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TMI Blog2020 (12) TMI 912X X X X Extracts X X X X X X X X Extracts X X X X ..... In commercial contracts entered during the course of business, certain clauses providing penalty for non-observance/breach of the terms of contract have been stipulated. According to the appellant, these clauses have been provided to safeguard the interest of the appellant. 3. A show cause notice dated April 10, 2017 was issued to the appellant under section 73(1) of the Finance Act mentioning therein that the appellant had collected an amount towards compensation/penalty from the buyers of coal on the short lifted/un-lifted quantity of coal; collected amount towards compensation/penalty from the contractors engaged for breach of terms and conditions; and collected amount in the name of damages from the suppliers of material for breach of the terms and conditions of the contract. According to the Department this amount charged by the appellant during the period from July 2012 to March, 2016 appeared to be taxable as a 'declared service' under section 66E (e) of the Finance Act. The relevant portion of the show cause notice is reproduced below:- "5. M/s SECL is charging & collecting amount in the name of compensation/penalty from the buyers of coal on the short-lifted/un-lifted qu ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ses repeatedly as financial consequences flow and that such penal clauses were invoked only in cases where party to the contract did not adhere to the terms of the contract. It was also stated that the appellant collects penalty (compensation) and forfeits security deposit/earnest money deposit for non-compliance of the terms of contract from buyers of coal on the quantity of un-lifted/short lifting of coal in terms of paragraph 3.6 of Coal Supply Agreement and not for tolerating any act or situation. The appellant also pointed out that penalty is charged from the vendors if there was a delay in supply of goods ordered by the appellant and that penalty is charged if the contractor also does not execute the terms of the contract in time. Such amount received by the appellant is shown in the books of the appellant under the head "Liquidated Damages & Penalty Recovered." The appellant also stated that the extended period of limitation could not have been invoked in the facts and circumstances of the case and neither interest or penalty was imposable. 6. The Principal Commissioner, however, did not accept the contentions advanced on behalf of the appellant and confirmed the demand of ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... hat there is specifically no clause in the contract regarding 'agreeing to refrain from any act or tolerating any act for a defined consideration', because it says that penal clauses, are provided in the contracts so that the parties to the contract do not breach the clauses repeatedly as financial consequences are involved. ******* ******* ******* 17. Thus, as per the law of ad seriatim, invoking of first clause provided relief to the suppliers inasmuch as they continued to work under the said contract, without being made to lose the contract or bear further losses. Thus, buy charging certain penalty/liquidated damages, a monetary consideration, M/s. SECL has refrained itself from taking any consequential steps detrimental to the interest of the suppliers. By simple evaluation, the relevant instances clearly fall within the activity of "agreeing to the obligation to refrain from an act, or to tolerate an, act or a situation, or to do an act'. . ******* ******* * ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ach of contract through the payment of liquidated damages. Hence, the consideration is both intentional and at the desire of the parties; (iv) The Constitution Bench of the Supreme Court in Fateh Chand vs. Balkishan Das [AIR 1963 SC 1405] held that reasonable compensation for a breach of contract has to be proportionate to the actual injury suffered, which means injury tolerated since the word "suffering" is synonymous to "tolerating". (v) A case of compensation or damages for breach of a contract always involves one party tolerating/suffering an injury. Hence, the claim of the appellant in the present case that their contract is not for tolerating anything is fundamentally wrong; (vi) The aim of compensation is to place the person in the same position as without breach, thereby allowing him to tolerate the situation arising out of breach of contract; and (vii) The decision of the Tribunal in K.N. Foods runs contrary to the judgment of the Supreme Court in Fateh Chand. 9. The submissions advanced by the learned authorized representative of the appellant and the learned authorized representatives of the Department have been considered. 10. The issue that is involved is w ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Act for the period from July 2012 till March 2016 for the reason that by collecting the said amount the appellant had agreed to the obligation to refrain from an act or to tolerate the non-performance of the terms of the contract by the other party. 15. Section 65B (44) defines 'service' to mean any activity carried out by a person for another person for consideration, and includes a declared service. Under section 66E (e), a declared service shall constitute agreeing to the obligation to refrain from an act, or to tolerate an act or situation, or to do an act. Section 66 B provides that service tax shall be levied at the rate of 12 per cent on the value of all services, other than those services specified in the negative list, provided or agreed to be provided in the taxable territory by one person to another and collected in such manner as may be prescribed. Section 66D contains a negative list of services, while section 66E contains a list of declared services. 16. Section 67 of the Finance Act deals with valuation of taxable service for charging service tax. It is reproduced below:- 67. (1) Subject to the provisions of this Chapter, where service tax is chargeable on any t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... istinction was made between "conditions' to a contract and "consideration for the contract". It has been prescribed under the said GST Rules that certain "conditions' contained in the contract cannot be seen in the light of "consideration' for the contract and merely because the service recipient has to fulfil such conditions would not mean that this value would form part of the value of the taxable services that are provided. 20. The Supreme Court in Commissioner of Service Tax vs. M/s Bhayana Builders [2018 (2) TMI 1325] , while deciding the appeal filed by the Department against the aforesaid decision of the Tribunal, also explained the scope of Section 67 of the Act. The Supreme Court observed that 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 under Section 67. The observations are: "The amount charged should be for "for such service provided": Section 67 clearly indicates that the gross amount charged by the service provider has to be for the service provided. Therefore, it is not any amount charged which can become the basis of value on which service tax ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... plied) 23. It would, therefore, be appropriate to examine the definition of "consideration" in section 2(d) of the Contract Act, as the Contract Act deals with all kinds of contracts and pre-dates the Finance Act. The definition of "consideration"" is as follows:- "2(d) When, at the desire of the promisor, the promisee or any other person has done or abstained from doing, or does or abstains from doing, or promises to do or to abstain from doing, something, such act or abstinence or promise is called a consideration for the promise."" 24. What follows from the aforesaid decisions of the Supreme Court in Bhayana Builders and Intercontinental Consultants, and the decision of the Larger Bench of the Tribunal in Bhayana Builders is that "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. It should also be remembered ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... aid that recovering any sum by invoking the penalty clauses is the reason behind the execution of the contract for an agreed consideration. It is not the intention of the appellant to impose any penalty upon the other party nor is it the intention of the other party to get penalized. 28. It also needs to be noted that section 65B(44) defines "service" to mean any activity carried out by a person for another for consideration. Explanation (a) to section 67 provides that "consideration" includes any amount that is payable for the taxable services provided or to be provided. The 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 purpose of imposing compensation or penalty is to ensure that the defaulting act is not undertaken or repeated and the same cannot be said to be towards toleration of the defaulting party. The expectation of the appellant is that the other party complies with the terms of the contract and a penalty is imposed only if there ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... clauses for breach of the terms of the contract but, as noted above, there is a marked distinction between 'conditions to a contract' and 'considerations for a contract'. 33. It would be apt to refer to a judgment of the European Court of Justice (First Chamber) in Case C-277/2005, in Societe Thermale d'Eugenic-les-Bains vs. Ministere de I'Economie, des Finances et de I'Industrie as it deals with the issue whether an obligation to refrain from an act or to tolerate an act or situation would result in supply of services when a sum paid as a deposit by a client to a hotelier, where the client exercises the cancellation option available to him and that sum is retained by the hotelier, can be regarded as consideration for the supply of a reservation service. Under Article 2(1) of the Sixth Directive, 'the supply of goods or services effected for consideration within the territory of the country by a taxable person acting as such' is subjected to VAT. Article 6(1) of the Sixth Directive provides that "supply of services" shall mean any transaction which does not constitute a supply of goods within the meaning of Article 5 and that such transactions may include inter alia an obligation ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ties may make contractual provision - applicable in the event of non-performance - for compensation or a penalty for delay, for the lodging of security or a deposit. Although such mechanisms are all intended to strengthen the contractual obligations of the parties and although some of their functions are identical, they each have their own particular characteristics. xxxxxx xxxxxxx xxxxxxx 32. Whereas, in situations where performance of the contract follows its normal course, the deposit is applied towards the price of the services supplied by the hotelier and is therefore subject to VAT, the retention of the deposit at issue in the main proceedings is, by contrast, triggered by the client"s exercise of the cancellation option made available to him and serves to compensate the hotelier following the cancellation. Such compensation does not constitute the fee for a service and forms no part of the taxable amount for VAT purposes (see, to that effect, as regards interest applied on account of late payment, Case 222/81 BAZ Bausystem [1982] ECR 2527, paragraphs 8 to 11)." (emphasis supplied) 35. Reference can also be made to a decision of the Tribunal in Lemon Tree Hotel. The is ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... nal in K.N. Food Industries examined the provisions of section 66E(e) in the context of an assessee manufacturing for and on behalf of M/s Parley and clearing the same upon payment of central excise duty. In a situation when the capacity of the assessee was not fully utilized by M/s Parley, ex-gratia charges were claimed so as to compensate the assessee from financial damage or injury. The Department invoked the provisions of 66E(e) to levy tax on the amount so received. The Tribunal held that the ex-gratia charges were for making good the damages due to the breach of the terms of the contract and did not emanate from any obligation on the part of any of the parties to tolerate an act or a situation and cannot be considered to be towards payment for any services. The relevant portion of the decision is reproduced below: "4. ******* ******* ******* We find that appellant is admittedly manufacturing confectionaries for and on behalf of the M/s Parle and is clearing the same upon payment of Central Excise duty on the basis of MRP declared by M/s Parle. It is only in situation when the appellants capacity, as a manufacturer, is not being fully utilized by M/s Parle, their claim of ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... wledged by the Supreme Court that in a case of breach of contract, one party tolerates an act or situation. 38. The decision of the Supreme Court in Fateh Chand does not help the Department. The facts indicate that the Delhi Improvement Trust had granted lease hold rights for ninety years to Dr. M.M. Joshi in respect of a property. The relevant clauses of the agreement are:- i) The plaintiff has agreed to sell the building to the defendant for Rs. 1,12,500/-. ii) Rs. 1000, being earnest money deposit, was to be paid to the plaintiff at the time of the execution of the agreement. iii) The plaintiff had to deliver actual possession to the defendant on March 30 1949 and the defendant had to give Rs. 24,000/- out of the sale price. iv) The defendant had to get the sale deed registered by July 1, 1949. If, for any reason, the defendant failed to get the sale deed registered by the stipulated date, then the sum of Rs. 25,000/- (Rs. 1000 received as earnest money deposit and the subsequent Rs. 24,000/- out of the sale price) would be forfeited and the agreement cancelled. 39. The plaintiff received the agreed sum on March 25, 1949 and possession was delivered, but the sale of t ..... X X X X Extracts X X X X X X X X Extracts X X X X
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