Service Tax not Applicable on Notice Pay Recoveries made from employees

Rajasthan Rajya Vidhyut Prasaran Nigam Ltd. Vs Commissioner of Central Goods and Services Tax (CESTAT Delhi)

No service tax payable on amount of notice pay recovered from employer in lieu of sudden termination of employees

The CESTAT, Delhi in M/s Rajasthan Rajya Vidhyut Prasaran Nigam Ltd. v. Commissioner of CGST, Customs [Service Tax Appeal No. 53020 of 2018 dated January 14, 2022] set aside the order passed by the Revenue Department confirming demand of service tax on the notice pay recovered by the assessee from its employees for premature resignation. Held that, no service tax is payable on notice pay in lieu of sudden termination, as it does not give rise to the rendition of service either by the employer or the employee, and compensation for failure under a contract cannot be consideration for service. Further held that such contract cannot be termed as declared service.

Facts:

M/s Rajasthan Rajya Vidhyut Prasaran Nigam Ltd. (“the Appellant” / “the Employer”) is a public sector undertaking of the Government of Rajasthan and engaged in transmission of electricity. An audit took place by the Service Tax Department, and it was found that the Appellant did not discharge service tax of INR 28,10,698/- for the amount recovered from its employees on their premature resignation i.e. without giving the requisite notice period.

Thereafter, a Show Cause Notice (“SCN”) dated July 07, 2016 was issued demanding service tax amounting to INR 3,55,472 along with interest under Section 75 the Finance Act, 1994 (“the Finance Act”) and imposing penalty under Section 78 of the Finance Act.

Subsequently, the Assistant Commissioner passed Order in Original dated December 14, 2016 confirming the demand of service tax along with interest and penalty, which was further upheld vide Order-in-Appeal dated June 19, 2018 (“the Impugned Order”), by the Commissioner (Appeals) (“the Respondent”) and hence the Appellant has filed this petition.

The Respondent contended that, the Appellant had an agreement to tolerate a situation i.e. employees resignation without the requisite notice period in return for a consideration and therefore, the amounts received or recovered from its employees is exigible to service tax under Section 66E(e) of the Finance Act and such liquidated damages as a penalty for resigning without notice period is built into the employment contract.

Issue:

Whether the amounts received or recovered by the Employer from its employees for resigning from the service without giving the requisite notice is exigible to service tax?

Held:

The CESTAT, Delhi in Service Tax Appeal No. 53020 of 2018 dated January 01, 2022 held as under:

• Noted that, service was leviable under Section 66B of the Finance Act on all services, other than those included in the negative list. Service was defined to mean any service carried out for a consideration and included ‘declared services’ under section 66E of the Finance Act and it further includes, ’agreeing to the obligation to refrain from an act, or to tolerate an act or a situation, or to do an act’.
• Observed that, declared service becomes exigible to service tax if it is done for a consideration and the Respondent has confused compensation for consideration. While a consideration is something received for performance under the contract, compensation is received if the other party reneges or fails to perform as per the contract. Consideration is the object of the contract and compensation is not.
• Further observed that, consideration is the result of successful performance of the contract while compensation is paid by the party frustrating the contract to the other. Compensation is also paid, if the contract so provides, when one party performs under the contract but not within the conditions laid down, such as delays in performance.
• Denied with the contention of the Respondent and distinguished contract from agreement and stated that what falls within the ambit of Section 66E(e) of the Finance Act are cases where the essence of the agreement, is tolerating a situation or refraining from an act in return for a consideration and if the agreement is for something else and if one of the parties fails to perform as per the agreement and pays to the other a compensation as pre-decided in the agreement, it does not fall under Section 66E(e).
• Opined that, the matter is about an employment contract between the employee and the notice period and the compensation are incorporated in the employment contract itself, but these are not the purpose of the contract and therefore, any compensation paid towards the same is not a consideration for the contract.
• Relied on the judgment of the Hon’ble Madras High Court in Ge T & D India Limited v. Deputy Commissioner of Central Excise [W.P. No. 26292 of 2018 dated December 13, 2019] wherein it was held that, no service tax is payable on notice pay in lieu of sudden termination, as it does not give rise to the rendition of service either by the Employer or the employee.
• Set aside the Impugned Order.
• Held that, any compensation paid towards the failure under a contract cannot be consideration for service under the contract.

Our comments:

Under GST regime:

Recently, the AAAR, Madhya Pradesh in M/S. Bharat Oman Refineries Limited [Advance Ruling No. MP/AAAR/07/2021 dated November 8, 2021] reversed the ruling passed by the AAR and held that merely because the employer is being compensated does not mean that any services have been provided by him or that he has ‘tolerated’ any act of the employee for premature exit.

Under Service Tax regime:

In the service tax regime, the Hon’ble Madras High Court in Ge T & D India Limited v. Deputy Commissioner of Central Excise [W.P. No. 26292 of 2018 dated December 13, 2019] in a similar case has held that no service tax is payable on notice pay. Relevant portion is reproduced below:

“The employer cannot be said to have rendered any service per se much less a taxable service and has merely facilitated the exit of the employee upon imposition of a cost upon him for the sudden exit. The definition in clause (e) of Section 66E as extracted above is not attracted to the scenario before me as, in my considered view, the employer has not ‘tolerated’ any act of the employee but has permitted a sudden exit upon being compensated by the employee in this regard.

……Notice pay, in lieu of sudden termination however, does not give rise to the rendition of service either by the employer or the employee.”

Relevant Provision:

Section 65B(22) of the Finance Act:

“Interpretations.

’65B. In this chapter, unless the context otherwise requires,–

(22) “declared service” means any activity carried out by a person for another person for consideration and declared as such under section 66E;”

Section 66E(e) of the Finance Act:

“Declared services.

66E. 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;”

FULL TEXT OF THE CESTAT DELHI ORDER

This appeal is filed by the appellant assailing the order-in-appeal ¹ dated June 19, 2018 passed by the Commissioner of Customs (Appeals), Jodhpur upholding the order-in-original dated December 14, 2016 passed by the Assistant Commissioner of Central Excise, Bikaner.

2. The appellant is a public sector undertaking of the Government of Rajasthan and is engaged in transmission of electricity. Its records were audited by the Service Tax Department and it was found that the appellant has not discharged service tax on Rs. 28,10,698/- which it recovered from its employees on their premature resignation, i.e., without giving the requisite notice period. A Show Cause Notice² dated 1.7.2016 was issued proposing to demand Service Tax amounting to Rs. 3,55,472/- on the amount which the appellant had recovered from its employees for premature resignations. It was also proposed to recover interest under Section 75 and impose penalty under section 78 of the Finance Act, 1994.

3. The Assistant Commissioner passed the Order in Original dated December 14, 2016 confirming the demand of service tax along with interest as proposed and imposed a penalty equal to the service tax confirmed under section 78. On appeal, the Commissioner (Appeals) has, by the impugned order, upheld the order in original. Hence, the appellant filed this appeal.

4. We have heard learned advocates for the appellant and the learned authorised representative for the revenue and perused the records.

5. The question which falls for consideration is “whether the amounts received or recovered by the employer from its employees for resigning from the service without giving the requisite notice is exigible to Service Tax as a Declared Service under Section 66E(e) of the Finance Act, 1994 or not”.

6. During the relevant period, service tax was leviable under section 66B on all services, other than those included in the negative list. Service was defined to mean any service carried out for a consideration and included ^„declared services‟. Declared services were defined to mean any activity carried out by a  person for another person for consideration and declared as such under section 66E. Section 66E included ^„agreeing to the obligation to refrain from an act, or to tolerate an act or a situation, or to do an act’. The legal provisions as applicable during the relevant period were as follows:

SECTION 65B.Interpretations.— In this Chapter, unless the context otherwise requires,—

…………..

(22) “Declared service” means any activity carried out by a person for another person for consideration and declared as such under section 66E;

(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.

SECTION 66B. Charge of service tax on and after Finance Act, 2012.

There shall be levied a tax (hereinafter referred to as the service tax) at the rate of fourteen percent. 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 66E. Declared services. — The following shall constitute declared services, namely:—

(a)

……..

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

7. The case of the Revenue is that the appellant had tolerated its employees resigning without the requisite notice period in return for a consideration and therefore, the amounts received or recovered from such of its employees is exigible to Service Tax under Section 66E(e). The case of the appellant is that it did not render any service nor has it entered into any agreement to tolerate its employees leaving without notice. It has only collected compensation for such an act of its employees. Therefore, the amounts received or recovered by it cannot be charged to service tax.

8. We find that both ^„Service‟ as defined in Section 65B(44) and ^„Declared Service‟ as defined in Section 65B (22) require the activity to be for a ^„Consideration‟. As per Section 66E (e) the following are declared services:

(a) agreeing to the obligation to refrain from an act, or

(b) agreeing to tolerate an act or a situation, or

(c) agreeing to do an act.

9. Each of the above is a declared service and therefore, becomes exigible to service tax if it is done for a consideration. The dispute in this case appears to have arisen because the officers confused compensation for consideration. While a consideration is something received for performance under the contract, compensation is received if the other party reneges or fails to perform as per the contract. Consideration is the object of the contract and compensation is not. The party which suffers because of the reneging or non-performance by the other can get compensated either in the form of unliquidated damages (where the court decides the quantum of damages) or liquidated damages (where the contract itself provides that damages of such and such amount will be paid in case of non-performance of the contract). While a contract for any service specifies both the service to be rendered and the consideration to be paid for such service, it also has other clauses which define the ^„conditions of the contract‟ which include details of how the parties must fulfil their parts of the contract. These conditions, often include a clause on ^„liquidated damages‟ if a party fails to fulfil its obligations under the contract as laid down in the conditions. Consideration is the result of successful performance of the contract while compensation is paid by the party frustrating the contract to the other. Compensation is also paid, if the contract so provides, when one party performs under the contract but not within the conditions laid down, such as delays in performance. A few illustrations will make this point clearer. A doctor performs a surgery and gets paid a fee. Here the surgery is the service of the doctor and the fee is the consideration and the purpose of the contract (written or otherwise), is the surgery. If due to medical negligence of the doctor, the patient loses his eye and the patient gets paid compensation, it is a payment for frustration of the implicit contract for the surgery which presumes that it will be performed carefully. The patient gets paid but it is not consideration; it cannot be said that the doctor and patient agreed that the patient would lose his sight and as a consideration for taking away the sight of the patient, doctor paid an amount. Similarly, a lawyer is expected to defend his client and pursue his best interests. If the lawyer is grossly negligent and the client suffers and gets paid compensation, it is for frustration of the contract which the client had with the lawyer. It cannot be said that there is either a written or implicit agreement that the advocate will be negligent and in allowing the lawyer to be negligent and cause loss, a consideration has been paid to the client. If a bank enters into a loan agreement, the essence of the contract is that the borrower would borrow the amount on interest for an agreed period. If the borrower wants to pre-pay the loan, it frustrates the contract from the point of view of the bank and loan pre-payment charges (in the form of liquidated damages) are charged by the bank as per the loan agreement. These charges are not paid for rendering the service but as a penalty for the borrower reneging on his contract and not borrowing money for the entire period as originally agreed. When a telephone or electricity company renders service and issues a bill, the implicit agreement is that the customer will pay the bill within time. If the customer delays paying the bill, he will be required to compensate the company for the delay in the form of late fee. The late fee is not the purpose of the agreement but is a penalty for failure on the part of the customer to meet his end of the deal in paying the bill within time.

10. The argument of the Revenue is that liquidated damages (in this case, the penalty for resigning without notice period) is built into the contract itself. Therefore, it is agreed beforehand that if one of the parties reneges or fails to perform, the other will tolerate the situation in return for the amount to be paid as decided in the contract. This, according to the Revenue is an agreement to tolerate a situation and hence constitutes a ^„Declared Service‟ under Section 66E(e) and is exigible to service tax.

11. This, in our view, is not the correct reading of the contract. Contract, is an agreement enforceable by law. Section 2 of The Indian Contract Act, 1872 is reproduced below:

“2. Interpretation-clause.—In this Act the following words and expressions are used in the following senses, unless a contrary intention appears from the context:

(a) When one person signifies to another his willingness to do or to abstain from doing anything, with a view to obtaining the assent of that other to such act or abstinence, he is said to make a proposal;

(b) When the person to whom the proposal is made signifies his assent thereto, the proposal is said to be accepted. A proposal, when accepted, becomes a promise;

(c) The person making the proposal is called the “promisor”, and the person accepting the proposal is called the “promisee”;

(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;

(e) Every promise and every set of promises, forming the consideration for each other, is an agreement;

(f) Promises which form the consideration or part of the consideration for each other are called reciprocal promises;

(g) An agreement not enforceable by law is said to be void;

(h) An agreement enforceable by law is a contract;

(i) An agreement which is enforceable by law at the option of one or more of the parties thereto, but not at the option of the other or others, is a voidable contract;

(j) A contract which ceases to be enforceable by law becomes void when it ceases to be enforceable.”

12. The agreement is a set of promises which form consideration for each other. Evidently, the promises have to be for performance under the contract and not for frustrating it. Consideration, correspondingly, is at the desire of the promisee. It must be something which the promisee desires and not something which he does not want. Each party to a contract desires the other to perform his part of the deal and not that the other party does not perform so that it can get a compensation. For instance, the patient desires the doctor to perform surgery with due care and does not desire that the doctor should be negligent and cause harm so that he can get compensation. The fact that the quantum of penalty or compensation is not decided by a court of law but is pre-agreed and built into the contract for the service itself in the form of liquidated damages does not make it a consideration; it remains compensation. It is a fall-back option if one of the parties frustrates the contract either by reneging on its commitments or by failing to perform.

13. What falls within the ambit of Section 66E(e) are cases where the essence of the agreement, i.e., the purpose for which the agreement is entered into itself is tolerating a situation or refraining from an Act in return for a consideration. Such an agreement could be:

(a) an agreement agreeing to the obligation to refrain from an act, or

(b) agreeing to tolerate an act or a situation, or

(c) agreeing to do an act.

14. Evidently, if none of these are the purpose or the essence of the agreement or if there is no consideration for such an agreement, it does not fall within the ambit of Section 66E(e). If the agreement is for something else and if one of the parties fails to perform as per the agreement and pays to the other a compensation as pre-decided in the agreement, it does not fall under Section 66E(e). This view was taken by this Tribunal in several cases. In M/s. Repco Home Finance Ltd.³, the larger bench of this Tribunal held that no service tax can be charged on loan pre-payment charges. In South Eastern Coalfields Ltd.⁴, the amounts received by the appellant as penalty from other parties for non-observance or breach of terms of contract in the commercial contracts it entered into were held to be not chargeable to service tax under section 66E(e). In MNH Shakti Ltd.⁵, Revenue’s demand of service tax under section 66E(e) on the compensation which the appellant received from the Government for cancellation of the coal blocks was set aside. In the case of Ruchi Soya Ltd. ⁶ , the appellant entered into an agreement for maintenance of wind farms and paid the contractor. However, where the machine availability was not as per the norms, the contractor issued credit notes to the appellant as compensation. Revenue’s demand of service tax on this compensation amount under Section 66E(e) was set aside by this Tribunal.

15. The present case deals with contracts of employment. Employment contracts are entered into with the expectation that the employer will continue to keep him employed for the period as agreed and that the employee will perform his duties diligently. They are not entered into so that the employer can remove the employer from service or so that the employee can resign and leave the service. However, often, for various reasons the employer may decide to terminate the services of the employee which puts the employee to inconvenience and he has to find another job. Conversely, the employee may decide to resign and leave the service which inconveniences the employer who will have to make alternative arrangements such as finding a substitute. A notice period on both sides is provided for so that the other party can make arrangements. If the employer decides to terminate the services without giving the required notice, the employment contract itself provides for a compensation to be paid. Similarly, if the employee resigns without notice, compensation is paid by the employee or recovered from his dues. Both the notice period and the compensation are incorporated in the employment contact itself but these are not the purpose of the contract. Consequently, any compensation paid is not a consideration for the contract.

16. Since the provision of section 66E(e) appears to have given rise to some confusion, the Central Board of Excise and Customs issued CBEC‟s guidance notes dated 20.06.2012 para 2.9.3 clarifies as follows:

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

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.”

17. Referring to the above clarification by the CBEC, High Court of Madras has, in GE T&D India Ltd.⁷ held that notice pay, in lieu of sudden termination, does not give rise to the rendition of service either by the employer or the employee and allowed the writ petitions. Thus, the specific issue in this case is no longer res integra. GE T&D India Ltd. was followed in Intas Pharmaceuticals⁸, State Street Syntel Services Pvt. Ltd.⁹, Shri Ram Pistons and Rings Ltd.¹⁰ and HCL Learning Ltd.¹¹.

18. Learned Departmental Representative submitted that the clarification by the CBEC was clear and it was held that the termination pay received by the employee is not exigible to tax because in such as case, it is the employee who is the service provider and the service provided by him in the course of employment is excluded from the definition of service. However, where the employer recovers any amount, the service provider will be the employer and his services are not excluded from the definition of service. Therefore, a distinction needs to be made on this count. However, on a specific query from the bench, he fairly submits that there are no case laws to support this argument nor is there any case law contrary to the judgment of the Madras High Court in the GE T&D.

19. In view of our finding that compensation for failure under a cannot is NOT consideration for service under the contract and also following the law laid down by Madras High Court in GE T&D that Notice pay, in lieu of termination, however, does not give rise to the rendition of service either by the employer or the employee, the impugned order upholding confirmation of a demand of service tax on the notice pay received/recovered by the appellant from its employees for premature resignation cannot be sustained and needs to be set aside.

20. In view of the above, the appeal is allowed and the impugned order is set aside.

Notes: 

1. Impugned order

2. SCN

3. Service Tax Appeal No. 511 of 2011-LB decided by MISCELLANOUS ORDER NO. 40053/2020 dated 8.6.2020

4. 2020-TIOL-1711-CESTAT- DEL

5. 2021-TIOL-732-CESTAT-KOL

6. 2021-TIOL-402-CESTAT-DEL

7. 2019 (12) TMI- 1566- Madras High Court

8 . 2021-TIOL-367- CESTAT-AHM

9. 2021- TIOL- 152-CESTAT-MUM

10. 2020 (42) GSTL 79 (Tri-All)

11. 2019-TIOL-3545-CESTAT- All

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(Author can be reached at [email protected])