Notice Pay Recovered from Employees Who Leave Without Completing Notice Period Not Liable to Service Tax: CESTAT [Read Order]

The Ahmedabad Bench of the Customs, Excise, and Service Tax Appellate Tribunal (CESTAT) ruled that notice pay recovered from employees who leave without completing the stipulated notice period is not liable to service tax, as such recovery is not consideration for any service but compensation for breach of contract.

Cosmo First Limited, the appellant, is engaged in the manufacture of BOPP films and PP granules. During an audit, the department found that the appellant had recovered notice pay from employees who resigned before completing the notice period and treated this amount as taxable under Section 66E(e) of the Finance Act, 1994, which covers “agreeing to the obligation to tolerate an act.”

The department issued a show cause notice demanding service tax of ₹77,791 along with interest and penalties. The adjudicating authority confirmed the demand, and the Commissioner (Appeals) upheld the order. Aggrieved by the decision, the appellant approached the CESTAT.

The appellant’s counsel argued that the recovery of notice pay does not amount to a taxable service under Section 66E(e) since it is not consideration for tolerating an act but a compensation for the employee’s failure to serve the agreed notice period.

They further argued that under Section 65B(44), services provided by an employee to the employer in the course of employment are outside the scope of service tax.

The revenue counsel argued that by accepting the payment, the employer had agreed to tolerate the act of the employee leaving early, making it taxable under Section 66E(e). They submitted that both the adjudicating and appellate authorities had given reasoned findings holding the recovery liable to service tax.

The two-member bench comprising Dr. Ajaya Krishna Vishvesha (Judicial Member) and Satendra Vikram Singh (Technical Member) observed that the issue was no longer res integra and had been settled in earlier tribunal decisions.

The tribunal explained that consideration is paid for the performance of a contract, while compensation is paid for its breach, and the two cannot be equated. It pointed out that in employment contracts, notice pay is recovered as a penalty for non-performance, not as consideration for any service.

The tribunal further observed that the CBIC’s circulars under both service tax and GST regimes clarified that such recoveries are not taxable, as they are not payments for any service rendered or agreed to be rendered. The tribunal set aside the impugned order, holding that notice pay recovered from employees is not liable to service tax, and allowed the appeal.

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