DECEMBER 22, 2015

By Suhrid Bhatnagar

AS per clause (e) of Section 66E of the Finance Act, 1994 (the Finance Act) 'agreeing to the obligation to refrain from an act, or to tolerate an act or a situation, or to do an act' shall constitute a 'declared service' and shall be taxable. Further, to satisfy the definition of service {defined in clause (44) of Section 65B ibid}, the activity should be carried out by a person for another for consideration and the term 'service' includes a 'declared service'. Here it must be emphasized that the declared service is 'agreeing to the obligation to refrain from an act, or to tolerate an act or a situation, or to do an act', not 'to refrain from an act, or to tolerate an act or a situation, or to do an act'.

While this is a declared service, the terms used therein have astounding similarity with section 2 of the Indian Contract Act, 1972defining 'consideration'.

There are three activity components of this declared service:

1. Agreeing to the obligation to refrain from an act

2. Agreeing to the obligation to tolerate an act or a situation

3. Agreeing to the obligation to do an act

And section 2 of the Contract Act defines consideration as under:

2. Interpretation-clause.

In this Act the following words and expressions are used in the following senses, unless a contrary intention appears from the context:-

(a) When one person signifies to another his willingness to do or to abstain from doing anything, with a view to obtaining the assent of that other to such act or abstinence, he is said to make a proposal;

(b) When the person to whom the proposal is made signifies his assent thereto, the proposal is said to be accepted. A proposal, when accepted, becomes a promise;

(c) The person making the proposal is called the "promisor" and the person accepting the proposal is called the “promisee";

(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;

(e) Every promise and every set of promises, forming the consideration for each other, is an agreement;

(f) Promises which form the consideration or part of the consideration for each other, are called reciprocal promises;

(g) An agreement not enforceable by law is said to be void;

(h) An agreement enforceable by law is a contract;

(i) An agreement which is enforceable by law at the option of one or more of the parties thereto, but not at the option of the other or others, is a voidable contract;

(j) A contract which ceases to be enforceable by law becomes void when it ceases to be enforceable.

A comparison of the two reveals:

While in terms of section 2 of the Contract Act, the above is consideration being given by a promisee to a promisor in lieu of promise, conversely if the same is done for consideration,it becomes a declared service in terms of section 66E(e) of the Finance Act. Nonetheless, every promise in an agreement is consideration for each other i.e. for the promisor and promisee.

As per rule 3 of the Point of Taxation Rules, 2011:

RULE 3. Determination of point of taxation.- For the purposes of these rules, unless otherwise provided, 'point of taxation' shall be,-

(a) the time when the invoice for the service provided or agreed to be provided is issued:

Provided that where the invoice is not issued withinthe time period specified in rule 4A of the Service Tax Rules, 1994, the point of taxation shall be date of such completion of provision of the service.

(b) in a case, where the person providing the service, receives a payment before the time specified in clause (a), the time, when he receives such payment, to the extent of such payment.

Provided that …..

Explanation .- For the purpose of this rule, wherever any advance by whatever name known, is received by the service provider towards the provision of taxable service, the point of taxation shall be the date of receipt of each such advance.

This declared service is not such which is provided in the ordinary course of business or trade, therefore, for such a service, it is difficult to imagine that an invoice in terms of rule 4A of the Service Tax Rules, 1994 may be issued.

Also, there is no scope of 'advance' in such cases.

Therefore, the point of taxation in these cases, as per the language of clause (e),shall be when the provision of service is completed i.e. the moment the person ' agrees' to the obligation to refrain from an act, or to tolerate an act or a situation, or to do an act. This is because as per section 66B of the Finance Act service tax is levied on value of services provided or 'agreed to be provided'. And here the service of 'agreeing to the obligation' has been 'agreed to be provided'.

Although, it occurs that the provision of service is completed only when the 'service provider' refrains from an act, or tolerates an act or a situation, or does an act. However, this is a wrong notion which comes due to use of word 'agree' at two different times for taxability of this service- “service of 'agreeing to the obligation' which is 'agreed to be provided'". In view of this, the point of taxation is the point when the agreement, written or verbal, is entered into.

As per the above if the agreement entered into is not for a fixed time frame, and the service tax is paid at the time of agreement as per point of taxation, it shall be immaterial whether the service of 'refraining from an act, or to tolerate an act or a situation, or to do an act' is provided or not. And the Exchequer shall be enriched without the 'service provider' actually 'refraining from an act, or tolerating an act or a situation, or doing an act'.

In real life situations, we see many examples of refraining from an act, of tolerating an act or a situation and of doing an act as an obligation agreed to by a party.

In the Taxation of Services: An Education Guide issued by the CBEC, example of non-compete agreement has been given for this declared service. A non-compete agreement is one in which one party agrees, for consideration, not to compete with the other in any specified products, services, geographical location or in any other manner. Such action on the part of one person is also an activity for consideration and will be covered by the declared services. This example relates to agreeing to the obligation to refrain from an act.

Airlines, Railways and Roadways Services- all deduct cancellation charges from the passengers. These charges are for tolerating the act of not taking the reserved transport by the passenger. Therefore, these charges are liable to service tax under this declared service. Same is the scene with hotels deducting cancellation charges from the advances received from customers. The provision of cancellation charges is already informed to the customer and, therefore, it is an agreement to the obligation to tolerate an act or situation.

For a manufacturer entering into an agreement with the buyer that in case of cancellation of order, the buyer has to bear a particular amount,is an agreement to the obligation to tolerate an act or situation.

Penal provisions for non-performance of service or for deficiency in service also imply consideration in lieu of tolerating an act or situation.

An employer forfeiting the security amount or caution money, received from the employee at the time of appointment, in lieu of the notice period also amounts to tolerating an act or situation. [As reported in DDT 2740/08.12.2015, DGCEI has issued a Modus Operandi Circular in this regard.]

Similarly, as various literatures suggest, penalty on early termination of rental or lease agreement, p re-payment charges on early payment of loan installment, detention charges paid to the shipping lines in cases of retention of the container in the factory beyond a point, demurrage charges paid to the port authorities for not clearing the goods within specified time and compensation on termination of business agreements, all these are examples of consideration for agreeing to the obligation to tolerate an act or situation.

All the agreements where the person is agreeing to an obligation which is not for refraining from an act or not tolerating an act or a situation, are examples of doing an act. However, the act may be for direct sale of goods which shall not fall in the purview of service tax. By adopting the definition of supply of services from GST Law of Singapore, it can be said that 'anything which is not a supply of goods but is done for a consideration (including if so done the granting, assignment orsurrender of any right) is a supply of services'.Therefore, any agreement which is not for supply of goods is to be at least deemed as an agreement for supply of service. If the agreement is not for supply of service per se , but to do an act, such agreement shall fall in ' agreeing to the obligation to do an act '. An example of agreeing to an obligation to do an act is to work as arbitrator for consideration between two parties for settlement of dispute.

Since nothing has been said as regards the voidability of non-compete agreement in the Education Guide, it appears that such agreements, except in the cases where goodwill is sold, are agreements in restraint of trade and are therefore void in terms of section 27 of the Contract Act which reads as under:

27. Agreement in restraint of trade, void-- Every agreement by which anyone is restrained from exercising a lawful profession, trade or business of any kind, is to that extent void.

Exception 1 : Saving of agreement not to carry on business of which good will is sold - One who sells the goodwill of a business may agree with the buyer to refrain from carrying on a similar business, within specified local limits, so long as the buyer, or any person deriving title to the goodwill from him, carries on a like business therein, provided that such limits appear to the court reasonable, regard being had to the nature of the business.

It, therefore, transpires from the example of non-compete agreements in the declared service, that agreement in restraint of trade which are void as per the Contract Act, but for the exception of case of sale of goodwill, are taxable as a declared service. Therefore, it is immaterial for taxation under service tax as to whether the agreement is void as per the Contract Act.

Taking cue from the above, it can be concluded that the agreements in restraint of marriage (section 26) and agreements in restraint of legal proceedings (section 28) which are void as per the Contract Act, are also taxable as they fall under agreeing to the obligation to refrain from an act if there is a consideration in lieu of refraining from the act. Resultantly, if A enters into an agreement with B that if B does not marry C, A shall pay B a pre-decided amount, this being an agreement in restrain of marriage shall be void, but service tax shall be payable by B for agreeing to refrain from marriage with C on the value of consideration. Similarly, if A enters into an agreement with B that A shall pay a pre-decided amount to B if B does not file a case in court against C,this being an agreement in restrain of legal proceedings is void, but service tax shall be payable by B for agreeing to refrain from filing a case in court against C on the value of consideration. It may be noted here that agreements in restraint of marriage or legal proceedings are void i.e. not enforceable by law, but they are not illegal.

The Finance Act, 1994 or the rules made thereunder do not specify that the agreements which are not legal in terms of refraining from an act or tolerating an act or a situation or doing an act, are not covered in this declared service. Therefore, it points out that illegal agreements are also covered in this declared service. In this context it is imperative to quote the GST Law in Australia which says that 'it does not matter whether it is lawful to do, to refrain from doing or to tolerate the act or situation constituting the supply (of service)' .

If our Service Tax law does not specify that unlawful acts do not constitute the said declared service, it is like ratifying the status of law as given in GST Law of Australia.

In view of the above, all the agreements casting an obligation to refrain from an act, or to tolerate an act or a situation, or to do an act are taxable, whether or not the act under the obligation in terms of agreement is legal.

Visualizing the situations where there is an agreement for obligation to do an illegal act,may occur odd to anyone. Does payment of money by one person to another to carry out an illegal act create a service provider – service receiver relationship?

I leave you with this question

(The author is Superintendent, Central Excise Audit Commissionerate, Jaipur and the views expressed are strictly personal.)