Service Tax Inapplicable on Notice-Pay Deduction from Employees: Analysis of CESTAT Ahmedabad Ruling in Linde Engineering India Private Limited

1. Background of the Dispute

Linde Engineering India Private Limited, the appellant before CESTAT Ahmedabad, is engaged in providing various taxable output services such as:

  • Consulting engineering services
  • Erection, commissioning and installation services
  • Construction services for commercial and industrial establishments

During an audit for the financial years 2015-16 and 2016-17, the Department observed that the appellant had recovered a sum of Rs. 38,30,162/- from employees as “notice pay.” This amount represented deductions or recoveries made where employees left employment without serving the stipulated notice period under their employment contracts.

The central question was whether such “notice pay” recovered from employees constituted “consideration” for a taxable service under Section 66E(e) of the Finance Act, 1994, which deals with the declared service of:

“Agreeing to an obligation to refrain from an act, or to tolerate an act or a situation, or to do an act.”

The Department treated the notice-pay recovery as falling within this declared service and accordingly initiated service tax proceedings.

2. Department’s Stand and Proceedings Before Lower Authorities

2.1 Basis of the Service Tax Demand

The Department took the view that:

  • When an employee resigns without serving the prescribed notice period, the employer is effectively tolerating that act.
  • The amount recovered as notice pay is, according to this view, consideration received by the employer for tolerating the premature exit of the employee.
  • As a result, this recovery was brought within the ambit of Section 66E(e) as a declared service.

On this basis, a show cause notice dated 13.03.2018 was issued to the appellant proposing to:

  • Demand service tax of Rs. 5,42,310/- under Section 73(1) of the Finance Act, 1994 on the amount of Rs. 38,30,162/- treated as taxable value
  • Recover interest
  • Impose penalties under the relevant provisions of the Finance Act, 1994

2.2 Order-in-Original and First Appeal

The adjudicating authority, vide order-in-original dated 13.02.2019, confirmed:

  • The service tax demand of Rs. 5,42,310/-
  • Interest and consequential penalties

On appeal, the Commissioner (Appeals), by order-in-appeal dated 23.05.2019, upheld the order-in-original, reiterating that:

  • Notice-pay recoveries were taxable as declared services under Section 66E(e)
  • The appellant was liable to pay service tax on such recoveries

Aggrieved, the appellant approached the CESTAT Ahmedabad.

The essential issue before the Tribunal was:

Whether the amount of Rs. 38,30,162/- recovered by Linde Engineering India Private Limited from employees as notice pay for not serving the required notice period constituted “consideration” for a “declared service” under Section 66E(e) of the Finance Act, 1994, so as to attract service tax of Rs. 5,42,310/-.

This necessarily involved:

  • Distinguishing between “consideration” for an activity which is the subject-matter of a contract, and
  • “Compensation” or liquidated damages payable on account of breach or non-performance of contractual obligations

4. Tribunal’s Reliance on Precedent: Rajasthan Rajya Vidhyut Prasaran Nigam Limited

CESTAT Ahmedabad noted that the issue had already been examined extensively by CESTAT New Delhi in:

Rajasthan Rajya Vidhyut Prasaran Nigam Limited Vs Commissioner of Central Excise and Service Tax, Jodhpur I, 2022 (1) TMI 909 (CESTAT New Delhi)

Given the similarity of facts, the Ahmedabad Bench reproduced and followed the reasoning of this earlier decision.