Foreign supplier damages not subject to service tax under Finance Act. Tribunal rules in favor of appellant.

The appellant received damages from a foreign supplier for breach of contract. The tax department sought to levy service tax on the damages under the Finance Act. The Tribunal ruled in favor of the appellant, stating that damages for breach of contract are compensatory and not subject to service tax. Citing previous decisions and a Ministry of Finance Circular, the Tribunal held that such damages do not constitute consideration for a taxable supply. The Commissioner's demand for service tax was deemed unsustainable, and the appellant's appeal was allowed.

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Issues Involved:
1. Whether the damages received by the appellant from the foreign supplier for breach of contractual obligations can be subjected to levy of service tax under section 66E(e) of the Finance Act, 1994.

Summary of the Judgment:

Issue 1: Taxability of Damages as Declared Service under Section 66E(e) of the Finance Act, 1994

M/s Sarda Energy & Minerals Ltd. [the appellant] received an amount of EURO 8.5 Million towards damages in arbitration proceedings concerning a purchase order. The department considered this amount taxable under section 66E(e) of the Finance Act, 1994, and issued a show cause notice on 25.10.2016. The Commissioner, by order dated 07.08.2017, confirmed the demand and imposed a penalty upon the appellant. This order was impugned in the appeal.

The appellant contended that the damages received cannot be subjected to service tax, citing the Tribunal's decisions in South Eastern Coalfields Ltd. versus Commissioner of Central Excise & Service Tax, Raipur and M/s Krishnapatnam Port Company Limited versus Commissioner of Central Excise & Service Tax, Guntur. The Tribunal had held that such damages do not attract service tax as they are not for any service provided but are compensatory in nature. The appellant also referred to a Circular dated 03 August, 2022, issued by the Ministry of Finance, which clarified that payments in the nature of liquidated damages, compensation, and penalties arising out of breach of contract do not attract service tax.

The Tribunal examined whether the appellant provided a "declared service" under section 66E(e) of the Finance Act, which includes agreeing to the obligation to refrain from an act, to tolerate an act or a situation, or to do an act. The Tribunal noted that for an activity to be taxable as a declared service, there must be a flow of consideration specifically for such an activity.

In South Eastern Coalfields, the Tribunal had observed that penal clauses in contracts are safeguards for commercial interests and not intended as consideration for any service. The recovery of liquidated damages or penalties cannot be considered as payment for any service provided. This decision was followed in subsequent cases, including Northern Coalfields Ltd. versus Commissioner, CGST, CE and Customs, Jabalpur and Krishnapatnam Port.

The Tribunal concluded that the issue in the present case is covered by these decisions, and service tax could not have been demanded from the appellant. The Circular dated 03.08.2022 also emphasized that there must be an express or implied agreement to do or abstain from doing something against payment of consideration for a taxable supply to exist. Payments such as liquidated damages for breach of contract do not constitute consideration for tolerating an act or situation.

Therefore, the demand confirmed by the Commissioner was not sustainable. The order dated 07.08.2017 was set aside, and the appeal was allowed.

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