SERVICE TAX ON LIQUIDATED DAMAGES

[VINOD KUMAR]

DEAR EXPERT, PLEASE REPLY WHETHER SERVICE TAX UNDER SECTION 66E IS LEVIABLE ON LIQUIDATED DAMAGES ON ACCOUNT OF LATE SUPPLY OF MATERIAL.

[YAGAY andSUN]

Dear Vinod,

Yes, Service Tax is applicable on Liquidated Damages under Section 66E of the Finance Act, 1994.

Regards

YAGAY and SUN

(Management and Indirect Tax Consultants)

[PAWAN KUMAR]

Dear Sir,

As per my view, Nature of LD is a penalty in simple words. Buyer can impose LD for delay supply of material on supplier. As it has no nexus with the service performed, No liability of service tax would arise.

[Madhukar N Hiregange]

Consideration for service provided is important and needs to be understood. Normally penalties are not consideration. If the LD is penalty as per the terms of agreement which it is then no liability under ST.

[Rajagopalan Ranganathan]

Section 66 (E) (e) of Finance Act, 1994 states that-

(e) agreeing to the obligation to refrain from an act, or to tolerate an act or a situation, or to do an act.

and the above acts constitutes a declared service. Liquidated damages is paid by the supplier for delayed supply of the materials and such delay is tolerated by the buyer on payment of an amount as agreed upon by a written or oral agreement, then such an act is a declares service and liquidated damage paid is the consideration for the service rendered and service tax is payable on such consideration. This is my opinion.

[Madhukar N Hiregange]

The education guide { for what it is worth} talks about penalty not being a consideration. If as per the terms of agreement LD is in nature of penalty there may be no liability. However the law in this regard has developed. Maybe if one is not planning to pay they can in writing provide their view of why it is not liable a d ask the jurisdictional officer to confirm.

If he does not conform then maybe longer period can be defended.

[Mahir S]

Sir,

There is a vast difference between the word Penalty and Liquidate Damages.

A 'penalty' is intended as a punishment for some sort of failure and may bear no relation to the actual quantum of loss suffered.
In contrast, Liquidated Damages are intended as a pre-agreed way to compensate purchaser, who has suffered loss as a result of actions (or inactions) by the other.

In view of above, service tax is required to be paid for such liquidated damages under section 66E of the finance act.

It would be advisable to pay up the service tax immediately and without any further delay.

[YAGAY andSUN]

Dear All,

This discussions is becoming interesting now. We have done bit research on this matter for the purpose of contributing in this discussion.

We are referring three definition of Liquidated Damages and relevant provisions and judgment for the purpose of providing clarification on this matter that LD is leviable to Service Tax.

1. Definition of LD: - Liquidated damages (also referred to as liquidated and ascertained damages) are damages whose amount the parties designate during the formation of a contract for the injured party to collect as compensation upon a specific breach (e.g., late performance).

2. Definition of LD: - Liquidated Damages are a variety of actual damages. Most often, the term "liquidated damages" appears in a contract, and often is the title for a whole clause or section. Parties to a contract use liquidated damages where actual damages, though real, are difficult or impossible to prove.

3. Definition of LD: - Sum of money (agreed-to and written into a contract) specified as the total amount of compensation an aggrieved party should get, if the other party breaches certain part(s) of the contract. The contract also establishes what actions or failures to act constitute a breach. For the agreement to be legally enforceable, the nature of the contract should be such that it is difficult to determine actual damages, and the amount of damages should be reasonable under the circumstances.

From the above definitions, the meaning of liquidated damage is clear.

Section 66 (E) (e) of Finance Act, 1994 states that-

(e) Agreeing to the obligation to refrain from an act, or to tolerate an act or a situation, or to do an act and the above acts constitutes a declared service.

Now, if any seller do not supply the goods or there is delay in supply of goods, or installation of such goods takes more time than scheduled times, and the buyer suffers, then, such activity would come under the purview of declared services and such services are taxable under the provisions of Finance Act, 1994.

Rule 6 (2)(vi) (Cases in which the commission, costs, etc.) of Service Tax (Determination of Value) Rules, 2006: -

Subject to the provisions contained in sub-rule (1), the value of any taxable service, as the case may be, does not include-

(vi) Accidental damages due to unforeseen actions not relatable to the provision of service;

According to above Rule 6 (2) (vi) if any accidental damage occurs due to unforeseen actions then such amount would not be included in the taxable value of services.

But liquidated damage arises due to breach of conditions of agreement, contract or MOUs, therefore, if such damages are not due to unforeseen actions, then, it will be considered as consideration and service tax would be applicable.

Further, It was held in Commissioner of Central Excise, Hyderabad-IV v Victory Electricals [2013 TIOL 1794 Tribunal MAD LB] wherever the taxpayer, as per the terms of the contract and on account of delay in delivery of manufactured goods is liable to pay a lesser amount than the agreed price as a result of the contractual terms, such resultant reduced price should be treated as the ‘transaction value’, regardless of whether the clause is titled ‘penalty’ or ‘liquidated damages’.

After going through the above definitions, Section/Rules and judgment, It is our considered view that on liquidated damage under Finance Act, 1994, service tax would be applicable under Section 66 (E) (e).

Regards

YAGAY and SUN (knowledge is power, when shared)

(Management and Indirect Tax Consultants)

[VINOD KUMAR]

THANK YOU ALL EXPERTS FOR THEIR VALUABLE OPINION.

AI Summary

Service tax on liquidated damages may apply where LD is pre agreed compensation treated as consideration for a declared service. Debate centers on whether liquidated damages for delayed supply constitute consideration for a declared service under section 66E(e). One view treats LD as a non taxable penalty; the prevailing analytical view treats commercially agreed LD as pre agreed compensation and therefore consideration attracting service tax. Rule 6(2)(vi)'s exclusion for accidental damages was distinguished from contractual LD. A tribunal authority treating contractually reduced amounts due to delay as transaction value was cited in support of taxability.