Relief for South Eastern Coalfields: Liquidated Damages for Breach of Contract Not Taxable as ‘Tolerance of Act’ Service [Read Order]

The Delhi Bench of the Customs, Excise, and Service Tax Appellate Tribunal (CESTAT) ruled that liquidated damages, penalties, and compensation recovered for breach of contract are not taxable under the category of “tolerating an act” service under Section 66E(e) of the Finance Act, 1994.

South Eastern Coalfields Ltd. (SECL), the appellant, is engaged in mining and sale of coal. During audit, the department alleged that the appellant had failed to pay service tax on amounts collected as liquidated damages, penalties, forfeiture of earnest money deposits, and compensation from contractors, suppliers, and coal purchasers for breach of contractual conditions during the period from April 2016 to June 2017.

Show cause notices were issued proposing recovery of service tax along with interest and penalties on the ground that such recoveries amounted to consideration for “tolerating an act or situation” under Section 66E(e) of the Finance Act, 1994. The adjudicating authority confirmed the demand. Aggrieved by the orders, the appellant approached the CESTAT.

The appellant’s counsel argued that liquidated damages and penalties recovered for breach of contract were compensatory in nature and could not be treated as consideration for any service. The counsel relied on the Tribunal’s earlier decision in the appellant’s own case reported in 2021 (55) GSTL 549 (Tri.-Del.), where identical demands were set aside. The appellant argued that there was no agreement to tolerate breach of contract and no service was rendered by the appellant.

The revenue counsel argued that the amounts collected by the appellant were taxable under Section 66E(e) as consideration for tolerating breach of contractual obligations by contractors and purchasers.

The two-member bench comprising Binu Tamta (Judicial Member) and P.V. Subba Rao (Technical Member) observed that liquidated damages, penalties and forfeiture amounts recovered for breach of contract were merely compensatory in nature and were not consideration for any service. The tribunal observed that there was no separate agreement between the parties to tolerate any breach or violation of contractual terms.

The tribunal pointed out that Section 66E(e) would apply only when there is a clear agreement to tolerate an act or situation in return for consideration. The tribunal explained that recovery of damages due to non-performance or breach of contract cannot automatically be treated as a taxable service.

The tribunal set aside the service tax demand on liquidated damages, penalties and compensation recovered by the appellant and allowed the appeal on this issue.

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