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 flow of consideration for refraining from, tolerating, or doing an act; accordingly such amounts are not taxable as a 'declared service' under the definition of service and consideration. The departmental circular interpreting Section 66E(e) and the definition of consideration supports treating penal charges as non-taxable, leading to setting aside of the assessment that sought to levy service tax on such recoveries.

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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.

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