Case Law Details
Sarda Energy & Minerals Ltd Vs Pr. Commissioner Central GST Central Excise & Customs (CESTAT Delhi)
CESTAT Delhi held that unless payment has been made for an independent activity of tolerating an act under an independent arrangement entered into for such activity or tolerating an act, such payment will not constitute ‘consideration’ and such activities will not constitute ‘supply’.
Facts- M/s Sarda Energy & Minerals Ltd. received an amount of EURO 8.5 Millions towards damages in arbitration proceedings in connection with the purchase order dated 23.10.2007 issued for Pressure Filter Model HOSESCH FFP 1516-70/70 M60-PP/GI along with spares. This amount which the appellant claims was received as damages was considered by the department to be taxable under section 66E (e) of the Finance Act, 1994.
Accordingly, a show cause notice dated 25.10.2016 was issued to the appellant. The appellant submitted a reply denying the allegations made in the show cause notice and contended that the said amount received as damages cannot be subjected to levy of service tax.
The Commissioner, by order dated 07.08.2017, confirmed the demand proposed in the show cause notice and also imposed penalty upon the appellant for Rs. 37,199/- under section 78 of the Finance Act. It is this order dated 07.082017 passed by the Commissioner that has been impugned in this appeal.
Conclusion- It would also be pertinent to refer to the Circular dated 03.08.2022 issued by the Department of Revenue regarding the applicability of goods and service tax on liquidated damages, compensation and penalty arising out of breach of contract in the context of ‘agreeing to the obligation to refrain from an act or to tolerate an act or a situation, or to do an act’. This Circular emphasizes that there has to be an express or implied agreement to do or abstain from doing something against payment of consideration for a taxable supply to exist and such an act or a situation cannot be imagined or presumed to exist merely because there is a flow of money from one party to another. It also mentions that unless payment has been made for an independent activity of tolerating an act under an independent arrangement entered into for such activity or tolerating an act, such payment will not constitute ‘consideration’ and such activities will not constitute ‘supply’.
The demand could not have been, for the reasons stated above, confirmed as the appellant had not provided the ‘declared service’ contemplated under section 66 (E) (e) of the Finance Act.
It is, therefore, not possible to sustain the order dated 07.08.2017 passed by the Commissioner. It is, accordingly, set aside and the appeal is allowed.
FULL TEXT OF THE CESTAT DELHI ORDER
M/s Sarda Energy & Minerals Ltd.1 received an amount of EURO 8.5 Millions towards damages in arbitration proceedings in connection with the purchase order dated 23.10.2007 issued for Pressure Filter Model HOSESCH FFP 1516-70/70 M60-PP/GI along with spares. This amount which the appellant claims was received as damages was considered by the department to be taxable under section 66E (e) of the Finance Act, 19942 and, accordingly, a show cause notice dated 25.10.2016 was issued to the appellant. The appellant submitted a reply denying the allegations made in the show cause notice and contended that the said amount received as damages cannot be subjected to levy of service tax. The Commissioner, by order dated 07.08.2017, confirmed the demand proposed in the show cause notice and also imposed penalty upon the appellant for Rs. 37,199/- under section 78 of the Finance Act. It is this order dated 07.08.2017 passed by the Commissioner that has been impugned in this appeal.
2. To appreciate the contentions that have been advanced by Shri J.M. Sharma, learned Consultant for the appellant assisted by Ms. Pooja Agarwal and Dr. Radhe Tallo learned authorized representative appearing for the Department it would be necessary to briefly state the relevant facts.
3. The appellant had placed a purchase order upon M/s Larox Corporation, now known as M/s Outotec Oyi of Finland3 for supply of the filter with spare parts. Clause VI of the purchase order relates to performance guarantee. It provides that the foreign supplier will guarantee the production of 100 ton per hour filter cake with a moisture of less than 8.5%. Clause XII of the purchase order deals with disputes and arbitration and provides that arbitration can be resorted to if a dispute cannot be settled amicably under or in relation to the purchase in accordance with the latest rules of conciliation and arbitration of the International Chambers of Commerce.
4. A dispute arose between the parties regarding the filter that was supplied by the foreign supplier since it had many defects and the level of production could also not be achieved. Accordingly, the appellant sent a legal notice dated 26.11.2011 through an advocate and paragraph 29 of the notice is reproduced below:-
“29. Because of your aforesaid failures to perform your contractual obligations in designing, supplying, installing, testing and commissioning a pressure filter with the promised production capacity, you are hereby being called upon to replace the old and faulty pressure filter with a new pressure filter and in addition pay a sum of Euros 10,11,81,378.00 as damages under heads mentioned in the Annexure A along with interest thereon @ 24% per annum w.e.f. date of notice up to the date of payment of the said amount. If you noticee are for any reason not willing to replace the said pressure filter with the new workable pressure filter in that event you are hereby called upon to pay another sum of Euro 6,44,670.00 on account of refund price of the pressure filter within 15 days from the date of receipt of the present notice, failing which you will be liable to pay interest on this amount also @ 24% per you annum w.e.f. the date of payment made by our client to you noticee.”
5. In terms of Clause XII of the purchase order, the appellant also initiated arbitration proceedings. After the preliminary issue regarding the jurisdiction was settled in favour of the appellant on 11.08.2014, the appellant and the foreign supplier arrived at a settlement that for breach of contract, the foreign supplier shall pay an amount of EURO 8.5 Million to the appellant. A consent award was passed on 14.04.2016 on the basis of the Settlement and the relevant portion of the award containing the Settlement in clause 3 is reproduced below:-
“3. SETTLEMENT
3.1 On 26 February 2016, the Parties reached terms of settlement in respect of , amongst other matters, the subject matter of this Arbitration, which terms are recorded in a confidential settlement agreement (the “Settlement Agreement”). It is a term of the Settlement Agreement that the Parties shall make an application to the Tribunal for an award by consent dismissing the Arbitration.
3.2 By an application dated 26 February 2016 the Parties jointly requested the Tribunal to make an award by consent dismissing the Arbitration pursuant to Article 32 of the rules of Arbitration International Chamber of Commerce (2012) and that the parties will each bear half of the ICC costs of the Arbitration and Tribunal costs and each party bears its own costs of the Arbitration. In view of the above, on 14 March 2016 the Tribunal formally closed the proceedings (Article 27 of the Rules). The Tribunal has reviewed the terms of the Parties‟ joint request and accepts to issue the Award by Consent. At its session of 24 March 2016 the Court fixed the costs of arbitration of USD 338 000 (i.e. fees and expenses of the arbitration and the ICC administrative expenses).”
6. The Settlement referred in Clause 3 of the award is as follows :-
“Sarda and Outotec have agreed that for the breach of the contract, Outotec will pay, in accordance with the provisions below, 8.5 million Euros [Eight million and five hundred thousand Euros] (“the Settlement Sum”) {which, for the avoidance of doubt, is inclusive of any applicable taxes} to Sarda in full and final settlement of (i) all claims made by Sarda against Outotec in the Arbitration and (ii) any claims Sarda has or may have against Outotec or any other company belonging to Outotec Group whose parent company is Outotec Oyi, including future claims not yet known to it, in respect of the supply, erection and commissioning by Outotec to Sarda of the Hoesch FFP 1516 Filter press machine.
3. Sarda, on receipt of BG by authenticated SWIFT, will by the following working day lodge an application to the Tribunal through e-mail for an award by consent dismissing the Arbitration (the “Award”), which application is attached to this Settlement Agreement at Annex-1 and has been signed by Outotec. In the event that the Tribunal is unwilling to make the Award, Sarda shall, forthwith upon being notified by the Tribunal of its refusal to make the Award, lodge an application to the Tribunal through e-mail withdrawing the Arbitration which application is attached to this Settlement Agreement at Annex-2”.
7. It is this amount of EURO 8.5 Million received by the appellant from the foreign supplier for breach of contract that led to the issuance of the show cause notice dated 25.10.2016 to the appellant and the relevant portion of the show cause notice is reproduced below:-
“8.4 In the instant case, the Noticee by withdrawing the said arbitration appeal pending before the International Arbitration Tribunal by way of out of court settlement for the amount of EURO 8.50 Millions mutually agreed upon with their rival overseas supplier for supply of poor quality of Plant & machinery, the said activity very well covered under the definition of declared service under sub-clause (e) of section 66E of the Finance Act”.
8. The reply submitted by the appellant did not find favour of the Commissioner, who by order dated 07.08.2017, confirmed the demand proposed in the show cause notice and the relevant portion of the order is reproduced below :-
“Applying the same analogy to the instant case, I hold that the act of Noticee of settling the dispute outside the Court, without following the course of arbitration, tantamount to service and is taxable, being Declared Service under the provisions of sub-clause (e) of Section 66E of Finance Act, 1994, and hence Noticee‟s argument on the nature of service being actionable claim under Section 65B ibid shall not sustain”.
9. Accordingly, the Commissioner passed the following order:-
“20. In light of the above discussions and findings, I pass the following order :
(a) I confirm the reduced demand of Service Tax amounting to Rs. 8,08,16,636/- (Rupees Eight Crores Eight lakhs sixteen thousand six hundred and thirty six only), including cess, and order it to be recovered from the Noticee in terms of provisions of Section 73 of the Finance Act, 1994 read with Rule 6 of the Service Tax Rules, 1994.
(b) The demand of Rs. 1,17,18,413/- (Rupees One Crore Seventeen Lakhs Eighteen Thousand Four Hundred Thirteen only) is dropped after allowing Noticee the benefit of cum-tax value.
(c) I order for recovery of interest form the Noticee at the appropriate rate on the above Service Tax under Section 75 of the Finance Act, 1994.
(d) I impose a penalty of Rs. 8,08,16,636/- (Rupees Eight Crores Eight lakhs sixteen thousand six hundred and thirty six only) on the Noticee under the provisions of Section 78 of the Finance Act, 1994.
(e) I further impose a penalty of Rs. 37,199/- (Rupees Thirty Seven Thousand One Hundred Ninety Nine only) under Section 78 of the Finance Act, 1994 on the Noticee in respect of the payment of Service Tax on receipt of penalties against cancellation of orders”.
10. The issue that arises for consideration in this appeal is as to whether the damages received by the appellant from the foreign supplier for breach of contractual obligations can be subjected to levy of service tax under section 66E (e) of the Finance Act.
11. Learned Consultant appearing for the appellant submitted that the issue is covered by the decision of the Tribunal in South Eastern Coalfields Ltd. versus Commissioner of Central Excise & Service Tax, Raipur4, which decision was subsequently followed by the Tribunal in M/s Krishnapatnam Port Company Limited versus Commissioner of Central Excise & Service Tax, Guntur5. Learned Consultant also submitted that the Government of India, Ministry of Finance, Department of Revenue (Tax Research Unit) had also issued a Circular dated 03 August, 2022 relating to applicability of goods and service tax on payments in the nature of liquidated damages, compensation, penalty, cancellation charges, late payment surcharge arising out of breach of contract in which agreeing to the obligation to refrain from an act or to tolerate an act, or to do an act has been explained in detail and it has been held that this would not attract levy of service tax.
12. Learned authorized representative appearing for the Department has, however, supported the impugned order.
13. The submissions advanced by the learned consultant appearing for the appellant and the learned authorized representatives for the Department have been considered.
14. The issue is whether the appellant provided 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 post July 1, 2012.
15. 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:
“Section 65B (44)
“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”.
16. “Declared Services” have been defined in section 66E and subsection (3) 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;”
17. The demand proposed in the show cause notice has been confirmed by the Commissioner for the reason that by settling the dispute in arbitration proceedings by a consent settlement would amount to not letting the arbitration proceedings continue and so the said activity would be covered under the definition of “declared service” under section 66E (e) of the Finance Act.
18. 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.
19. 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 also specify the:
a. consideration for agreeing to the obligation to refrain from an act; or
b. consideration for agreeing to tolerate an act or a situation; or
c. consideration to do an act.
20. 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) of the Finance Act and would be taxable under section 68 of the Finance Act 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).
21. In South Eastern Coalfields, the Tribunal examined at length the provisions of section 66E(e) of the Finance Act and made the following observations:-
“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.
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‟.”
22. The aforesaid decision of the Tribunal in South Eastern Coalfields was followed by the Tribunal in Northern Coalfields Ltd. versus Commissioner, CGST, CE and Customs, Jabalpur and Krishnapatnam Port6.
23. The issue in the present case is covered by the aforesaid decisions rendered by the Tribunal and, therefore, it has to be held that service tax could not have been demanded from the appellant.
24. In this connection it would also be pertinent to refer to the Circular dated 03.08.2022 issued by the Department of Revenue regarding the applicability of goods and service tax on liquidated damages, compensation and penalty arising out of breach of contract in the context of „agreeing to the obligation to refrain from an act or to tolerate an act or a situation, or to do an act‟. This Circular emphasizes that there has to be an express or implied agreement to do or abstain from doing something against payment of consideration for a taxable supply to exist and such an act or a situation cannot be imagined or presumed to exist merely because there is a flow of money from one party to another. It also mentions that unless payment has been made for an independent activity of tolerating an act under an independent arrangement entered into for such activity or tolerating an act, such payment will not constitute „consideration‟ and such activities will not constitute „supply‟. The relevant portion of the Circular is reproduced below:
“Agreement to do or refrain from an act should not be presumed to exist
There has to be an express or implied agreement: oral or written, to do or abstain from doing something against payment of consideration for doing or abstaining from such act, for a taxable supply to exist. An agreement to do an act or abstain from doing an act or to tolerate an act or a situation cannot be imagined or presumed to exist just because there is a flow of money from one party to another. Unless there is an express or implied promise by the recipient of money to agree to do or abstain from doing something in return for the money paid to him, it cannot be assumed that such payment was for doing an act or for refraining from an act or for tolerating an act or situation. Payments such as liquidated damages for breach of contract, penalties under the mining act for excess stock found with the mining company, forfeiture of salary or payment of amount as per the employment bond for leaving the employment before the minimum agreed period, penalty for cheque dishonour etc. are not a consideration for tolerating an act or situation. They are rather amounts recovered for not tolerating an act or situation and to deter such acts; such amounts are for preventing breach of contract or nonperformance and are thus mere ‘events’ in a contract. Further, such amounts do not constitute payment (or consideration) for tolerating an act, because there cannot be any contract: (a) for breach thereof, or (b) for holding more stock than permitted under the mining contract, or (c) for leaving the employment before the agreed minimum period or (d) for doing something leading to the dishonour of a cheque. As has already been stated, unless payment has been made for an independent activity of tolerating an act under an independent arrangement entered into for such activity of tolerating an act, such payments will not constitute ‘consideration’ and hence such activities will not constitute “supply” within the meaning of the Act.”
(emphasis supplied)
25. The demand could not have been, for the reasons stated above, confirmed as the appellant had not provided the „declared service‟ contemplated under section 66 (E) (e) of the Finance Act.
26. It is, therefore, not possible to sustain the order dated 07.08.2017 passed by the Commissioner. It is, accordingly, set aside and the appeal is allowed.
Note:-
1 the appellant
2 the Finance Act
3 foreign supplier
4 [2021] 124 taxmann.com 174/2021 (55) GSTL 549 (New Delhi – CESTAT)
5 Service Tax Appeal No. 30227 of 2016 decided on 25.04.2022 [2023] 4 Centax 105 (Tri. – Hyd.)]
6 (2023) 3 Centax 211 (Tri. – Delhi)
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