Liquidated damages for contractual breach are not consideration for tolerating default, so service tax demand cannot stand.

Liquidated damages or delay charges recovered for breach of contractual delivery obligations are not consideration for a declared service under section 66E(e) unless the agreement specifically provides for tolerating the default for separate consideration. The service tax charge depends on an express arrangement to refrain from an act, tolerate an act or situation, or do an act, with consideration flowing for that activity. Amounts characterised as penalty or compensatory damages are intended to secure contractual compliance, not to tax mere breach. On that basis, delay charges for non-compliance with delivery timelines are outside the scope of declared service and the related service tax, interest, and penalty demand cannot be sustained.

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Issues: Whether delay charges or liquidated damages recovered for delayed delivery of contractual obligations constitute consideration for a declared service under section 66E(e) of the Finance Act, 1994, and whether the consequential demand of service tax, interest, and penalty can be sustained.

Analysis: The liability under section 66E(e) arises only where there is an agreement specifically for agreeing to refrain from an act, tolerate an act or a situation, or do an act, and where consideration flows for that very activity. Amounts recovered as penalty or liquidated damages for breach of contractual terms are compensatory in nature and are intended to secure compliance with the contract. They do not, by themselves, represent consideration for any service, because the contract is for supply or performance and not for tolerating default. Following the earlier Tribunal view relied upon, delay charges collected for non-compliance with delivery timelines cannot be treated as consideration for toleration of breach.

Conclusion: The delay charges were not taxable as a declared service under section 66E(e), and the demand of service tax was unsustainable. The connected interest and penalty also could not survive.

Final Conclusion: The impugned order confirming service tax on delay charges was set aside and the appeal succeeded with consequential relief.

Ratio Decidendi: Liquidated damages or contractual penalty recovered for breach of contractual terms are not consideration for "tolerating an act" unless the agreement specifically provides for such toleration for a separate consideration.

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