Liquidated damages are not consideration for tolerating breach, so service tax cannot be levied on vendor delay recoveries.

Service tax was not chargeable on liquidated damages recovered from vendors for delay or non-performance, because such amounts were compensatory or deterrent in nature and not consideration for an independent taxable service. For the period before 01.07.2012, liquidated damages did not fall within section 65(105) of the Finance Act, 1994; for the period after 01.07.2012, they also did not amount to consideration under section 66E(e) for agreeing to refrain from an act, tolerate an act or situation, or do an act, as the contract did not create a separate service of toleration with consideration. The demand was therefore unsustainable.

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Issues: Whether service tax was leviable on liquidated damages recovered from vendors for delay or non-performance of contractual obligations, both for the period prior to 01.07.2012 and under clause (e) of section 66E of the Finance Act, 1994 for the period thereafter.

Analysis: For the period prior to 01.07.2012, liquidated damages did not fall within any taxable service covered by section 65(105) of the Finance Act, 1994. For the period from 01.07.2012, the demand was tested under section 66E(e), which covers agreeing to refrain from an act, tolerate an act or situation, or do an act for consideration. The amounts recovered as liquidated damages were held to be compensatory or deterrent in nature, arising from breach or non-performance of contract, and not consideration for any independent service. The agreement did not specifically provide for any service of toleration with a flow of consideration, and the distinction between conditions of contract and consideration for contract was material. The later CBIC circular also supported this position.

Conclusion: Service tax was not leviable on the liquidated damages recovered by the appellant, and the demand could not be sustained.

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