project gets delayed, or any other terms of the contract gests breached, which were expected to cause some damage or loss to the appellant, the contract itself provides for compensation to make good the possible damages owning to delay, or breach, as the case may be, by way of payment of liquidated damages by the contractor to the appellant. As such, the contracts provide for an eventuality which was uncertain and also corresponding consequence or remedy if that eventuality occurs. As such the present ex-gratia charges made by the M/s Parle to the appellant were towards making good the damages, losses or injuries arising from “unintended” events and does not emanate from any obligation on the part of any of the parties to tolerate an act or a situation and cannot be considered to be the payments for any services.”
37. Much reliance has been placed by the learned authorized representative of the Department on the decision of the Supreme Court in Fateh Chand. The submission is that the word “suffering” is synonymous to “tolerating” and the Supreme Court in Fateh Chand held that a reasonable compensation for breach of contract has to be proportionate to the actual injury suffered. Thus, according to the learned authorized representative of the Department it has been acknowledged by the Supreme Court that in a case of breach of contract, one party tolerates an act or situation.
38. The decision of the Supreme Court in Fateh Chand does not help the Department. The facts indicate that the Delhi Improvement Trust had granted lease hold rights for ninety years to Dr. M.M. Joshi in respect of a property. The relevant clauses of the agreement are:-
i) The plaintiff has agreed to sell the building to the defendant for Rs.1,12,500/-.
ii) 1000, being earnest money deposit, was to be paid to the plaintiff at the time of the execution of the agreement.
iii) The plaintiff had to deliver actual possession to the defendant on March 30 1949 and the defendant had to give Rs. 24,000/- out of the sale price.
iv) The defendant had to get the sale deed registered by July 1, 1949. If, for any reason, the defendant failed to get the sale deed registered by the stipulated date, then the sum of Rs.25,000/- (Rs.1000 received as earnest money deposit and the subsequent Rs.24,000/- out of the sale price) would be forfeited and the agreement cancelled.
v) The plaintiff received the agreed sum on March 25, 1949 and possession was delivered, but the sale of the property was not completed before the expiry of the stipulated period. The plaintiff, therefore, sought a decree for possession of land and building and a decree of Rs. 6500/- as compensation for use and occupation of the building. It was alleged that the agreement stood cancelled because the defendant committed a default in performing the agreement and the sum of Rs. 25,000/- paid by the defendant stood forfeited.
40. It is in this context and in the context of section 74 of the Contract Act, that the Supreme Court observed:
”20. Section 74 declares the law as to liability upon breach of contract where compensation is by agreement of parties predetermined, or where there is a stipulation by way of penalty. But the application of the enactment is not restricted to cases where the aggrieved party claims relief as a plaintiff. The section does not confer a special benefit upon any party; it merely declares the law that notwithstanding any term in the contract for predetermining damages or providing for forfeiture of any property by way of penalty, the court will award to the party aggrieved only reasonable compensation not exceeding the amount named or penalty stipulated.”
41. The Supreme Court also noticed that section 74 of the Contract Act merely dispenses with the proof of ―actual loss or damages”. It does not justify the award of compensation, when in consequence of the breach no legal injury at all has resulted, because compensation for breach of contract can be awarded to make good the loss or damage which actually arose or which the parties knew when they made the contract ‗to be likely to result from the breach‘. The Supreme Court also found that there was no evidence that any loss was suffered by the plaintiff in consequences of the default by the defendant, save as to the loss suffered by being kept out of possession of the property. The Supreme Court, therefore, held that plaintiff would be entitled to retain only an amount of Rs. 1000/- that was received as earnest, out of amount of Rs. 25,000/-.
42. The conclusion drawn by the learned authorized representatives of the Department from the aforesaid decision of the Supreme Court that compensation received is ‘synonymous‘ with ‘tolerating‘ or that the Supreme Court acknowledged that in a breach of contract, one party tolerates an act or situation is not correct.
43. It is, therefore, not possible to sustain the view taken by the Principal Commissioner that penalty amount, forfeiture of earnest money deposit and liquidated damages have been received by the appellant towards “consideration” for “tolerating an act” leviable to service tax under section 66E(e) of the Finance Act.
44. The impugned order dated December 18, 2018 passed by the Commissioner, therefore, cannot be sustained and is set aside. The appeal is, accordingly, allowed.
(Pronounced on December 22, 2020.)