Liquidated Damages and Service Tax under Section 66E(e): CESTAT Delhi’s Ruling in Principal Commissioner Vs Bharat Heavy Electricals Limited (BHEL)

Introduction

The Delhi Bench of the Customs, Excise and Service Tax Appellate Tribunal (CESTAT) in Principal Commissioner Vs Bharat Heavy Electricals Limited (BHEL) has once again examined whether amounts recovered as liquidated damages, penalty, or late delivery charges under commercial contracts can be subjected to service tax as a “declared service” under Section 66E(e) of the Finance Act, 1994.

The Tribunal reaffirmed that such recoveries, arising out of breach or non-compliance of contractual terms, do not amount to consideration for agreeing to tolerate an act or situation. Hence, no service tax is payable on these amounts under Section 66E(e).

Factual Background

Parties and Nature of Business

  • The respondent, Bharat Heavy Electricals Limited (BHEL), is a Central Government Public Sector Undertaking.
  • BHEL is engaged in the manufacture and supply of plant and machinery and also undertakes associated services for the engineering industry.
  • Supply contracts entered into by BHEL typically provide for:
    • Supply of goods and/or services at a defined contractual price.
    • Time-bound delivery obligations.
    • A liquidated damages/penalty clause for delays in supply or execution.

Contractual Structure and Liquidated Damages Clause

Under these contracts:

  1. The customer agrees to pay a specified contractual price for goods and/or services.
  2. This price is based on the premise that BHEL will deliver within the contractually stipulated time.
  3. If BHEL delays supply of goods or completion of services beyond the agreed timeline, the contractual value payable by the buyer is reduced.
  4. The reduction is governed by a Liquidated Damages Clause, which prescribes a pre-determined deduction/charge for delay.

Thus, the commercial arrangement was principally for supply of goods/services, with liquidated damages operating as a deterrent and compensatory mechanism in case of delay.

Show Cause Notice and Adjudication Proceedings

Department’s Allegation

A show cause notice dated 17.04.2018 was issued to BHEL alleging the following:

  • BHEL was recovering amounts described as penalty or late delivery charges from:
    • Contractors, and
    • Material suppliers,
  • These recoveries were made on account of:
    • Delay in supply of goods, or
    • Delay in execution of works.
  • According to the Department, these recoveries represented consideration for “tolerating an act or a situation” and were therefore chargeable to service tax as a declared service under Section 66E(e).
  • It was alleged that BHEL failed to discharge service tax on such amounts.

Assessee’s Response

BHEL filed a reply contesting the notice, broadly contending that:

  • The essence of the contracts was the supply of goods/services at an agreed consideration.
  • The liquidated damages clauses were not independent service arrangements but contractual remedies for breach or delay.
  • No service, as defined under Section 65B(44), was being rendered when such damages were recovered.
  • Hence, no liability under Section 66E(e) arose.

Order of the Additional Commissioner

Despite the defence, the Additional Commissioner passed an order dated 31.03.2019, holding that:

  • The amounts recovered as penalty/late delivery charges were taxable as declared services under Section 66E(e).
  • A demand of service tax for the period 01.07.2012 to 31.03.2017 was confirmed, along with interest and penalty.

Order of Commissioner (Appeals)

BHEL challenged the adjudication order before the Commissioner (Appeals), CGST & Central Excise, Bhopal.

By order dated 19.07.2019, the Commissioner (Appeals):

  • Set aside the order of the Additional Commissioner.
  • Allowed the appeal filed by BHEL.
  • Held that the charges recovered as liquidated damages/penalty/late delivery charges were not liable to service tax under Section 66E(e).

This appellate order was then assailed by the Department before the CESTAT Delhi.

Department’s Arguments before CESTAT

The learned authorised representative appearing for the Department advanced, inter alia, the following arguments:

1.