APRIL 13, 2020

By Narendra Singhvi, Joint Partner, Lakshmikumaran & Sridharan

AGREEING to the obligation to refrain from an act, or to tolerate an act or a situation, or to do an act. These words, feeling like lyrics of a rap song, have been music to ears of the revenue department since July, 2012.

These activities are treated as supply of services under the GST laws and were treated similarly under the erstwhile Service Tax law. A plain and isolated reading of the relevant legal provisions [i.e. S. No. 5(e) in Schedule-II of the Central/ State Goods and Services Tax Act, 2017 (CGST Act) and Section 66E(e) of the Finance Act, 1994] suggests the wide scope of these provisions to refer to each and every activity undertaken by one person for another, whether actively or passively. However, what is disturbing is the manner, in which these provisions have been interpreted by the revenue department to defy even the fundamentals of GST and Service Tax law.

The most common instances of incorrect application of these provisions are liquidated damages and notice-pay. As an established industry practice, commercial contracts generally have clauses providing for liquidated damages to ensure that the parties honour their respective obligations. Further, employment contracts generally have clauses providing for notice-pay again to ensure that the parties honour their obligations. Similar is the nature of demurrage charges in shipping contracts, foreclosure charges in loan contracts etc.

Entertaining a view that these amounts are received in return of agreeing to tolerate the act of breach of contractual obligations, demand notices have been issued across the industry demanding Service Tax/ GST thereon. The advance ruling machinery in GST regime has also advanced similar interpretation in the above situations, uniformly holding that such amounts are liable to GST vide S. No. 5(e) in Schedule-II of the CGST Act. The exemption, from payment of GST and Service Tax, extended to liquidated damages paid to Government, is also being taken shelter of, to justify the conclusion that such liquidated damages are otherwise taxable.

It cannot be gainsaid that the levy of GST is envisaged and structured as a contractual levy seeking to cover understanding of two persons towards making of a supply. Payment of an amount, though contemplated under a contract, need not necessarily be towards an agreed supply. What is indispensable for levy of GST is the positive understanding of two persons towards making of a supply, whether active or passive. In other words, the carrying out of the active or passive act must be certain and accordingly agreed to between the parties.

When a person agrees to make a supply of services to another person for consideration, the certainty of making such supply constitutes the entry point for contractual understanding between them. Such certainty is completely absent in the instances illustrated hereinabove, as the event, triggering the payment of such charges, may or may not happen. The reason for contemplating such charges is not towards the making of any supply, but to act as a deterrent against breach of the respective obligations. There is no agreement of tolerating any act or situation, as the understanding of the parties is to honour the respective obligations, and not otherwise.

In the above context, it is important to extract the following observations of Hon'ble CESTAT in KN Food Industries Private Limited v. Commissioner of CGST, - 2019-TIOL-3651-CESTAT-ALL:

"In the present case apart from manufacturing and receiving the cost of the same, the appellants were also receiving the compensation charges under the head ex-gratia job charges. The same are not covered by any of the Acts as described under Section 66E (e) of the Finance Act, 1994. The said Sub-clause proceeds to state various active and passive actions or reactions which are declared to be a service namely; to refrain from an act, or to tolerate an act or a situation, or to do an act. As such for invocation of the said clause, there has to be first a concurrence to assume an obligation to refrain from an act or tolerate an act etc. which are clearly absent in the present case. In the instant case, if the delivery of project gets delayed, or any other terms of the contract gests breached, which were expected to cause some damage or loss to the appellant, the contract itself provides for compensation to make good the possible damages owning to delay, or breach, as the case may be, by way of payment of liquidated damages by the contractor to the appellant. As such, the contracts provide for an eventuality which was uncertain and also corresponding consequence or remedy if that eventuality occurs. As such the present ex-gratia charges made by the M/s Parle to the appellant were towards making good the damages, losses or injuries arising from "unintended" events and does 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 the payments for any services."

In GE T&D India Limited v. Deputy Commissioner of Central Excise, - 2020-TIOL-183-HC-MAD-ST, Hon'ble Madras High Court has held in negative about applicability of Section 66E(e) of the Finance Act, 1994 to receipt of notice-pay by an employer from the employee.

Howsoever wide the wordings of S. No. 5(e) in Schedule-II are construed, the requirement of a positive understanding of a certain act cannot be overlooked. It is for this reason that retrospective amendments in Section 7 of the CGST Act were carried out in 2018. Prior to this amendment, the activities specified in Schedule-II were included within the scope of the expression 'supply' vide Section 7(1)(d). In other words, by way of an inclusive definition, the subject activities discussed hereinabove qualified as 'supply' vide Section 7(1)(d). However, Section 7(1)(d) was omitted retrospectively w.e.f. 01.07.2017 vide the CGST Amendment Act, 2018 (No. 31 of 2018). Simultaneously, Section 7(1A) was introduced retrospectively w.e.f. 01.07.2017 to provide that where certain activities/ transactions constitute a supply in accordance with Section 7(1), they shall be treated as either supply of goods or supply of services as referred to in Schedule-II. The effect of Section 7(1A), thus, is that the activities specified in Schedule-II must first answer the description of 'supply' and their inclusion in Schedule-II is only to clarify whether they constitute supply of goods or services. The scheme of this amendment only reinforces the position that the wide-looking wordings of S. No. 5(e) in Schedule-II cannot override the requirement of certainty of supply with quid pro quo.

The opposite view entertained by the revenue department has created a dilemma for the whole industry, as the receipt of these charges is very common in all kinds of contracts. The real tolerance, if any, is by the industry of such unintended view of the legal provisions. While the Government is introducing schemes to settle pending tax litigations, this kind of approach followed by the revenue department will invite innumerable and avoidable litigations. Time has come for the CBIC to step in and provide guidance to the field formations on applicability of GST on these charges.

[The views expressed are strictly personal.]