Service tax on forfieted AMount, Service Tax

[Prakash Gupta]

Dear All,

Please share your view on applicability of the service tax on forfieted amount. the assessee is providing service of residential construction services.

Thanks,

Regards

Pankaj Singh

Posts / Replies

[Mahir S]

Pankaj ji,

According to Section 66B of the Act, service tax would be payable on services ‘provided or agreed to be provided’ in the taxable territory.

Accordingly, advances retained or forfeited by service provider in the event of cancellation of contract by the service receiver become taxable as these represent consideration for a service that was agreed to be provided.

[Akash Deep]

Dear Sir,

NO service tax on the amount forfeited. any amount retained as penalty can not be treated as consideration, hence no service taz

[Ganeshan Kalyani]

The forfeited amount is not penalty rather it is amount received to provide or agree to provide taxable service. Hence it would attract service tax as rightly replied by Mahir Sir.

[Rajagopalan Ranganathan]

Sir,

According to Section 66 E (e) of Finance Act, 1994 agreeing to the obligation to refrain from an act, or to tolerate an act or a situation, or to do an act is a 'Declared Service'. Forfeited amount is a consideration for not executing the contractual obligation by the service provider either partly or fully. Therefore the amount forfeited is a consideration for tolerating the act of not performing the contractual obligation by the service provider. Therefore amount forfeited by the service provider and lying with service receiver is a consideration for the declared service. Hence the same is liable to service tax in the hands of service receiver.

[Akash Deep]

Dear All,

Thanks to rajgopalan sir to take the discussion under correct provision. Forfeit is an act of surrendering something in order to make goods a mistake. Service provider (Promisor) (constructor o) offered a person to construct a residential complex against certain sum of money payable in installments. Other person (Service Receiver) (Promisee) accepted the offer and agreed to pay installments on last day of every month. It was also agreed that service provider shall completed the construction and delivered the complex in 12 months and service receiver shall pay the last installment on the last day of 12th month. It was further agreed that any breach of terms of contract by either party would give right to the other party to claim for damages or penalty.

After paying two installments service receiver decided to pay no further installments due of financial difficulty. Service provider ask for damages/penalty from service receiver and threatened to go to the court if not paid. service receiver decided to forfeit first two installments already paid by him. (These are the fact, i assume which Mr.Prakash Gupta have in his mind).

Now the question is whether the amount forfeited by service receiver and lying with service provider is exigible to service tax or not.

To get covered under declared service defined under section 66E(e) it has to be a stand alone transaction. The effect of breach of a contract can not be treated as a separate transaction of service.Act of forfeiting is effect of breach of contract. contract and effect of breaching a contract is a whole body and same can not be separated. By forfeiting two installments already paid service receiver is only performing his obligation under contract only. what is coverd under section 66E(e) is the stand alone transactions like non competence agreement. for example if a street food vendor start a food stall in your office premises and you tolerate it because at the lunch time he presented a nice meal to you free of cost. you continue the habit for full month. This is the situation where you tolerate the act of street food vendor for a consideration (free lunch meal). such situation are covered under section 66(E)(e). not the situation where your kids tutor provider abruptly decided not to teach your kid and you decided not to pay for the classes which he has already taken. in the second situation, money you have not paid is your compensation for the inconvenience caused and the cost of searching new tutor and mental agony what ever it may be. in second situation. money not paid by you is the effect of non performance of obligation by tutor which he alternatively performed by way of forfeiting the amount retained by you.

Further, Money retained by constructor is not a consideration. Consideration as defined under Section 2(d) has to be paid at the desire of the promisor. the act constituting the consideration must have been done at the desire or request of the promisor. in this case forfeit was not done on the desire of the promisor (service provider). in fact service provider already has the right to retain such amount by virtue of contract. one can not desire for what he already have. so the amount forfeited by service received and retained by service provider does not amount to consideration.

 

.

[vijay kumar]

In terms of Section 66B, the charge of service tax is on service provided or agreed to be provided. Since the service was agreed to be provided and advance/consideration for service to be rendered was received, even POT is also satisfied. Hence taxable.

In this regard, please refer to para 3.1.1. of Edcucation Guide, which reads as follows:

3.1.1 What is the significance of the phrase ‘agreed to be provided’?
The phrase “agreed to be provided” has been retained from the definition of taxable service
as contained in the erstwhile clause (105) of section 65 of the Act. The implications of this
phrase are –
• Services which have only been agreed to be provided but are yet to be provided
are taxable
• Receipt of advances for services agreed to be provided become taxable before
the actual provision of service
• Advances that are retained by the service provider in the event of cancellation of
contract of service by the service receiver become taxable as these represent
consideration for a service that was agreed to be provided.

[KASTURI SETHI]

Dear Experts,

Let us first of all examine the definition of ‘Service ‘ as per Section 65B (44) of Finance Act 1994 which reads as follows:-

(44) “service” means any activity carried out by a person for another for consideration, and includes a declared service, but shall not include-

(a) an activity which constitutes merely,-

(i) a transfer of title in goods or immovable property, by way of sale, gift or in any other manner; or

(ii) such transfer, delivery or supply of any goods which is deemed to be a sale within the meaning of clause (29A) of article 366 of the Constitution; or

(iii) a transaction in money or actionable claim;

(b) a provision of service by an employee to the employer in the course of or in relation to his employment;

(c) fees taken in any Court or tribunal established under any law for the time being in force.

------------------------------------------------------------------------------------------------------

From a perusal of above, it is very much clear that in order to charge service tax there must be some sort of activity involved and that activity must be carried out. The term “activity” has not been defined under the Finance Act and hence it becomes debatable whether a transaction would constitute an “activity” or not. As per different dictionaries, the word , “activity” means

(a) work performed to create a result

(b) state of being active, something that is done as work

(c) measurable amount of work performed

(d) the condition in which things are happening or being done.

As per dictionary meaning of phrase, ‘carried out’ means

complete activity,accomplished,achieved,finalized, rimplemented, performedsed realized carried through consummate, discharged effected effectuated, fulfilled

 

Upon analyzing the meaning of activity carried out from all aspects, it is amply crystal clear that it must involve an active action which could be measured in terms of ‘work completed’ and create a result. Any participation which is of passive nature shall not be covered under the phrase, “Activity carried out” Hence such work which does not qualify as “an activity carried out” shall not be termed as “service” as per definition under Section 65B(44) of the Finance Act 1994.

In the instant case, activity has not been carried and advance amount has been forfeited. Activity for which was advance was given to the Service Provider by the Service Recipient has been forfeited. Ultimate object of receiver has not been achieved. Thus it can be inferred that no service has been provided in true spirit of the definition of ‘Service’ in terms of section 65 B(44).

Now the aspect of forfeiture has to be analysed. The word, ‘forfeit’ means a fine or penalty. Forfeited amount means amount of penalty or fine imposed and recovered by the service provider which is the result of violation of a particular contract or non fulfillment of vested responsibilities by the service recipient. Had the receiver not violated any clause of the agreement/contract, the advance amount would not have been forfeited. By any stretch of imagination, it cannot be established that such amount of penalty (forfeited amount) has been collected out of an activity provided or agreed to be provided by the service provider. Work has not been completed and hence no service provided. The forfeited amount is a penal action which has been taken by the Service Provider which cannot be co-related with the consideration of the actual service provided or agreed to be provided by him. Since no activity has been carried out (completed) and thus no service has been provided in terms of Section 65 B(44) of the Finance Act and hence no question of forfeited amount to be included into consideration towards service for payment of service tax.

Further as per Section 67 of Finance Act what is chargeable to service tax is the ‘gross amount charged’ for the provision of service and hence in order to prove that it is necessary that first an activity should qualify as a service and then the role of section 67 shall come into ambit. Section 67 (3) shall come into picture only thereafter. Further the Board vide its instructions issued vide F No: 137/25/2011- ST dated 03-08-2011 has clarified that delayed payment charges received by the stock brokers are also, therefore, not includible in taxable value as the same are not the charges for providing taxable service. Such charges are on account of delay in making payments by the service recipient to the service provider and are in the nature of penal charges for not making payment within stipulated time. Further CBEC did not restrict this principle to stock brokers, it has categorically mentioned that same principle shall be applied to other services as well provided that the amount recovered towards penal charges should be separately mentioned in the invoice. In case the penal charges are not mentioned separately, only then these would be covered by “gross amount charged” by the service provider, otherwise by no means service tax can be charged on penal charges.

Now the issue arises of ‘Declared Service’. Also as per Section 66E of the Act wherein some activities have been categorically covered under the definition of “Declared Service” the activities which includes, ‘ agreeing to the obligation to refrain from an act, or to tolerate an act or a situation, or to do an act’, is covered. It is to be noticed that in order to qualify any activity under this entry there must be an agreement which is entered into by both the parties in order to refrain from the act. It is important that the very motive of this agreement should be to refrain or conduct any activities mentioned under this entry. Any penal charges which are charged due to violation of any other agreement shall not qualify under such entry. More so merely refraining from an act without agreeing to refrain has also been kept out of the ambit of this entry. For instance, if a contractor delays the construction of a project and some penalties are recovered from him, it does not mean that the company has agreed to tolerate the delay and the penalties recovered is ‘consideration’ for said toleration of act. It has also been established that any amount received in settlement of dispute cannot be considered as a “service” liable to service tax.

ANOTHER ASPECT OF FORFEITED AMOUNT

As per the definition of ‘service’ no activity has been carried out (completed). As per definition activity has to be accomplished/finalized/implemented etc. In other words it should result oriented. Here activity has not been finalized which resulted in forfeiture of advance amount. The very purpose of advance has been defeated whatever may be the background. In a nutshell service has not been provided as per the definition of ‘service’.

Now you see above in the definition of service, there is a coma after the word ‘consideration’ and includes a declared service, (again coma) but shall not include--

1. an activity which constitutes merely,-

• 1. --------------------------------------
  2. ------------------------------------------
  3. a transaction in money or actionable claim;

If we go through the construction of the sentence it means that ‘a declared service’ is not the part of ‘Service’ because it is not in continuity. It is the role of a coma put after ‘consideration’ and again put after ‘declared service’

Secondly, a transaction in money shall be excluded from the definition of ‘service’

From both prospectives, forfeited amount (penalty amount) cannot form part of taxable value for the purpose of leviability of Service Tax under Section 67 of the Act. In a nutshell, first of all any activity must conform to definition of ‘service’ as provided under Section 65 B(44) and thereafter, the questions of implementation of valuation, Point of Taxation Rules, Place of provision Service Rules etc. will arise.

It is my interpretation. This is my view.

[KASTURI SETHI]

Education guide has no statutory force. It is a fact that Act will prevail.

[KASTURI SETHI]

I want to correct one line in the title, "another aspect of forfeited amount."

The following line may be read as under:-

"If we go through the construction of the sentence it means that ‘a declared service’ is the part of ‘Service’ because it is in continuity. No full stop after 'consideration.'.It is the role of a coma put after ‘consideration’ and again put after ‘declared service'

[KASTURI SETHI]

ADDENDUM TO MY REPLY DATED 22.1.16

Declared Service is also subject to the definition of ‘Service’ under Section 65 B (44). Any service whether declared or otherwise has to be accomplished and it shall not include a transaction in money. Only transaction in money is out of the gamut of definition of service. It is neither the intention of Govt. nor legislature to tax any amount without providing or receiving service. If there is a clause in the agreement between the service provider and the service receiver to the effect that price is inclusive of Service Tax, only then forfeited amount will form part of consideration for the purpose of payment of ST, otherwise not. If price is not inclusive of ST, then forfeited amount is a dispute between Service Provider and Service Receiver and Govt. or legislature does not come into picture. Service Tax is levied on service, if service is not provided ST on what ? Service Tax is leviable on advance amount but that amount is also subject to the definition of ‘service’ i.e. Service (activity) has to be accomplished. If service provider does not provide service to service receiver, the service receiver will get his money back, in that eventuality service tax deposited on the advance has to be refunded inasmuch as Service has not been carried out in terms of Section 65 B (44). If any person collects ST from anyone in the guise of taxable service or otherwise that is recoverable under Section 73 A and Section 87 of the Finance Act, 1994. The definition of ‘Consideration’ under Section 67 has no role to play. All the provisions of Section 67 (including the definition of ‘Consideration’ in Explanation (a) to Section 67) are applicable only if Service provided.

Hence forfeited amount (penalty amount) cannot form part of consideration for charging ST and ST is not payable on penalty amount.

[SANJAY SINGHAL]

V clear thought process. Kasturi sir. Well explained.

[priti surana]

Dear experts,

Query which i want you to address is somewhat different, though more or less related to these posts. one of my clients is having business of construction of residential complexes. in the financial year 2014-15 they had written off to profit & loss account some booking advance money which were received some 3 years back and took them as income, as the advances were not able to be refunded, though refundable, as no one had claimed the money. There is only a verbal agreement between the service provider and receiver and the money is taken against receipts or slips. Contract is entered into once the final payment is done and service receiver is given the possession of the unit. So there was no such binding contract when the advance money was received. We had paid service tax on the aforesaid amount under VCES 2013 on 25% of the money received. And had completed the audit of records under EA-2000 scheme for the year 2014-15, on the basis of provisional balance sheet, with no para raised. Now in audit of financial year 2015-16, the department people are asking to pay balance service tax on 75% of the advance money then received, not refunded, and taken as income, saying that the same is forfeited amount, even if it was settled in audit of 14-15. Now two major issues are there:

1. Can department question their own audit just on the ground that the previous audit was on the basis of provisional balance sheet and not the final audit report. Whereas the EA-2000 scheme is for audit of records, and not of audit report figures.

2. Is their demand of balance service tax on 75% of value tenable?

Looking forward for your valuable replies. Thanks in advance.

[KASTURI SETHI]

Sh.Surana Ji,

I agree with the views of the department. Audit of records means all records including statutory as well as non-statutory (inclusive of data also). The Audit is on the right track.

Demand on balance amount is sustainable.

[priti surana]

Thank you sir Kasturi Sethi for the reply, yet i am not convinced so far the demand of balance service tax is concerned. Indirectly we have provided no service. Definition of service includes the word "activity" and activity has not been taken out at any point of time. Even if dept is taking it as service, then we have assumed our part of liability under vces.

can you please elaborate.

Again coming to the audit of data, they could have waited and asked for audited balance sheet before concluding it instead of questioning their own audit on the ground that the previous audit was on provisional data.

i will be highly obliged if you can throw some light on the issue.

Thank you