2025 (7) TMI 1141 - AT - Service Tax

Levy of service tax - declared services or not - amounts collected by the appellant in the form of fines/penalties liquidated damages forfeiture of earnest money/security deposits etc. from the contractors who failed to provide the services within the agreed stipulated time/standards - tolerating the act of service providers/contractors for poor performance or not meeting the obligations in full - Section 66E(e) of the Finance Act 1994 - HELD THAT - A consistent view has been taken by courts that the amount charged necessarily has to be a consideration for the taxable service provided under the statute and the amount which has no nexus with the taxable service is not a consideration for the service provided and therefore would not become a part of the value of the service which is taxable. Such amounts have been held to be in the nature of penal charges on account of breach or nonperformance of contractual obligations or non-adherence to contractual stipulations and are recovered with the intention to make good for the losses suffered and to act as a deterrent to ensure that the buyer or the supplier do not violate the terms of the contract entered into. These amounts cannot be termed as a consideration in lieu of rendering of a service under Section 65B (44) of the Act. Further it has been laid down that for an activity to be covered as a Declared Service under Section 66E of the Act there must necessarily be an independent agreement to refrain or tolerate or to do an act between the parties concerned. In view of the clarification by Circular No.214/1/2023-ST dated 28.02.2023 and the law as settled by the Courts the amounts in question cannot be held as a consideration for providing any services. Any amount recovered by the appellant per se cannot be so understood for rendering of service. For an amount to qualify as consideration there has to be quid pro quo or performance of an activity for consideration. So far as these amounts are concerned no activity against the said amounts has been actually undertaken. There is therefore no rendering of service in terms of Section 65B (44) of the Finance Act 1994 and therefore no demand in terms of Section 66 E(e) of the act would be maintainable. The amounts in question as confirmed by the lower authority were certainly not towards rendition of any service hence not leviable to service tax. The order of the lower authority can therefore not be sustained and is therefore set aside. Appeal allowed.

Summary

ISSUES:

Whether amounts collected as fines, penalties, liquidated damages, and forfeiture of earnest money/security deposits from contractors constitute consideration for a declared service under Section 66E(e) of the Finance Act, 1994.Whether such amounts are leviable to service tax as "agreeing to the obligation to refrain from an act, or to tolerate an act or a situation, or to do an act" under Section 66E(e).The legal interpretation of "consideration" under Section 65B(44) and its application to penal sums recovered for breach or non-performance of contracts.The applicability and effect of Circular No. 214/1/2023-ST and precedent decisions on the taxability of liquidated damages, penalties, and forfeiture amounts.

RULINGS / HOLDINGS:

The amounts collected by way of fines, penalties, liquidated damages, and forfeiture of earnest money/security deposits do not constitute "consideration" for any taxable service under Section 66E(e) of the Finance Act, 1994.Such amounts are compensatory in nature, intended to compensate for loss or damage due to breach of contract and act as deterrents, and are not payments for "agreeing to the obligation to refrain from an act, or to tolerate an act or a situation, or to do an act."There must be an independent agreement specifying the obligation to tolerate or refrain from an act and a corresponding flow of consideration for the activity to qualify as a declared service under Section 66E(e); absent such agreement, the sums are not taxable.The recovery of liquidated damages or penalties is "not the reason behind the execution of the contract for an agreed consideration" and does not amount to a service rendered or a supply.The order imposing service tax demand on the impugned amounts under Sections 75, 76, and 77 of the Finance Act, 1994 is unsustainable and is set aside.

RATIONALE:

The Court applied the statutory framework of the Finance Act, 1994, particularly Sections 65B(44), 66B, 66E(e), 75, 76, and 77, and the Contract Act, 1972 (Sections 73 and 74) relating to breach of contract and liquidated damages.Precedents including the Tribunal's decision in South Eastern Coalfields Ltd. v. CCE & ST and subsequent appellate orders in the appellant's own case were relied upon to interpret the scope of "declared services" under Section 66E(e).It was emphasized that "consideration" must be linked to an activity or service rendered, and mere recovery of penalties or damages for breach of contract does not amount to taxable consideration.The Court noted the binding nature of the Tribunal's decision, which was not contested further by the Revenue before the apex court, thereby affirming the settled legal position.CBIC Circular No. 214/1/2023-ST and earlier Circular No. 178/10/22-GST were considered authoritative clarifications explaining that liquidated damages and penalties imposed for breach of contract or violation of laws are compensatory and punitive, not consideration for tolerating an act or refraining from an act, and thus not taxable.The Court distinguished payments that constitute consideration for ancillary supplies (e.g., late fees, early termination fees) from penal sums, underscoring the necessity of an express or implied agreement for toleration or refraining from an act to attract tax under Section 66E(e).