2025 (6) TMI 1815 - AT - Service Tax

Refund of service tax remitted under protest - pre-closure/foreclosure (of the loan) charges collected by NBFC - liquidated damages or not - period April 2011 to June 2017 - HELD THAT - Admittedly in 2023 (2) TMI 896 - CESTAT CHENNAI after following decision of a Larger Bench it has been held that foreclosure charges collected by a Non-banking Financial CoAmpany is not liable to Service Tax under Banking and Financial Services . This very foreclosure charge was treated as payment towards liquidated damages in the present dispute the refund of which was denied by the Department. It is found that even the charge of the Revenue for treating the same as liquidated damages would not survive in view of the very Larger Bench decision in Commissioner of Service Tax Chennai Vs. Repco Home Financial Limited 2020 (7) TMI 472 - CESTAT CHENNAI . Further the Delhi Bench of the Tribunal considered the levy of Service Tax for liquidated damages within the meaning of Section 66E(e) of the Finance Act 1994 in the case of South Eastern Coalfields Limited Vs CCE ST Raipur 2020 (12) TMI 912 - CESTAT NEW DELHI and it was held that 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. Conclusion - The denial of refund by treating the receipt as liquidated damages liable to Service Tax does not have any legal sanctity. The impugned order set aside - appeal allowed.

Summary

1. ISSUES PRESENTED and CONSIDERED

The core legal question considered by the Tribunal was whether the denial of refund of service tax paid on foreclosure/pre-closure charges collected by a Non-banking Financial Company (NBFC) was in accordance with law. Specifically, the issue centered on whether such foreclosure charges constitute "liquidated damages" liable to service tax under the Finance Act, 1994, or whether they fall outside the ambit of taxable services under the category of "Banking and Financial Services."

2. ISSUE-WISE DETAILED ANALYSIS

Issue: Whether foreclosure/ pre-closure charges collected by an NBFC are liable to service tax as "liquidated damages" or constitute a taxable service under the Finance Act, 1994.

Relevant Legal Framework and Precedents: The Tribunal relied primarily on the decision of a Larger Bench in Commissioner of Service Tax, Chennai Vs. Repco Home Financial Limited - 2020 (42) G.S.T.L. 104 (Tri.-LB), which examined the nature of foreclosure charges in the context of service tax liability. The Finance Act, 1994 provisions, especially Section 66E(e) defining taxable services and Section 65B(44) defining "service," as well as Explanation (a) to Section 67 regarding "consideration," were central to the analysis.

Additionally, the Delhi Bench decision in South Eastern Coalfields Limited Vs CCE & ST Raipur - 2021 (55) G.S.T.L. 549 (Tri.-Del.) was considered, which dealt with the levy of service tax on liquidated damages under Section 66E(e) of the Finance Act and held that liquidated damages or penalties do not constitute consideration for a taxable service.

Court's Interpretation and Reasoning: The Tribunal noted that foreclosure charges arise when a borrower chooses to pre-close a loan, thereby shortening the loan tenure unilaterally. The Larger Bench in Repco Home Financial Limited clarified that foreclosure charges are a form of liquidated damages, which are genuine pre-estimates of damages agreed upon in the contract to compensate for the lender's loss due to early termination of the loan agreement.

The Larger Bench emphasized that liquidated damages differ from penalties in that they represent a genuine pre-estimate of loss rather than a sum imposed in terrorem. The Court explained that under Indian law, particularly Section 74 of the Contract Act, the distinction between liquidated damages and penalties is eliminated to the extent that both are binding if stipulated in the contract.

In applying this to the service tax context, the Tribunal highlighted that liquidated damages do not constitute a "service" provided by the recipient to the payer, as there is no activity or service rendered in exchange for the amount received. Instead, the amount is compensatory in nature, intended to cover losses from breach of contract, not consideration for service.

The Delhi Bench decision reinforced this interpretation by observing that recovery of liquidated damages or penalties is not towards any service per se, nor is there an intention by the party paying such damages to receive a service. The imposition of such damages is to ensure compliance with contractual obligations and deter breaches, not to compensate for a service rendered.

Key Evidence and Findings: The facts were undisputed that the appellant NBFC collected foreclosure charges as part of the loan agreement, and these charges were treated by the Revenue as liquidated damages subject to service tax. The Tribunal noted that the appellant had already obtained refunds for earlier periods following the Larger Bench ruling and sought similar relief for subsequent periods, which was denied by the Revenue.

The Tribunal found no legal basis for denying the refund on the ground that the foreclosure charges were liquidated damages liable to service tax, given the authoritative Larger Bench ruling and consistent judicial precedents.

Application of Law to Facts: Applying the Larger Bench's reasoning, the Tribunal held that foreclosure charges collected by the appellant are liquidated damages and do not amount to a taxable service under the Finance Act. Therefore, service tax paid on such charges was not legally sustainable, and the refund denial was contrary to law.

Treatment of Competing Arguments: The Revenue contended that foreclosure charges were taxable as liquidated damages under Section 66E(e) and thus not refundable. The Tribunal rejected this, relying on the Larger Bench decision which explicitly held that liquidated damages do not constitute a service and hence are not subject to service tax. The Tribunal also relied on the Delhi Bench and Chennai Bench decisions which supported this view.

3. SIGNIFICANT HOLDINGS

The Tribunal set forth the following crucial legal reasoning verbatim from the Larger Bench decision:

"The foreclosure of loan is, therefore, a material breach of contract as it curtails the loan service period unilaterally, which can prompt the promisor to claim damages. Damages can be determined by Courts or they can also be incorporated in the loan agreements and other commercial contracts so as to ensure certainty in dealings and also serve as a deterrent measure. This aspect of damage is known as liquidated damages."

And further:

"A penalty is a sum of money so stipulated in terrorem, and liquidated damages are a genuine pre-estimate of damages. So far as the law in India is concerned there is no qualitative difference in the nature of liquidated and unliquidated damages, as Section 74 eliminates the somewhat elaborate refinement made under the Common Law between stipulations providing for payment of liquidated damages and stipulations in the nature of penalty, which under the Common Law is stipulation in terrorem; a genuine pre-estimate of damages is regarded as liquidated damages, and is binding."

From the Delhi Bench decision:

"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."

Core principles established include:

• Foreclosure charges collected by NBFCs constitute liquidated damages and are not taxable services.
• Liquidated damages represent compensation for breach of contract rather than consideration for a service.
• Service tax is not leviable on amounts received as liquidated damages or penalties since no service is rendered.
• Refund of service tax paid on such foreclosure charges is legally justified.

Final determinations:

• The denial of refund of service tax on foreclosure charges was legally unsustainable.
• The impugned order rejecting the refund was set aside.
• The appeal was allowed with consequential benefits to the appellant.