2026 (3) TMI 21 - AT - Service Tax

Declared service: agreed capacity-holding compensation qualifies as export of services where recipient is located abroad.

The note addresses whether compensation for underutilised production capacity constitutes a declared service under clause (e) of Section 66E and whether ... Declared service under Section 66E(e) - consideration requirement for declared services - place of provision of services - location of service recipient (export of services) Declared service under Section 66E(e) - consideration requirement for declared services - Whether the compensation for underutilisation of installed production capacity constituted a declared service and satisfied the consideration requirement - HELD THAT: - On construction of the service definition and the declared service entry, the Tribunal held that a declared service remains subject to the foundational requirement of a consideration flowing for the activity. Applying the definition of 'consideration' in Section 2(d) of the Indian Contract Act, 1872, the Bench distinguished post breach damages (which arise as a legal consequence of breach and do not ordinarily constitute consideration) from pre agreed remuneration components that are part of the contractually agreed price. The manufacturing agreement between the parties expressly obliged the Indian entity to maintain, hold available and use specified capacity for the foreign principal and provided remuneration comprising a Manufacturing Fee and an Idle Cost Compensation; the contractual scheme treated the Idle Cost Compensation as part of the agreed remuneration (a factor to ensure fair compensation for functions performed, assets employed and risks assumed). Because the capacity was created and held at the promisor's desire and the contract envisaged payment for unutilised capacity as part of the agreed consideration (not as a subsequent remedy for breach), the payment was a contractual consideration for an agreed obligation and therefore fell within the scope of the declared service entry. The Tribunal therefore concluded that, on the facts, the impugned receipts were not mere post breach damages but formed part of the contractually agreed consideration and constituted a declared service under clause (e) of Section 66E(e). [Paras 14] Compensation for idle capacity is a part of the agreed contractual remuneration and, on the facts, constitutes a declared service under Section 66E(e). Place of provision of services - location of service recipient (export of services) - Whether the declared service so identified was provided in India or at the location of the foreign recipient (i.e., whether it qualified as export of services) - HELD THAT: - Having found that a declared service existed, the Tribunal examined the Place of Provision of Services Rules. The POPS Rules adopt the general destination principle that, in the absence of a specific rule taking precedence, the place of provision is the location of the service recipient (Rule 3). The Bench analysed Rule 5 (services directly related to immovable property) and the applicable guidance and concluded that the idle capacity receipts were not a grant of a right to use immovable property situated in India nor services directly in relation to an identifiable immovable site; rather, the contractual arrangement concerned manufacture and agreed remuneration for capacity held for the foreign principal. Consequently the general rule (location of service recipient) applied. The recipient was located outside the taxable territory (Germany) and the other export conditions were satisfied. For these reasons the declared service was held to be provided outside India and to qualify as export of services under the Rules. [Paras 15, 16] The place of provision is the location of the foreign recipient; the declared service was provided outside India and thus qualifies as export of services. Final Conclusion: The Tribunal held that the under utilisation receipts were a declared service (they formed part of the contractually agreed consideration) but, applying the Place of Provision Rules, the service was provided at the location of the foreign recipient and therefore constituted an export of services; the departmental demand was not sustainable and the appeal is dismissed. Issues: (i) Whether the compensation paid for underutilisation of installed production capacity constitutes a 'declared service' under clause (e) of Section 66E of the Finance Act, 1994; (ii) If it is a declared service, whether the place of provision is outside India such that the service qualifies as export of services.Issue (i): Whether the compensation for underutilised capacity is a declared service under Section 66E(e) of the Finance Act, 1994.Analysis: The definition of 'service' requires an activity carried out for another for consideration and expressly includes 'declared service'. The concept of consideration is understood by reference to Section 2(d) of the Indian Contract Act, 1872: an act or abstinence done at the desire of the promisor. Amounts that are consequences of breach (damages or liquidated damages) ordinarily lack that element of consideration and thus do not constitute a service. The manufacturing agreement here expressly required the supplier to maintain, hold available and use production capacity for the counterparty and provided for a pre agreed remuneration structure comprising manufacturing fee and idle cost compensation. The idle cost compensation was an agreed component of remuneration tied to pre existing contractual obligations and not a post breach remedial payment; the package was negotiated and provided for in advance and the contract remained subsisting.Conclusion: The compensation for underutilisation of installed production capacity is a 'declared service' within clause (e) of Section 66E of the Finance Act, 1994.Issue (ii): If the amount is a declared service, whether the place of provision is outside India (i.e., export of service) under the Place of Provision of Services Rules, 2012 and Rule 6A of the Service Tax Rules, 1994.Analysis: The Place of Provision of Services Rules ordinarily apply the destination principle: the place of provision is the location of the service recipient (Rule 3) unless a service falls squarely within rules directed to immovable property related services (Rule 5). Rule 5 applies only where the service is directly in relation to a specifically identifiable immovable property (leasing, grant of rights to use immovable property, construction, or other direct links). The contractual scheme here, although linked to plant and machinery costs, constitutes an agreed commercial remuneration for holding capacity and does not amount to granting a right to use immovable property in the sense required by Rule 5. The service recipient is located outside India and the contractual and payment conditions otherwise satisfy the export conditions (including receipt in convertible foreign exchange and distinct legal entities).Conclusion: The place of provision of the declared service is the location of the recipient outside India; the declared service qualifies as export of services for the relevant period.Final Conclusion: On the facts, the compensation for underutilised production capacity is a declared service, but the place of provision is outside India and therefore the transaction is an export of services; the appeal by the revenue is dismissed and the adjudicated demand cannot be sustained.Ratio Decidendi: A declared service under Section 66E(e) requires consideration in the contract sense (an act or abstinence at the promisor's desire); where a payment is an agreed component of remuneration for a contractual obligation to hold or make capacity available (and not a post breach remedial payment), it qualifies as a declared service, but the place of provision is determined by the Place of Provision Rules - services directly and specifically linked to immovable property fall under Rule 5, otherwise Rule 3 (location of recipient) governs, so an agreed capacity holding remuneration payable by a recipient abroad is an export of services.