2026 (1) TMI 1491 - AT - Service Tax

Forfeiture of security deposits and penalties ruled not taxable as declared service where no consideration flows for refraining or tolerating acts

Forfeiture of security deposits, earnest money, fines, penalties and liquidated damages do not constitute consideration for a service where there is no ... Forfeiture of security deposits and liquidated damages as not constituting consideration - Penalties and fines recovered for breach of contract as non-taxable penal charges - Definition of 'service' and 'consideration' under Section 65B(44) and Explanation (a) to Section 67 - Whether the amounts collected by the appellant in the nature of forfeiture of security deposits/earnest money and fines/penalties, liquidated damages against delayed completion of works is chargeable to service tax under Section 66E(e) of the Finance Act, 1994 - HELD THAT:- As noted in the earlier decisions, the Department has issued Circular No.214/1/2023-ST dated 28.02.2023 analysing the provisions of Section 66E(e) read with 66B(44) and clarified that the activities contemplated under Section 66E(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 agreement specifically refers to such an activity and there is a flow of consideration for this activity’. In view thereof, the amount in question is not a consideration for providing any services. The present case is clearly covered by the earlier decisions and therefore, the amount collected by the appellant is not towards rendering ‘declared service’. The impugned order is unsustainable and is hereby set aside. The appeal is, accordingly, allowed. Issues: Whether amounts recovered as forfeiture of security deposits/earnest money, fines/penalties and liquidated damages on breach or delayed performance of contracts are chargeable to service tax as a 'declared service' under Section 66E(e) of the Finance Act, 1994.Analysis: Section 65B(44) defines 'service' as any activity carried out by a person for another for consideration; Section 66E(e) declares taxable the service of agreeing to refrain from an act, to tolerate an act or situation, or to do an act. For an activity to fall within Section 66E(e) there must be an agreement that specifically contemplates such an obligation and a flow of consideration for that obligation. Amounts recovered under penal clauses (liquidated damages, forfeiture of deposits, fines/penalties) arise as automatic consequences of breach or non-performance under a contract where the primary consideration is for supply of goods or services, not for toleration or refraining; such recoveries are compensatory/penal in nature and lack the requisite nexus as consideration for a declared service. The reasoning in prior Tribunal decisions and subsequent withdrawals by Revenue establish that where no independent agreement contemplates toleration or refraining for consideration, such penal recoveries are not consideration for a taxable declared service.Conclusion: Amounts recovered as forfeiture of security deposits/earnest money, fines/penalties and liquidated damages for breach or delayed performance are not consideration for a declared service under Section 66E(e) and therefore are not chargeable to service tax. The impugned order is set aside and the appeal is allowed.