Non-applicability of service tax on liquidated damages, penalties, and forfeiture of earnest money ordered CESTAT

Non-applicability of service tax on liquidated damages, penalties, and forfeiture of earnest money ordered CESTAT

M/s. South Eastern Coalfields Ltd. (appellant) – a public sector undertaking and a subsidiary of Coal India Ltd. is operational in 18 different mines and is engaged in the business of mining and selling coal, which is an excisable good.

The appellant entered into commercial contracts during the course of business. There were certain clauses in the said contract that contained a penalty clause for non-observance or the breach of the terms and conditions of the contract. The appellant contended that these clauses under the contract have been provided to safeguard their interest.

Under Section 73(1) of the Finance Act, a show-cause notice was issued where it was mentioned that the appellant had collected an amount towards compensation or penalty from the buyers of coal on the short lifted quantity of coal and that it was in breach of terms of the contract.

According to the Principal Commissioner of Central Exercise and Service Tax (Respondent) the amount charged during July 2012 - March 2016, by the appellant was taxable as it was a declared service under Section 66E(e) of the Finance Act.

The respondent confirmed that the amount charged by the appellant in the form of penalty, earnest money deposit forfeiture, and liquidated damages would tantamount as consideration for tolerating an act on behalf of the buyers and contractors of coal, the service tax would be levied on that amount as per Section 66 E(e) of the Finance Act.

An appeal was filed before the Customs, Excises, and Service Taxes Appellate Tribunal (CESTAT), New Delhi Bench, against the order of the respondent. The matter was listed before the Coram headed by the President, Justice Dilip Gupta.

CESTAT referred to the judgments of the European Court of Justice (First Chamber) in Case C-277/2005, in Societe Thermale d 'Eugenic-les-Bains v. Ministere de I 'Economie, des Finances et de I 'Industrie. In this case, an issue was dealt whether an obligation to refrain from an act or to tolerate an act would result in the supply of services if a sum paid as a deposit by a customer to a hotelier. The customer exercised the cancellation option and that sum was retained by the hotelier.

CESTAT held that no Service Tax is applicable on Liquidated damages, forfeiture of earnest money deposit, and penalty. The order of the respondent was quashed and it held that the amount claimed by the appellant from the buyers and contractors were to make good the damages, losses, or injuries arising from "unintended" events. There would be no obligation on the part of the appellant to tolerate an act or a situation and cannot be considered to be the payments for any services.