No Service Tax liability on liquidated damages

[CA Bimal Jain]

The CESTAT, Chennai in the case of M/S. BHARAT HEAVY ELECTRICALS LIMITED VERSUS COMMISSIONER OF G.S.T AND CENTRAL EXCISE, TIRUCHIRAPPALLI - 2023 (4) TMI 1196 - CESTAT CHENNAI held that recovery of liquidated damages from defaulting party cannot be said to be towards any service, since the purpose of imposing damages is to ensure that the defaulting act is not undertaken or repeated.

Fact:

M/s. Bharat Heavy Electricals Ltd. (“the Appellant”) was engaged in manufacturing of heavy engineering equipment and also provides service of erection of power plant/projects.

The Appellant has agreements with vendors for supply of various equipment for erection, commissioning and installation of plants and projects. Since, the Appellant is required to complete the projects under strict time period, therefore, the agreements include clause of payment of liquidated damages by vendors in case of any delay in supply and service as per contracts.

The Directorate General of Goods and Services Tax Intelligence (“the DGGI”) put up an enquiry against the Appellant and found that the Appellant is charging liquidated damages but not discharging service tax on the same. The Revenue department ("the Respondent”) recorded the statement and issued the Show Cause Notice dated April 05, 2018 ("the SCN") demanding the Service Tax on the liquidated damages recovered during the period from July 2012 to June 2017, along with appropriate interest and penalties. The Appellant filed a detailed reply to the SCN, however, the Respondent was not satisfied with the reply, and confirmed the demands proposed in the Show Cause Notice vide Order-in-Original No. 39/2018-ST dated December 06, 2018 ("the OIO”).

Aggrieved by the OIO, the Appellant filed an appeal  before the Commissioner of G.S.T. and Central Excise (Appeals), Tiruchirappalli but, that was also rejected.

Aggrieved by the OIA the Appellant filed an appeal before the CESTAT, Chennai.

Issue:

Whether the Appellant would be liable to pay Service Tax on liquidated damages collected from vendors?

Held:

The CESTAT, Chennai in M/S. BHARAT HEAVY ELECTRICALS LIMITED VERSUS COMMISSIONER OF G.S.T AND CENTRAL EXCISE, TIRUCHIRAPPALLI - 2023 (4) TMI 1196 - CESTAT CHENNAI held as under:

Relied on the case of, M/S SOUTH EASTERN COALFIELDS LTD. VERSUS COMMISSIONER OF CENTRAL EXCISE AND SERVICE TAX, RAIPUR - 2020 (12) TMI 912 - CESTAT NEW DELHI  wherein the Hon’ble bench has analysed the scope and ambit of sections 65B (44), 66E (e) and 67 (1) of the Finance Act, 1994 and also analysed various decisions of the Hon’ble Supreme Court and thereafter, concluded that the view of the Principal Commissioner therein that the penalty amount, forfeiture of earnest money deposit and liquidated damages received by the Appellant therein towards “consideration” for “tolerating an act” as being amenable to Service Tax under Section 66E (e) of the Finance Act, was not sustainable.

Held that, the recovery of liquidated damages or penalties from another party cannot be considered as payment for any specific service. The imposition of compensation or penalty is intended to prevent or deter the defaulting party from repeating the same offense, and it cannot be regarded as payment for tolerating the defaulting party's conduct.

Hence, the CESTAT allowed the Appeal.

Relevance of stated issue in GST:

It is to be noted that, in this regard circular no. 178/10/2022-GST dated August 03, 2022 has been issued to state that no GST leviable on liquidated damages, compensation and penalty arising out of breach of contract pertaining to ‘agreeing to the obligation to refrain from an act or to tolerate an act or a situation, or to do an act’ unless there is supply of services with reciprocity in this regard.

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