Case Law Details
Principal Commissioner Vs Bharat Heavy Electricals Limited (BHEL) (CESTAT Delhi)
The CESTAT Delhi considered an appeal filed by the Principal Commissioner challenging the order of the Commissioner (Appeals), which had set aside the order of the Additional Commissioner confirming service tax, interest and penalty for the period from 1 July 2012 to 31 March 2017. The dispute concerned whether penalty or late delivery charges collected by the respondent under contractual liquidated damages clauses were liable to service tax under Section 66E(e) of the Finance Act, 1994.
The respondent, a Central Government Public Sector Undertaking engaged in the manufacture of plant and machinery, entered into contracts for the supply of goods and services. Under these contracts, the agreed contractual price was payable subject to timely delivery. Where delivery of goods or services was delayed, the contractual value payable by the buyer stood reduced in accordance with the liquidated damages clause. The Department issued a show cause notice alleging that the respondent collected amounts described as penalty or late delivery charges from contractors and material suppliers for delay in supply of goods or execution of work but had not discharged service tax under Section 66E(e). The adjudicating authority confirmed the demand, but the Commissioner (Appeals) allowed the respondent’s appeal.
Before the Tribunal, the Department argued that the contractual clauses amounted to an agreement to tolerate an act or situation for consideration and therefore constituted a declared service under Section 66E(e). The respondent submitted that the issue had already been decided by the Tribunal in South Eastern Coal Fields Ltd. and subsequently followed in P. Poorva Kshetra Vidyut Vitran Co. Ltd.
The Tribunal accepted the respondent’s contention and relied upon the earlier Division Bench decision. It noted that Section 65B(44) defines “service” as any activity carried out by one person for another for consideration and includes declared services under Section 66E(e). For a transaction to fall within Section 66E(e), the agreement must specifically provide consideration for agreeing to refrain from an act, tolerate an act or situation, or do an act.
The Tribunal observed that contractual agreements must be read as a whole to ascertain the parties’ intention. In the present case, the intention of the parties was the supply of goods and services for the agreed contractual consideration. The purpose of including liquidated damages or penalty clauses was to safeguard commercial interests and ensure contractual compliance, not to create an independent arrangement under which one party agreed to tolerate breach of contract for consideration. Neither party intended breach of the contractual terms, and the recovery of liquidated damages was only a consequence of non-compliance.
The Tribunal further noted that recovery of liquidated damages or penalties cannot be regarded as consideration for any service. Such recoveries are not linked to any activity undertaken by the recipient for consideration, nor do they represent payment for tolerating default. Referring to the principles governing compensation for breach of contract under Section 74 of the Indian Contract Act, the Tribunal reiterated that liquidated damages represent reasonable compensation arising from contractual breach and not consideration for a taxable declared service.
Since the issue stood concluded by the earlier Division Bench decisions, which squarely applied to the facts of the present case, the Tribunal held that liquidated damages collected as penalty or late delivery charges could not be subjected to service tax under Section 66E(e) of the Finance Act, 1994.
Accordingly, the CESTAT Delhi rejected the Department’s appeal and disposed of the cross application.
FULL TEXT OF THE CESTAT DELHI ORDER
This appeal has been filed by the Principal Commissioner, CGST, Bhopal1 to assail the order dated 19.07.2019 passed by the Commissioner (Appeals), CGST & Central Excise, Bhopal2 by which the order dated 31.03.2019 passed by the Additional Commissioner has been set aside and the appeal has been allowed. The Additional Commissioner had confirmed the demand of service tax for the period 01.07.2012 to 31.03.2017 with interest and penalty.
2. The issue involved in this appeal is as to whether the charges collected by the respondent towards penalty/late delivery charges can be subjected to service tax under section 66E (e) of the Finance Act, 19943.
3. The respondent is a Central Government Public Sector Undertaking engaged in the manufacture of plant and machinery. According to it, for supply of goods and services to the engineering industry the contractual price representing the price of goods/services is payable by the customer subject to the condition that the delivery of goods/services is effected by the dates specified in the contract failing which the contractual value representing the price of goods/services payable by the buyer stands reduced by a certain amount. This condition of the contract providing for deduction of contractual value is termed as Liquidated Damages Clause.
4. A show cause notice dated 17.04.2018 was issued to the respondent mentioning therein that the respondent was charging and collecting amount in the name of penalty/late delivery charges from the contractors/material supplier on account of delay in supply of goods, delay in execution of work but the respondent was not making payment of the service tax under section 66E (e) of the Finance Act on this amount. The respondent filed a reply denying the allegations made in the show cause notice but the Additional Commissioner, by the order dated 31.03.2019, confirmed the demand of service tax. The respondent filed an appeal before the Commissioner (Appeals) which has been allowed by order dated 19.07.2019.
5. Shri Harshvardhan, learned authorised representative appearing for the Department submitted that the Commissioner (Appeals) committed an illegally in allowing the appeal. The contention is that the activity of the respondent is a declared service and the contract/agreement of the appellant contain clauses for tolerating the act or situation for a consideration.
6. Shri Z.U. Alvi, learned counsel appearing for the respondebt has submitted that this issue as to whether the amount collected towards liquidated charges can be subjected to service tax under section 66E (e) of the Finance Act has been decided by a Division Bench of the Tribunal in M/s South Eastern Coal Fields Ltd. Vs. Commissioner of Central Excise And Service Tax, Raipur4 which was subsequently followed by the Tribunal in P. Poorva Kshetra Vidyut Vitran Co. Ltd. Vs. Principal Commissioner, CGST And Central Excise, Bhopal5.
7. Learned counsel for the respondent is justified in submitting that the issue stands covered by the Division Bench judgement of the Tribunal in M/s South Eastern Coal Fields Ltd. The Division Bench observed as follows:
“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.
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 pre-determined, 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.”
8. The aforesaid decision of the Tribunal in M/s South Eastern Coal Fields Ltd. was followed by a Division Bench of the Tribunal in P. Poorva Kshetra Vidyut Vitran Co. Ltd.
9. It, therefore, follows that the liquidated damages collected by the respondent as penalty/late delivery charges cannot be subjected to service tax under section 66E (e) of the Finance Act.
10. The appeal is, accordingly, rejected. Cross application stands disposed of.
(Dictated & Pronounced in open Court)
Notes:
1 the Department
2 the Commissioner (Appeals)
3 the Finance Act
4 2020 (12) TMI 912-CESTAT-NEW DELHI
5 2021 (2) TMI 821-CESTAT NEW DELHI
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