Service Tax on Liquidated Damages for Delay: CESTAT Hyderabad Confirms No Tax in Absence of Service Element

Background of the Dispute

The Hyderabad Bench of the Customs, Excise and Service Tax Appellate Tribunal (CESTAT) in Brahmos Aerospace Pvt Ltd Vs Commissioner of Central Tax has reaffirmed that liquidated damages received for delay or non-compliance of contractual terms do not constitute consideration for any taxable service, particularly the declared service of “tolerating an act” under section 66E(e) of the Finance Act, 1994.

The proceeding arose from an Order-in-Original dated 31.12.2019, by which service tax demand and penalty were confirmed against M/s Brahmos Aerospace Pvt Ltd (the assessee). The central issue was whether sums collected as contractual penalty/liquidated damages (LD) due to delayed performance by the counterparty could be subjected to service tax as consideration for an alleged service of “tolerating” such delay.

Department’s Stand: LD as Consideration for “Tolerating an Act”

Basis of the Demand

  1. The department observed that the assessee had received amounts described as penalty or liquidated damages from contractual counterparties who failed to comply with time limits specified in the agreements.
  2. Treating these sums as liquidated damages for delayed performance, the department invoked section 66E(e) of the Finance Act, 1994, which classifies as a declared service the activity of “agreeing to the obligation to refrain from an act, or to tolerate an act or a situation, or to do an act”.
  3. On this foundation, it was alleged that:
    • By accepting delayed performance and retaining the LD/penalty,
    • The assessee had effectively “tolerated” the breach or delay,
    • And the amounts so collected constituted taxable consideration for that “toleration”.

Outcome at Adjudication Stage

  • The Adjudicating Authority accepted this view in full.
  • Service tax was demanded on the entire amount treated as LD/penalty.
  • Penalty under applicable provisions was also imposed.
  • The assessee challenged this outcome before CESTAT Hyderabad.

Assessee’s Arguments Before the Tribunal

The learned Advocate representing M/s Brahmos Aerospace Pvt Ltd contended that the controversy was already settled in favour of assessees by several decisions of the Tribunal, including a prior ruling in the assessee’s own case.

Reliance on Earlier Decisions

The assessee pointed out that:

  • In its own earlier case, the same Bench had passed Final Order No. A/30419/2025 dated 08.10.2025, categorically holding that no service tax is payable on amounts received as liquidated damages.
  • The assessee also relied upon a series of judicial precedents, including:
    • Airport Authority of India Vs CST, Delhi [2015 (39) STR 35 (Tri-Del)]
    • South Eastern Coal Fields Ltd Vs CCE [2021 (55) GSTL 549 (Tri-Del)]
    • CCGST, Bhopal Vs M/s Madhya Pradesh Poorva Kshetra Vidyut Vitran Co Ltd [Order dt.13.07.2022]
    • Inox Air Products Pvt Ltd Vs CCE [2008 (232) ELT 338 (Tri-Bang)]

The common thread in these decisions is that amounts recovered as liquidated damages or contractual penalties for non-fulfilment of agreed terms are compensatory in nature and not consideration for “tolerating” a breach.