Liquidated damages and penalty charges are not consideration for tolerated breach and do not attract service tax under declared services.

Amounts collected as liquidated damages, penalty or late delivery charges under contractual default clauses are not liable to service tax under section 66E(e) of the Finance Act, 1994. The provision applies only where there is an agreement, for consideration, to refrain from an act, tolerate an act or situation, or do an act. Contractual stipulations for pre-determined damages are intended to secure performance and protect commercial interests, not to create a bargain for tolerating breach. Such recoveries are compensatory in nature and do not amount to consideration for a declared service.

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Issues: Whether the amounts collected as penalty or late delivery charges under liquidated damages clauses are liable to service tax as consideration for a declared service under section 66E(e) of the Finance Act, 1994.

Analysis: Liability under section 66E(e) arises only where there is an agreement, for consideration, to refrain from an act, to tolerate an act or a situation, or to do an act. The contractual clauses in question were intended to secure performance of the contract and protect the commercial interest of the payer, not to create a bargain for tolerating breach. Liquidated damages or penalty recovered on default do not themselves constitute consideration for a service, because the dominant purpose of the contract is performance and compliance, while the penal stipulation operates only upon non-compliance. The nature of such recovery is compensatory under the contract law principle governing pre-determined damages and not a taxable service.

Conclusion: The amounts recovered as liquidated damages, penalty, or late delivery charges are not exigible to service tax under section 66E(e) of the Finance Act, 1994.

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