2025 (8) TMI 170 - AT - Service Tax

Service Tax Not Applicable on Forfeited Earnest Money as Liquidated Damages Under Circular No. 214/1/2023-ST

The CESTAT New Delhi held that service tax is not leviable on forfeiture of earnest money deposits treated as liquidated damages or penalty/late delivery ... Levy of service tax - forfeiture of earnest money deposit - HELD THAT:- Issue of levy of service tax on such charges have been considered time and again by the Tribunal and in the decisions referred by the counsel during the arguments. It is found that the Tribunal has taken the consistent view with regard to non-levy of service tax on these charges. In the case of Bharat Heavy Electricals Limited [2022 (9) TMI 1457 - CESTAT NEW DELHI], relying on the earlier decisions following has been observed that 'It, therefore, follows that the liquidated damages collected by the respondent as penalty/late delivery charges cannot be subjected to service tax under section 66E (e) of the Finance Act.' Though the Circular was issued with regard to GST law and the same reasoning have been adopted for service tax matters vide Circular No. 214/1/2023-ST dated 28.02.2023 - In view of the above circulars and the decisions, there are no merit found in the impugned order. Appeal allowed. ISSUES: Whether service tax is leviable on forfeiture of earnest money deposit (EMD) under Section 66E(e) of the Finance Act, 1994 as a declared service.Whether forfeited earnest money constitutes 'consideration' for tolerating breach or non-performance of contractual obligations, thereby attracting service tax under Section 66B.Whether penalty or liquidated damages stipulated in a contract can be treated as consideration for taxable service.Applicability of interest and penalty provisions under Sections 73(1), 73(2), 75, and 78 of the Finance Act, 1994 on the service tax demand related to EMD forfeiture. RULINGS / HOLDINGS: The impugned order confirming demand of service tax on forfeited earnest money under Section 66E(e) and imposing penalty under Section 78 was set aside, holding that forfeiture of earnest money is not consideration for taxable declared service.Forfeited earnest money is characterized as a penalty or liquidated damages to deter breach of contract and not as consideration for tolerating an act or refraining from an act; hence, it does not fall within the scope of 'declared service' under Section 66E(e).Liquidated damages or penalty payments stipulated in contracts are compensatory in nature and do not constitute 'consideration' for a supply of service under Section 65B(44) and are therefore not taxable.Interest and penalty under Sections 75 and 78 are not sustainable where the underlying service tax demand itself is not valid. RATIONALE: The Court applied the legal framework under the Finance Act, 1994, particularly Sections 66B, 66E(e), 65B(44), 73, 75, and 78, and relied on precedents interpreting the scope of 'declared services' and 'consideration' for service tax purposes.Precedent decisions by the Tribunal, including Division Bench rulings, consistently held that liquidated damages or penalties for breach of contract are compensatory and do not amount to taxable services, as they lack the element of an activity carried out for another for consideration.Section 74 of the Contract Act, 1972 was invoked to emphasize that liquidated damages represent reasonable compensation for breach and are not intended as payment for tolerating breach or non-performance.Board Circulars No. 178/10/2022-GST and 214/1/2023-ST clarified that payments characterized as penalties or liquidated damages are not consideration for supply unless there is an express or implied agreement to tolerate breach or act, reinforcing the non-taxability of forfeited earnest money.The Court distinguished payments that are ancillary to principal supply and taxable (e.g., early termination fees, pre-payment penalties) from liquidated damages that compensate for loss without constituting consideration for a supply.The judgment reflects a doctrinal consistency with prior rulings, rejecting the characterization of forfeited earnest money as taxable declared service and thereby reversing the service tax demand, interest, and penalty.