NOTICE PAY: SERVICE UNDER GST, NON-SERVICE UNDER SERVICE TAX

[Dr. Sanjiv Agarwal]

While the taxability of activities and transactions between employer – employees have been outside the scope of tax net-whether under erstwhile service tax or now under GST, the issue of levy of GST tax on payment recovery of notice pay from employee has been a subject matter of dispute.

Whereas Revenue Authorities have been claiming it to be a taxable event in the garb of declared service in Service Tax era and now under ‘services not elsewhere classified’, the taxpayers believe that such notice pay payment or recovery is covered under services of employment and thus not taxable.

It is seen that generally the terms of employment contain a clause for earlier termination of contract if certain conditions are not adhered to. It provides that if the contract is terminable subject to specified notice period and if such notice is revoked, either party can do so by recovering or paying the salary of such specified period. The dispute relates to taxability of such notice period amount paid by employee or recovered or deducted by employer.

During the Service Tax era, such amount was being considered as taxable as a declared service u/s 66E(e) i.e.,  “agreeing to the obligation to refrain from an act, or to tolerate an act or a situation, or to do an act”. Now during GST era, it is being attempted to be a taxable service under clause 5(e) of Schedule-II to the CGST Act, 2017, i.e., ‘agreeing to the obligation to refrain from  an act, or tolerate an  act or a situation, or to do an act’.

In one of the recent advance rulings dated 30.07.2020 under GST law, IN RE: M/S. AMNEAL PHARMACEUTICALS PVT. LTD. [2021 (1) TMI 431 - AUTHORITY FOR ADVANCE RULING, GUJARAT], the applicant sought advance ruling on issue as to whether the applicant is liable to pay GST on recovery of Notice Pay from the employees who are leaving the company without completing the notice period as specified in the Appointment Letter issued as per the contract entered between Employer and the Employee?

Position in Service Tax Regime

During the pre-GST Service Tax era, this issue was being raised by the department but the issue was decided in favour of assessee and against the revenue.

In SHRI NANDINHO REBELLO VERSUS DCIT, CIRCLE-14, AHMEDABAD [2017 (4) TMI 965 - ITAT AHMEDABAD], in a income tax matter, notice pay was claimed in the return of income as deduction which was recovered from the salary by assessee’s previous employers. The  Tribunal found that this is a case of recovery of the salary which is already made to the assessee. It is pertinent to note that the assessee had actually received the salary from his previous employers after deducting the notice period as per the job agreement with them. Therefore, the actual salary received by the assessee was only taxable and, Tribunal allowed this ground of appeal of the assessee. However, this was in relation to income tax.

In GE T & D INDIA LIMITED (FORMERLY ALSTOM T & D INDIA LIMITED) VERSUS DEPUTY COMMISSIONER OF CENTRAL EXCISE [2020 (1) TMI 1096 - MADRAS HIGH COURT], the authorities demanded service tax on the amount of notice pay recovered by taxpayer from its employee’s salary. It was held that “notice pay” recovered by an employer from its employees in lieu of the employees serving their required employment termination notice period is outside the scope of service tax.

In M/S HCL LEARNING LIMITED VERSUS COMMISSIONER OF CENTRAL GOODS & SERVICE TAX, NOIDA, [2019 (12) TMI 558 - CESTAT ALLAHABAD] it was held (in November, 2019) that when amounts are recovered out of salary already paid, such amounts would not be subject to service tax as salaries are not subject to tax.

Advance Ruling in GST Regime

In the GST period, the contention of assessee remains the same, i.e., the notice period amount recovered/paid from/by the employee/employer should not be under the purview of GST since its arrangement to compensate the loss to employer/employee their losses as per contractual arrangement.

The Notice pay recovery is nothing but the amount stipulated in the employment contract for breach in serving the stipulated notice period. Since notice pay is a sum mutually agreed by the parties for breach of contract it can be regarded as a consideration flowing from the employment contract itself read with Section 74 of the Indian Contract Act, 1872 and not under any other separate contract wherein employer has agreed to refrain from doing any act against the concerned employee. Once notice pay recovery is stipulated in the contract an employer can only sue for recovery of such amount but cannot enforce mandatory serving of the notice period. Once it is concluded that an employee cannot enforce mandatory serving of the notice period, such employer cannot be said to have refrained from an act of suing the employee for mandatory serving against the notice pay recovery. In such scenario, notice pay recovered cannot be said to be a consideration against agreeing to the obligation to refrain from an act, or to tolerate an act.

Further, as per statutory provisions, Entry No. 1 of Schedule-III to the CGST Act, 2017 provides that “services by an employee to the employer in the course of or in relation to his employment shall not be regarded as supply of goods or supply of services.” Notice pay recovery is nothing but a deduction from the salary payable to the resigning employee. It is not a separate consideration flowing from any independent contact and the employee is relieved from the services and issued a reliving letter only once the terms of employment agreement (Appointment Letter) are fulfilled.

The Authority for Advance Ruling observed that the only issue to be decided is whether the applicant is liable to pay GST on recovery of Notice Pay from the employees who are leaving the company without completing the notice period as specified in the Appointment Letter issued as per the contract entered between them.

In the instant case, under appointment letter, it was clearly mentioned that, either parties shall serve a three months’ mandatory notice to terminate this contract. Thus, three months’ notice is mandatory for all employees/employer. In case, if any employee doesn’t serve the notice period after tendering the resignation, then as per contract (Appointment Letter) condition, company is entitled to recover the notice pay from the agreed portion of salary to compensate the loss to company. The condition is:

“Your services can be terminated by giving three months’ notice or notice pay in lieu of notice period from either side.”

Employees who resign from their job are expected to serve notice period as mentioned in the appointment letter i.e. three months. If the employee does not serve such notice period, the salary of the un-served portion of notice period is retained by the employer, which is called as “Notice Pay Recovery”.

The AAR observed that Notice Pay is nothing but the amount stipulated in the employment contract for breach in serving (not serving) the stipulated notice period. In other words, notice pay is a sum mutually agreed between the employer and the employee for breach of contract. It can be regarded as a consideration to the employer for ‘tolerating the act’ of the employee to not serve the notice period, which was the employee’s agreed contractual obligation.

The AAR formed a view that the position as interpreted in Service Tax period relate to the disputes of Service Tax Regime. Hence, these rulings are not applicable to the present case, involving advance ruling in respect of levy of GST. It, thus, held that applicant is liable to pay GST @ 18% under the entry of “services not elsewhere classified”, on recovery of Notice Pay from the employees who are leaving the company without completing the notice period as specified in the Appointment Letter issued as per the contract entered between them.

Comments: It appears that the AAR, Gujarat has not applied its mind legally/ judicially and by merely taking a stand that interpretation under service tax law on similar issue can not be followed, concluded that notice pay payment / recovery is liable to GST.

Such a biased opinion, devoid of any merit or reasoned analysis is bad in law and liable to be set aside on merits by higher forums. The nature of service and practice remains the same as also the legal provisions in pre and post GST era.