Penalty under service tax law fails without fraud or suppression; disputed liability and later tax payment protected the assessee.

Penalty under section 78 of the Finance Act, 1994 was found unsustainable where the show-cause notice was issued under section 73(1) without alleging fraud, collusion, wilful misstatement, suppression of facts, or intent to evade service tax. The short payment arose from the assessee's treatment of pure agent es and non-payment of reverse charge tax on director-related payments, but the record showed only a disputed interpretation of the service tax scheme and payment of tax once the liability was pointed out. On that basis, the requisite mens rea for penalty was absent and section 73(3) read with Explanation 2 applied, so the penalty was set aside.

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Issues: Whether penalty under section 78 of the Finance Act, 1994 was sustainable when the show-cause notice was issued under section 73(1) without alleging fraud, collusion, wilful misstatement, suppression of facts, or intent to evade service tax, and whether the case fell within the protective scope of section 73(3) read with Explanation 2.

Analysis: The short payment arose from the assessee's treatment of certain expenditure as pure agent costs and from its non-discharge of tax under reverse charge on director-related payments. The notice and the adjudication record indicated only failure to discharge tax liability and did not establish any deliberate evasion or the mens rea required for the penal provision. The disputed treatment of pure agent expenditure and the reverse charge liability reflected a contested interpretation of the service tax scheme, and the assessee discharged the tax once the liability was brought to notice. On that footing, the penalty provisions were not attracted, and Explanation 2 to section 73(3) was held to be applicable.

Conclusion: Penalty under section 78 was not sustainable and was set aside in favour of the assessee.

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