TAXABILITY OF NOTICE PAY RECOVERY FROM EMPLOYEES

[Dr. Sanjiv Agarwal]

Under the employment related services between employer and employees, an employee offers services to employer and the employer in turn salary plus other monetary and non-monetary benefits (perquisites). Both the parties are covered under a contract generally known as employment / appointment letter. In order to protect the interests of both parties, it is generally stipulated that in the event of premature termination of contract, there will be a compensation payable by either side, generally termed as notice pay.

What is Notice Pay Recovery?

In terms of appointment letter, whenever an employee joins or leaves an organization, he or she is bound by the terms of employment. An employee is usually required to serve the agreed notice period before he / she resigns. However, most of the employee agreements have a clause stipulating that if an employee wants to leave the company without serving the agreed notice period, then he is required to pay an amount equal to the unserved notice period.

This is called notice pay which is either recovered from the employee in cash or deducted / recovered from the salary payable to him.

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.

GST provision on employee-employer transactions

Section 7(2) (a) of the CGST Act, 2017 read with Entry 1 of Schedule III, states that services by an employee to employer in course of or in relation to his employment are neither treated as supply of goods nor supply of services.

Moreover, CBIC vide press release dated 10.07.2017 clarified that the services by an employee to the employer in the course of or in relation to his employment is outside the scope of GST (neither supply of goods or supply of services). It follows therefrom that supply by the employer to the employee in terms of contractual agreement entered into between the employer and the employee, may not be subjected to GST.

However, services provided by employer are in any case taxable services.

Applicability of GST on Notice Pay Recovery

Since notice pay recovery is in the course of or in relation to employment, as per Section 7(2) (a) of the CGST Act, 2017 read with Entry 1 of Schedule III, the same can be considered as exempt under GST.

Relevant judicial pronouncements

Though there are many advance rulings where in it has been ruled both ways for and against the taxability of notice pay, following judicial pronouncements are noteworthy:

In M/S RAJASTHAN RAJYA VIDHYUT PRASARAN NIGAM LTD. VERSUS COMMISSIONER OF CENTRAL GOODS AND SERVICES TAX, CUSTOMS AND CENTRAL EXCISE, JODHPUR I [2022 (1) TMI 909 - CESTAT NEW DELHI], the appellant was a public sector undertaking of the Government of Rajasthan and 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 amount recovered from its employees on their premature resignation, i.e., without giving the requisite notice period. The demand was confirmed and the Commissioner (Appeals) upheld the order in original. Hence, the appellant filed this appeal.

The CESTAT bench observed that notice period and compensation are incorporated in employment contract but they are not the purpose of contract. A notice period on both sides is provided for so that the other party can make arrangements. Compensation is a fall back option if one of the parties frustrates the contract but compensation paid for failure to fulfill conditions under a contract is not consideration for service under the contract. In the instant case, notice pay did not give rise to rendition of service either by employer or employee. Following the law laid down by Madras High Court in GE T & D INDIA LIMITED VERSUS DEPUTY COMMISSIONER OF CENTRAL EXCISE, CHENNAI [2019 (12) TMI 1566 - MADRAS HIGH COURT], it was held that service tax is not exigible on amount received by employer from employee for not serving  notice period.

Further, Appellate Authority for Advance Ruling, Madhya Pradesh in the case of IN RE: M/S. BHARAT OMAN REFINERIES LIMITED [2021 (12) TMI 999 - APPELLATE AUTHORITY FOR ADVANCE RULING, MADHYA PRADESH] also held that no service tax is applicable on services by employee to employer services by employee to employer by way of recovery on pre-mature termination of contract of employment.

In IN RE: M/S. SYNGENTA INDIA LIMITED [2022 (1) TMI 903 - AUTHORITY FOR ADVANCE RULING, MAHARASHTRA], it was held that GST is not payable on recovery of notice pay from resigning employee as it is not an act of forbearance or tolerance but is in accordance with employment contract.

In IN RE: M/S. EMCURE PHARMACEUTICALS LIMITED. [2022 (1) TMI 186 - AUTHORITY FOR ADVANCE RULING, MAHARASHTRA], by taking into account the decisions as well as analysis, it may be concluded that, recovery of notice pay from dues of employee/payment of notice pay by the employee who could not serve the notice for the period as per contractual agreement/appointment letter does not amount to supply and therefore as per section 7 (1A) of the CGST Act, 2017, the provisions of Schedule II does not come into play.

Conclusion

The ruling of High Court and other authorities clarify one of the most controversial issue being faced by taxpayers. The issue of Notice pay recovery is very common in any business entity and as such, tax payers may be well guided by this pronouncement. The employers face such dilemma and therefore, it could be advised that notice pay may not be subject to levy of GST.