FEBRUARY 06, 2020

By Rohini Mukherjee, Joint Partner, Lakshmikumaran & Sridharan

THE issue of applicability of GST on notice pay is no novel issue. This is a legacy dispute which has been carried forward from the erstwhile service tax regime. While it is customary for companies to recover amount from its employees towards notice pay for not serving the notice period stipulated in the terms of employment contract, it is equally customary for the revenue to dispute the non-payment of service tax and now, GST on such payments.

The case of the revenue to tax notice pay has been to cover such payments under the entry, 'agreeing to the obligation to refrain from an act, or to tolerate an act or a situation, or to do an act' ¹ as a supply of service. The same entry existed under the erstwhile service tax law as well.

In the context of the aforesaid entry, it can be said that employer agrees to tolerate the act of the employee of resigning from his job without serving the notice period. Further, by receiving the notice pay, the employer also refrains himself from taking any legal action against the employee for not serving the notice period stipulated under the employment contract.

Alternatively, a view is possible that the notice pay amount received by the employer from its employees is not towards any service as employer is not undertaking any activity for the employees in respect of the said amount and the amount is only recovered as damages for early termination of employment contract. This view draws support from paragraphs 2.3 and 2.3.1 of the Service Tax Education Guide released by the CBEC dated 20.6.2012, wherein it has been clarified that consideration itself pre-supposes a certain level of reciprocity. A gift, reward or alimony paid at the time of divorce are examples where there is no reciprocity. Further, any fine or penalty paid for violation of provision of law will not be in the nature of consideration for an activity. This emanates from the concept of quid pro quo (something in return).

While on this subject, it is worthwhile to note the Presentation issued by Finance Ministry 'Budget 2012: Changes in Service Tax' wherein it was indicated that expenses received from the employees for private use of company's facilities would be taxable, unless otherwise exempt. In the said Presentation, it was also provided that recoveries made by the employer from the employee for breach of contract is liable to service tax. This further adds fuel to the argument of the revenue for taxing notice pay.

As is evident, with two equally reasoned views possible on the subject, the issue of payment of service tax/GST has been raked up, time and again, by the department. There have been divergent stands taken by trade and industry with some companies discharging service tax/GST on notice pay and others not paying such tax. The fact that since most employees are unregistered persons under service tax/GST and credit not being available to such employees, taking a stand to discharge service tax/GST on notice pay is not revenue neutral.

Though issuance of circulars has been the order of the day in the GST regime, no attempts have been made to settle this issue. While this maybe for the reason that since the same entry with respect to toleration of an act continues as under the service tax regime, a clarification on this subject matter may impact ongoing litigations.

What is new on this front is a recent decision of the Madras High Court ² on the question of applicability of service tax on amounts received by the petitioner from outgoing employees in lieu of notice period. It was observed by the High Court that the employer cannot be said to have rendered any service per se much less a taxable service and has merely facilitated the exit of the employee upon imposition of a cost upon him for the sudden exit. Additionally, the High Court noted that the definition of Section 66E(e) whereby obligation to refrain from an act or tolerate an act or a situation, or to do an act constituted a taxable service is not attracted to the instant scenario. Accordingly, the High Court held that the employer has not 'tolerated' any act of the employee but has permitted a sudden exit upon being compensated by the employee in this regard. On this basis, it was held that notice pay, in lieu of sudden termination does not give rise to rendition of service either by the employer or employee and accordingly, service tax is not leviable on the same.

While the judgment may bring in a wave of relief for the tax payers especially the companies with ongoing litigations under the service tax regime or the ones facing any scrutiny under the GST regime, the likelihood of further litigation with respect to the impugned issue cannot be ruled out and the issue is yet to attain finality. Though the issue is far from settled at this point of time, the decision of the Madras High Court can be relied upon by taxpayers in their ongoing litigations.

[The views expressed are strictly personal.]

¹ Clause 5 (e) of Schedule II to the Central Goods and Services Act, 2017 read with Section 7 of Central Goods and Services Act, 2017

² GE T &D India Limited (W.P. Nos. 35734 of 2016) - 2020-TIOL-183-HC-MAD-ST