The Hyderabad Bench of the Customs, Excise and Service Tax Appellate Tribunal (CESTAT) has ruled that receipt of liquidated damages by the service provider for breach of conditions under an agreement to provide services would not attract Service Tax.
The Bench, consisting of members P.K. Choudhary (Judicial Member) and P.V. Subba Rao (Technical Member), held that claim for penalty/liquidated damages does not emanate from any obligation on the part of the service provider to 'tolerate an act or a situation' of the defaulting party, as provided under Section 66E(e) of the Finance Act, 1994, thus it cannot be considered to be a payment for any service.
The CESTAT ruled that the scope of levy of Service Tax cannot be extended to apply to situations where the actual activity was non-existent.
The appellant M/s. Krishnapatnam Port Company Limited entered into an agreement to render 'port services' with respect to the imports made by M/s. Simhapuri Energy (P) Ltd. The agreement also provided for payment of liquidated damages/ 'compensation charges' by the service recipient in the event of failure to achieve the 'Minimum Guaranteed Tonnage'.
The Service Tax Department issued a demand notice to the appellant proposing to recover Service Tax on the ground that the receipt of 'compensation charges' amounted to consideration for providing taxable service.
The Commissioner of Central Tax held that the said activity amounted to a 'declared service' under Section 66E(e) of the Finance Act, 1994. The Commissioner thus passed an order confirming the demand of Service Tax along with the penalty imposed on the appellant. Against this order, the appellant M/s. Krishnapatnam Port Company filed an appeal before the CESTAT.
The CESTAT held that the penalty clause was provided in the agreement to safeguard the commercial interest of the appellant and to compensate the appellant for financial damage or injury in case of failure to achieve the given contractual condition as stipulated. The CESTAT added that the penalty clause was added to discourage the service recipient from repeatedly breaching the terms and conditions of the agreement and the penalty clause was invoked only in cases where the service recipient failed to adhere to the contractual condition.
The CESTAT ruled that as per the Finance Act, 1994, the basic element to charge Service Tax is the element of service, i.e., there should be an activity in the form of 'service' or 'declared service'. The CESTAT held that 'compensation charges' were collected by the appellant for breach of the terms and conditions of the agreement and not towards any activity liable for Service Tax. The CESTAT thus ruled that such 'compensation charges' were not covered within the definition of taxable service under the Finance Act, 1994 and hence were not liable for Service Tax.
The CESTAT observed that as per Section 66E(e) of the Finance Act, 1994, a 'declared service' means agreeing to the obligation to refrain from an act, to tolerate an act or a situation, or to do an act.
The CESTAT thus held that for attracting the provisions of Section 66E(e), there has to be an action, passive action or a reaction which is declared to be a service. Therefore, the CESTAT held that there should be an obligation to refrain from an act, to tolerate an act, or to do an act in order to invoke the provisions of Section 66E(e), which was missing in the case of the appellant.
The CESTAT ruled that the appellant's claim for penalty or liquidated damages as contemplated under the agreement arose to make good the financial damages or injuries sustained by the appellant due to the non-fulfillment of the contractual stipulations/conditions by the service recipient. The CESTAT added that the claim for penalty/liquidated damages did not emanate from any obligation on the part of the appellant to 'tolerate an act or a situation' of the defaulting party and thus it cannot be considered to be a payment for any service.
The CESTAT held that the term 'service' means any activity carried out by a person for another for consideration. The CESTAT added that recovery of liquidated damages/penalty from the other party cannot be said to be towards any service per se, since the appellant did not carry any activity to receive the 'compensation charges'. Hence, the CESTAT ruled, the scope of levy of Service Tax cannot be extended to apply to situations where the actual activity was non-existent.
The CESTAT held that the compensation received by the appellant for making good the financial damages/injury cannot be said to be 'consideration' at all and it has no nexus with any taxable service.
"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. In other words, the amount charged has to be necessarily a consideration for the taxable service provided under the Finance Act. In the instant case, the compensation received for making good the financial damages/injury cannot be said to be 'consideration' at all and has no nexus with any taxable service."
The CESTAT held that there is a distinction between "conditions to a contract" and "considerations for the contract". The CESTAT ruled that a service recipient may be required to fulfill certain conditions contained in the contract but that would not necessarily mean that this value would form part of the value of taxable services that are provided.
Hence, the CESTAT ruled, the 'compensation charges' received by the appellant merely amounted to fulfillment of the condition envisaged in the agreement and it was not a consideration for the said contract.
Thus, the CESTAT allowed the appeal of the appellant and set aside the order of the Commissioner of Central Tax.
Case Title: M/s. Krishnapatnam Port Company Limited versus Commissioner of Central Excise & Service Tax, Guntur
Dated: 25.04.2022 (CESTAT Hyderabad)
Representative for the Appellant: Mr. C. Manickam, Advocate
Representative for the Respondent: Mr. S. Hanuma Prasad, Authorized Representative for the Respondent