Service Tax Not Payable On Liquidated Damages: CESTAT

The appellants/assessees are public sector undertakings established by the Government of Madhya Pradesh for the distribution of electricity. Madhya Pradesh Poorva Kshetra Vidyut Vitran Co. Ltd. deals with the Eastern part of the state, Madhya Pradesh Madhya Kshetra Vidyut Vitran Co. Ltd. deals with the Central part of the state, and Madhya Pradesh Paschim Kshetra Vidyut Vitran Co. Ltd. deals with the Western part of the state.

The issue raised was whether service tax can be levied on liquidated damages received by the appellants from the other parties who failed to perform as per the contracts.

The CESTAT observed that compensation can be in two forms, namely un-liquidated damages or liquidated damages. If the suffering party sues the other in a court and damages are awarded by the court, the damages are un-liquidated damages. The quantum of damages is decided by the court, taking into account the facts and circumstances of the case and the damage suffered. Liquidated damages are those damages which are built into the contract itself. They state that in the event of a default, the defaulting party must pay the other a certain amount.The purpose of liquidated damages in a contract is to dissuade the parties from reneging on the contract. In other words, the liquidated damages are in terrorem, i.e., to strongly dissuade the party from defaulting. What is chargeable to service tax under Section 66 E (e) of the  Finance Act, as a declared service is where the very purpose of the contract is to demonstrate tolerance of an act or a situation.

The Tribunal said that if (A) agrees with (B) to tolerate an act or situation for a consideration, it is covered under Section 66E (e) as declared service. However, if A agrees with B to do something and fails to do so, and pays liquidated damages for his failure, it is not covered under Section 66E (e) as a declared service. What is chargeable to service tax is where the tolerance itself is the purpose of the contract.

"Liquidated damages are compensation for the failure of the defaulting party to perform as per the contract. Therefore, no service tax can be levied on liquidated damages received under any contract," the CESTAT said.

Case Title: M/s Madhya Pradesh Poorva Kshetra Versus Commissioner of CGST & Central Excise

Citation: Service Tax Appeal No. 50289 Of 2019

Dated: 12.04.2022

Counsel For Appellant: Advocate Manoj Munshi

Counsel For Respondent: Authorized Representative for the Department Dr. Radhe Tallo

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