2025 (10) TMI 452 - AT - Service Tax

Forfeited sums are penal, not taxable consideration under s.66E(e); prior guidance and agreement flow must be shown

Hindustan Zinc Limited Versus Commissioner of Central Excise and CGST-Udaipur

CESTAT AT set aside the service tax demand and allowed the appeal, holding that forfeited sums (earnest money, security deposits, fines, penalties) are ... Recovery of service tax with interest and penalties - penal charges recovered by the appellant on account of breach or non-performance of contract - activity is declared service in terms of Section 66E of Finance Act, 1994 or not - adjudicating authorities below have ignored the earlier decisions - judicial indiscipline - HELD THAT:- Any amount which has no nexus with the taxable service cannot be the consideration for the service provider and thus does not become the part of the value which is taxable. Otherwise also there is a marked distinction between “conditions to a contract” and “consideration for the contract”. When a service recipient is required to fulfil certain conditions contained in the contract and to let some amount to be forfeited but that would not necessarily mean that value of forfeited amount would form part of taxable value. Such activity cannot be called as rendering of any service not even the declared service. Reverting to the facts of the present case, it is observed that the amount in question is the forfeited amount of earnest money, security deposit, fines and penalties received from the contractor on account of poor or unsatisfactorily delay in work as per the terms of the contract. The said act of forfeiture cannot be called as consideration for an act of tolerating in or in question (66E) (e) as the said activity is not resulting in extinguishment or forbearance of any right of the parties. Amount so collected/forfeited by the appellant was merely penal in nature to ensure full compliance, in future, of the terms and conditions of the contract between the appellant and its contractors. It is further observed that department also vide Circular No.214/1/2023-ST dated 28th February, 2023 has clarified about leviability of service tax on the declared services, “agreeing to the obligation to refrain from an act or to tolerate an act or a situation, or to do an act” under clause (e) of section 66E of Finance Act, 1994 and has clarified that the activities contemplated under section 66 E (e) i.e. when one party agrees to refrain from an act or to tolerate an act or a situation, or to do an act, are the activities where the agreements specifically refers to such an activity and there is a flow of consideration for this activity. In appellant’s own case [2024 (12) TMI 11 - CESTAT NEW DELHI], this Tribunal has set aside the demand of service tax confirmed on the identical allegations holding that the penalties, fines and forfeited amounts cannot be treated as consideration towards declared services defined under section 66 E(e) of the Finance Act. It is further observed that adjudicating authorities below have ignored the earlier decisions. Hence, the act of the authority is held to be an act of judicial indiscipline. The authorities below are warned to be careful in future. Such an order of reflecting judicial indiscipline is otherwise not sustainable. The order under challenge is set-aside - Appeal allowed. ISSUES PRESENTED AND CONSIDERED 1. Whether amounts forfeited as earnest money, security deposit, fines, penalties or liquidated damages recovered for breach/non-performance of contract constitute a 'declared service' under Section 66E(e) of the Finance Act (i.e., 'agreeing to the obligation to refrain from an act, or to tolerate an act or a situation, or to do an act'). 2. Whether such forfeited amounts can be treated as 'consideration' for a taxable service within the meaning of Section 65B(44) and valued under Section 67 of the Finance Act. 3. Whether demand of service tax (and consequential penalties) on such forfeited amounts is sustainable where earlier Tribunal/administrative decisions on identical facts have been rendered in favour of the assessee and the Department has not pursued further appeal (including executive circulars reflecting the settled approach). ISSUE-WISE DETAILED ANALYSIS Issue 1 - Taxability as Declared Service under Section 66E(e) Legal framework: Section 66E(e) defines certain 'declared services' to include 'agreeing to the obligation to refrain from an act, or to tolerate an act or a situation, or to do an act.' The question is whether receipt of forfeited amounts for breach/non-performance amounts to payment for such an agreement. Precedent treatment: Multiple Tribunal pronouncements have addressed similar charges (penalties, liquidated damages, forfeitures, cancellation charges) and have consistently held that such recoveries are not consideration for tolerating or refraining from an act and therefore do not attract tax under Section 66E(e). Higher court precedents emphasise the requirement of a nexus between the amount charged and the taxable service provided; amounts without such nexus are not part of taxable value. Interpretation and reasoning: The Court examined the nature of forfeited amounts in the contracts - they are penal/compensatory in nature, intended to ensure compliance and to make good losses arising from breach, not to procure an agreement to tolerate or refrain from acts. The Tribunal emphasised the distinction between 'conditions to a contract' and 'consideration for the contract': fulfilling contract conditions (including payment of stipulated penalties upon breach) does not convert such payments into consideration for a declared service. The act of forfeiture does not effectuate extinguishment or forbearance of any right in a manner that constitutes provision of the declared service in Section 66E(e). Ratio vs. Obiter: Ratio - Forfeited amounts arising from breach/non-performance are not consideration for agreeing to refrain or tolerate an act and therefore do not fall within Section 66E(e). Obiter - Observations on general contract drafting and penal nature of forfeitures support the ratio but are not novel legal propositions beyond application of statutory text and precedent. Conclusions: The Tribunal concluded that forfeited earnest money, security deposits, fines, penalties and liquidated damages in the facts before it do not constitute declared services under Section 66E(e) and are not taxable as such. Issue 2 - Whether Forfeited Amounts Constitute 'Consideration' under Section 65B(44) and are Valued under Section 67 Legal framework: 'Service' is defined as any activity carried out by a person for another for consideration (Section 65B(44)), and Section 67 requires that only amounts paid 'for such service provided' are taxable; value must have nexus to the taxable service. Precedent treatment: Authoritative decisions have articulated that taxable value must have a nexus with the service provided; amounts charged without nexus are not includible. The principle that penalty/compensatory recoveries lack the necessary nexus has been repeatedly applied by tribunals and accepted by the Department in several instances. Interpretation and reasoning: Applying the nexus test, the Tribunal found no direct link between the forfeited sums and any service rendered by the appellant. Forfeitures were not payments made in return for a service of tolerating or refraining from an act, but were contractual consequences of breach. The Tribunal relied on the accepted proposition that only amounts which are consideration for the service become part of the taxable value under Section 67. Ratio vs. Obiter: Ratio - Forfeited/penal amounts without nexus to a rendered service are not 'consideration' within Section 65B(44) and cannot be included in value under Section 67. Obiter - Explanatory remarks on contractual terms and examples of differing contractual mechanics. Conclusions: For the facts considered, forfeited amounts do not qualify as consideration for a taxable service and therefore are not chargeable to service tax under Sections 65B(44) and 67. Issue 3 - Precedential Consistency, Administrative Guidance, and Consequences for Penalties/Limitations Legal framework: Principles of consistency and binding precedents require similar treatment of similar matters; administrative circulars and the Department's decision not to appeal authoritative Tribunal decisions bear on enforcement and further appeals. Precedent treatment: The Tribunal observed a line of consistent decisions in favour of taxpayers on the specific issue and noted that executive action (including a circular interpreting Section 66E(e) and the Board's decision not to appeal a controlling Tribunal decision) reinforced the settled position. Interpretation and reasoning: The Tribunal found that adjudicating authorities below ignored the established precedent and administrative position when confirming the demand, amounting to judicial indiscipline. Given the settled jurisprudence and administrative stance, the Tribunal held that demands and consequential penalties based on the contrary view were unsustainable. While limitation arguments were raised by the appellant, the Tribunal's decision on taxability obviated detailed reliance on limitation; penalties based on an untenable demand were set aside as consequential relief. Ratio vs. Obiter: Ratio - Authorities must follow consistent precedent and administrative guidance; where taxability is settled against the Department and not appealed by the Board, demands contrary to that settled view cannot be sustained. Obiter - Reprimand on judicial indiscipline and exhortation for uniformity in similar matters. Conclusions: The Tribunal set aside the impugned demand and penalties, holding that the lower authorities erred in disregarding the consistent line of precedent and administrative position. The authorities are cautioned to observe consistency and avoid recurrence of such departures from settled law. Final Disposition The order confirming service tax on forfeited amounts (earnest money, security deposits, fines, penalties and liquidated damages) was set aside; the appeal was allowed. Consequential demands and penalties were quashed in view of the absence of taxable consideration and in light of controlling precedents and administrative position.