Liquidated damages are not taxable as declared services when they are compensatory and not consideration for tolerating breach.

Liquidated damages or delay charges recovered for breach of contract are not taxable as a declared service under section 66E(e) of the Finance Act, 1994 unless the agreement specifically provides for refraining from an act, tolerating an act or situation, or doing an act in return for consideration. Where the contractual clause is compensatory and intended to secure performance, it does not create a separate bargain for tolerating default. Read as a whole, the contract shows consideration for supply or services, while the penal clause protects the recipient's commercial interest. On this reasoning, service tax on such liquidated damages is not sustainable.

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Issues: Whether liquidated damages or delay charges received from clients are taxable as a declared service under section 66E(e) of the Finance Act, 1994 on the footing that the recipient agreed to tolerate the delay for consideration.

Analysis: Liability under section 66E(e) arises only where an agreement specifically contemplates an activity of refraining from an act, tolerating an act or situation, or doing an act, and there is a flow of consideration for that specific activity. Liquidated damages or penalty recovered for breach of contractual terms are compensatory in nature and are intended to secure performance of the contract, not to create a separate bargain for tolerating the default. Reading the contract as a whole, the consideration is for supply or services under the contract, while the penal clause merely safeguards the commercial interest of the recipient and does not amount to consideration for a taxable service. The issue was already decided on identical facts in the cited Tribunal decisions.

Conclusion: Liquidated damages received from clients are not taxable under section 66E(e) of the Finance Act, 1994, and the demand of service tax cannot be sustained.

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