2025 (5) TMI 1826 - AT - Service Tax

Taxability of service under the category tolerating an Act or situation - Circular No. 214/1/2023-ST - demand alongwith interest and penalty - HELD THAT - We find that the issue involved in the present case is no longer res integra having been decided by the Tribunal in the case of South Eastern Coal Fields Ltd. 2020 (12) TMI 912 - CESTAT NEW DELHI We also find that the CBIC vide Circular No. 214/1/2023-ST dated 28.02.2023 has accepted the decisions of the Tribunal in the cases of South Eastern Coal Fields Ltd. 2020 (12) TMI 912 - CESTAT NEW DELHI and Western Coalfields Ltd 2022 (9) TMI 741 - CESTAT MUMBAI Thus we are of the considered opinion that as the issue is no longer res integra therefore the impugned order cannot be sustained. The appeal is accordingly allowed.

Summary

1. ISSUES PRESENTED and CONSIDERED

The core legal questions considered in the appeal are:

(a) Whether the amounts forfeited by the appellant as advances from buyers constitute consideration for a taxable service under the category of "tolerating an act or situation" as defined under Section 66E(e) of the Finance Act, 1994?

(b) Whether forfeiture of advances, characterized as penalty or liquidated damages for breach of contract, amounts to a taxable service?

(c) The applicability and interpretation of the definition of "service" and "consideration" under the Central Excise and Service Tax laws, specifically in relation to Section 66E(e) and Section 65B(44) of the Finance Act, 1994.

(d) The relevance of judicial precedents and Circulars issued by the Central Board of Indirect Taxes and Customs (CBIC) clarifying the taxability of amounts received as penalties or liquidated damages.

2. ISSUE-WISE DETAILED ANALYSIS

Issue (a) and (b): Whether forfeited advances constitute consideration for taxable service under "tolerating an act or situation"

Relevant legal framework and precedents:

The legal framework centers on Section 66E(e) of the Finance Act, 1994, which declares as a taxable service the act of "agreeing to the obligation to refrain from an act, or to tolerate an act or a situation, or to do an act." Section 65B(44) defines "service" as any activity carried out by a person for another for consideration. Explanation (a) to Section 67 clarifies that "consideration" includes any amount payable for taxable services provided or to be provided.

Key judicial precedents relied upon include the Tribunal's judgment in South Eastern Coal Fields Ltd, which extensively examined the nature of consideration and the taxable scope of Section 66E(e). Other consistent decisions cited include Northern Coalfields Ltd, Krishnapatanam Port Co Ltd, Madhya Pradesh Power Transmission Co Ltd, and Western Coalfields Ltd.

The Supreme Court's interpretation of Section 74 of the Contract Act was also considered, which deals with liquidated damages and penalties, emphasizing that compensation payable for breach of contract is not necessarily indicative of a service rendered or taxable consideration.

Court's interpretation and reasoning:

The Tribunal held that for an activity to qualify as a taxable service under Section 66E(e), there must be a contractual agreement where one party agrees to refrain from an act, tolerate an act or situation, or do an act, and crucially, there must be a flow of consideration specifically for this obligation. The agreement must be independent and have a "necessary and sufficient nexus" between the consideration and the activity.

The Tribunal emphasized the distinction between "conditions to a contract" and "considerations for the contract." While a party may be required to fulfill certain conditions, these do not automatically constitute consideration for taxable services. The forfeiture of advances or imposition of penalties is a safeguard to protect commercial interests and is not consideration for tolerating an act or situation.

It was noted that the penal clauses are not the raison d'^etre of the contract but are deterrents against breach. The expectation is compliance, and penalties arise only on non-compliance. Therefore, recovery of liquidated damages or penalties is not compensation for a service rendered but a contractual remedy for breach.

Key evidence and findings:

The appellant's case was that the forfeited advances were deposits to safeguard against default, not payments for any service. The audit and department considered the forfeited amounts as taxable service consideration. The Tribunal found that the amounts did not represent consideration flowing for tolerating an act or situation but were penalties for breach of contract.

Application of law to facts:

The Tribunal applied the principles from the precedents to the facts, concluding that the forfeited advances lacked the necessary nexus with any taxable service under Section 66E(e). The amounts were not consideration for agreeing to tolerate an act or situation but were penalties for breach, thus not taxable.

Treatment of competing arguments:

The Revenue argued that the forfeited amounts were taxable under the declared service of tolerating an act or situation. The appellant contended that no service was rendered, and the amounts were merely penalties. The Tribunal rejected the Revenue's interpretation, relying on judicial precedents and the CBIC Circulars, which supported the appellant's stance.

Conclusions:

The Tribunal concluded that forfeiture of advances as penalties or liquidated damages does not amount to consideration for a taxable service under Section 66E(e). Such amounts are not taxable as service tax.

Issue (c): Interpretation of "service" and "consideration" under the Finance Act

Relevant legal framework and precedents:

Section 65B(44) defines service as an activity carried out for another for consideration. The CBIC Circular No. 214/1/2023-ST dated 28.02.2023 clarifies that the expression "agreeing to the obligation to refrain from an act, or to tolerate an act or a situation, or to do an act" requires a contractual agreement with a flow of consideration specifically for such obligation.

The Tribunal's decision in South Eastern Coal Fields Ltd and other cases was accepted by the CBIC, which decided not to pursue appeals against these judgments, reflecting authoritative acceptance.

Court's interpretation and reasoning:

The Tribunal interpreted the statutory definition strictly, requiring an independent contractual agreement with a clear nexus between consideration and the activity constituting the service. Mere penal clauses or forfeiture of deposits do not satisfy this requirement.

Key evidence and findings:

The CBIC Circulars and judicial decisions provide authoritative guidance that the mere existence of a penalty or forfeiture clause does not create a taxable service unless there is a specific agreement to tolerate an act or situation for consideration.

Application of law to facts:

The appellant's forfeiture of advances lacked an independent agreement for tolerating an act or situation. Hence, it does not qualify as a taxable service under the statutory definition.

Treatment of competing arguments:

The Revenue's argument that forfeited amounts fall within Section 66E(e) was countered by the Tribunal's reliance on statutory interpretation and CBIC Circulars, which emphasize the necessity of a contractual nexus and consideration.

Conclusions:

The Tribunal held that the definition of service and consideration excludes amounts forfeited as penalties without an independent agreement for tolerating an act or situation.

Issue (d): Applicability of CBIC Circulars and acceptance of Tribunal decisions

Relevant legal framework and precedents:

The CBIC Circular No. 214/1/2023-ST dated 28.02.2023 and Circular No. 178/10/2022-GST dated 03.08.2022 clarify and endorse the Tribunal's jurisprudence on the issue.

Court's interpretation and reasoning:

The Tribunal noted that the CBIC has accepted the Tribunal's decisions in South Eastern Coal Fields Ltd and Western Coalfields Ltd by deciding not to file appeals against these judgments. This acceptance strengthens the binding nature of the principles laid down.

Key evidence and findings:

The Circulars explicitly state that taxability under Section 66E(e) requires a contractual agreement with a flow of consideration for agreeing to refrain from an act, tolerate an act or situation, or do an act. Mere penal clauses or forfeiture do not meet this criterion.

Application of law to facts:

The appellant's case aligns with the clarifications in the CBIC Circulars, reinforcing the conclusion that forfeited advances are not taxable as service tax.

Treatment of competing arguments:

The Revenue's reliance on the forfeiture as taxable consideration is undermined by the CBIC's acceptance of Tribunal rulings and the Circulars' clarifications.

Conclusions:

The Tribunal concluded that the CBIC Circulars support the appellant's position and the impugned order cannot be sustained.

3. SIGNIFICANT HOLDINGS

The Tribunal held:

"Consideration must flow from the service recipient to the service provider and should accrue to the benefit of the service provider and that the amount charged has necessarily to be a consideration for the taxable service provided under the Finance Act. Any amount charged which has no nexus with the taxable service and is not a consideration for the service provided does not become part of the value which is taxable."

"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."

"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 Supreme Court also found that there was no evidence that any loss was suffered by the plaintiff in consequences of the default by the defendant, save as to the loss suffered by being kept out of possession of the property. The Supreme Court, therefore, held that plaintiff would be entitled to retain only an amount of Rs.1000/- that was received as earnest, out of amount of Rs.25,000/-."

"The conclusion drawn by the Learned Authorized Representatives of the Department from the aforesaid decision of the Supreme Court that compensation received is 'synonymous' with 'tolerating' or that the Supreme Court acknowledged that in a breach of contract, one party tolerates an act or situation is not correct."

Core principles established include:

(i) For an activity to be taxable under Section 66E(e), there must be an independent contractual agreement with a clear flow of consideration for agreeing to refrain from an act, tolerate an act or situation, or do an act.

(ii) Forfeiture of advances or imposition of penalties/liquidated damages for breach of contract does not amount to a taxable service.

(iii) The distinction between contractual conditions and consideration is critical in determining taxability.

(iv) CBIC Circulars have accepted the Tribunal's jurisprudence and clarified the law accordingly.

Final determination on the issue is that the impugned order confirming service tax demand on forfeited advances is unsustainable and is set aside. The appeal is allowed.