No Service Tax Payable on Amount Collected as Liquidated Damages: CESTAT [Read Order]

The Hyderabad Bench of the Customs, Excise, and Service Tax Appellate Tribunal (CESTAT) ruled that no service tax is payable on amounts collected as liquidated damages, as such collections are compensatory in nature and do not represent consideration for any service.

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Bharat Dynamics Limited, the appellant, is a public sector enterprise under the Ministry of Defence. The company had collected liquidated damages (LD) from vendors and contractors for delays or non-compliance with contract terms. The department issued a show cause notice demanding service tax on these amounts, treating the collection of LD as a declared service under Section 66E(e) of the Finance Act, 1994, which relates to obligations refrained from or tolerated under a contractual arrangement.

The Principal Commissioner of Central Tax, Hyderabad, confirmed the demand in an order. Aggrieved by this, Bharat Dynamics Ltd filed an appeal before the CESTAT.

The appellant’s counsel argued that LD is not considered for any service but a penalty or compensation for breach of contract. They stated that such amounts are not taxable under service tax laws. The appellant relied on several judicial precedents, including South Eastern Coal Fields Ltd v. CCE, Raipur, Bharat Heavy Electricals Ltd v. CCT, Medchal, and Krishnapatnam Port Co Ltd v. CCE & ST, Guntur. The counsel also pointed out that in a previous case involving Bharat Dynamics Ltd itself, the same Tribunal had already ruled in their favor on the same issue.

The department’s counsel did not oppose the appellant’s position and agreed that the issue had already been settled. They stated that the Tribunal’s earlier ruling in Bharat Dynamics Ltd’s favor had been accepted and not appealed further.

The two-member bench comprising A.K. Jyotishi (Technical Member) and Angad Prasad (Judicial Member) explained that liquidated damages are not collected in exchange for a service but are meant to compensate for a contractual breach. So, such payments do not fall within the scope of taxable services under Section 66E(e) of the Finance Act. The tribunal set aside the order confirming the service tax demand and allowed the appeal, granting Bharat Dynamics Ltd relief from the tax liability on liquidated damages.

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