2022 (5) TMI 253 - AT - Service Tax

Appellant wins case: Compensation for breach not taxable under Service Tax law

M/s. Krishnapatnam Port Company Limited Versus Commissioner of Central Excise & Service Tax, Guntur

The Tribunal ruled in favor of the Appellant, determining that compensation charges for breach of Minimum Guaranteed Tonnage under a service agreement ... Levy of service tax - liquidated damages/compensation charges received by the Appellant towards the breach and non-compliance of Minimum Guaranteed Tonnage (MGT) as per Agreement - consideration for declared service or not - HELD THAT:- The penalty clause is provided in the impugned Agreement dated 12.07.2011 to safeguard the commercial interest of the Appellant – (1) to compensate the Appellant for financial damage/injury in case of failure to achieve the MGT and also (2) to discourage the service recipient from repeatedly breaching the terms and conditions of the Agreement dated 12.07.2011 and the penal clause is invoked only in cases where the service recipient does not adhere to the contractual condition of ‘MGT’ as per Agreement dated 12.07.2011. As per 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. However, in the instant case, the said amount has not been collected towards any activity liable for Service Tax but as compensation/penalty for breach of terms and conditions of the contract [Agreement dated 12.07.2011] i.e. non-compliance of MGT. Thus, such compensation charges are not covered within the definition of taxable service under the Finance Act, 1994 and hence not liable for Service Tax. In the instant case, the parties entered into the said Agreement dated 12.07.2011 for import of a specified quantity of coal and for availing various port services for the same and not for flouting the terms of the agreement so that the penal clauses were the reason for the execution of the Agreement dated 12.07.2011 for an agreed consideration. It is only in situations where the condition of ‘MGT’ is not satisfied by the service recipient, the Appellant’s claim for penalty/compensation/liquidated damages - the term service is defined to mean any activity carried out by a person for another for consideration. The recovery of liquidated damages/penalty from the other party in the instant case cannot be said to be towards any service per se, as the Appellant did not carry on any activity to receive the ‘compensation charges’. Hence, scope of levy of Service Tax cannot be extended to apply to situations where the actual activity was non-existent. The issue of leviability of Service tax on penalty, liquidated damages, compensation, forfeiture amounts, cancellation charges etc. stands settled by various pronouncements wherein it has consistently been held that the said amounts recovered as charges for breach or non-compliance of contractual terms and conditions cannot be construed as ‘consideration’ for ‘refraining or tolerating an act’ and were thus not leviable on Service Tax in terms of Section 66E(e) of the Finance Act, 1994 - reliance can be placed in the case of M/S K.N. FOOD INDUSTRIES PVT. LTD. VERSUS THE COMMISSIONER OF CGST & CENTRAL EXCISE, KANPUR [2020 (1) TMI 6 - CESTAT ALLAHABAD] and M/S LEMON TREE HOTEL VERSUS COMMISSIONER, GOODS & SERVICE TAX, CENTRAL EXCISE & CUSTOM [2019 (7) TMI 767 - CESTAT NEW DELHI]. Appeal allowed - decided in favor of appellant. Issues:Whether compensation charges for breach of Minimum Guaranteed Tonnage (MGT) under a service agreement constitute consideration for a declared service under Section 66E(e) of the Finance Act, 1994, making it liable for Service Tax.Analysis:The Appellant, engaged in providing port services, entered an agreement with a service recipient for coal import, including penalties for failure to meet MGT. The Service Tax Department issued a demand notice, alleging compensation charges as consideration for taxable service. The Tribunal examined if these charges fell under Section 66E(e) of the Finance Act, 1994.The Tribunal noted that the penalty clause aimed to safeguard the Appellant's commercial interests and deter breaches. It emphasized that for Service Tax liability, there must be a taxable service activity, which was absent in this case. The compensation charges were for breach of contractual terms, not a service provided, hence not taxable.Regarding Section 66E(e), the Tribunal clarified that declared service involves refraining, tolerating, or doing an act. However, in this case, there was no obligation to refrain or tolerate an act, but rather to fulfill contractual obligations. The compensation was for financial damages due to non-fulfillment of MGT, not for tolerating an act.The Tribunal highlighted that the compensation did not relate to any service activity, as the Appellant did not perform any service to receive these charges. It stressed that for Service Tax to apply, there must be consideration for a taxable service, which was lacking in this scenario.Referring to legal precedents, the Tribunal distinguished between contract conditions and considerations. It reiterated that charges for breach or non-compliance of terms do not constitute consideration for taxable services. Various cases were cited to support this interpretation, establishing that penalty or compensation charges are not subject to Service Tax under Section 66E(e).In conclusion, the Tribunal set aside the demand notice, ruling in favor of the Appellant. It emphasized that the compensation charges were not consideration for a declared service, thus not liable for Service Tax. The decision aligned with established judicial interpretations, providing clarity on the non-taxability of such charges.This detailed analysis of the judgment from the Appellate Tribunal CESTAT HYDERABAD underscores the legal intricacies and interpretations surrounding the taxation of compensation charges in service agreements, offering a comprehensive understanding of the issues and the Tribunal's reasoning in reaching its decision.