Service Tax on Ex-Gratia Job Charges for Underutilised Capacity: CESTAT Allahabad Ruling Analysed
Background of the Dispute
The appeal in K. N. Food Industries Pvt. Ltd. Vs Commissioner of CGST & Central Excise (CESTAT Allahabad) revolved around whether amounts described as ex-gratia job charges received by a job worker were liable to service tax as consideration for a taxable service.
The assessee, K. N. Food Industries Pvt. Ltd., was engaged in manufacturing confectionery items classifiable under Chapter 17 of the Central Excise Tariff Act, 1985. The manufacturing activity was undertaken for and on behalf of the principal manufacturer, M/s Parle Biscuits Pvt. Ltd., under a specific manufacturing agreement.
Under the arrangement:
- M/s Parle Biscuits Pvt. Ltd. procured and supplied all required raw materials to the assessee.
- The assessee manufactured confectionery products using these materials.
- The finished goods were cleared on payment of Central Excise duty based on the MRP indicated by M/s Parle Biscuits Pvt. Ltd.
The principal compensated the assessee through job charges computed on a per kilogram basis of confectionery produced. However, an additional mechanism existed in the contract to deal with underutilisation of the assessee’s installed manufacturing capacity, which gave rise to the present controversy.
Nature of Ex-Gratia Job Charges
Contractual Right to Ex-Gratia Payment
Besides the regular per kg job charges, the contract provided that if M/s Parle Biscuits Pvt. Ltd. did not utilise the assessee’s manufacturing facility to a mutually agreed standard level, the assessee would be entitled to additional compensation termed ex-gratia job charges.
This entitlement arose only when:
- The actual quantity of goods ordered and manufactured fell below the agreed benchmark capacity utilisation; and
- Such underutilisation caused financial shortfall in normal job charges otherwise receivable by the assessee.
Method of Computing Ex-Gratia Charges
The ex-gratia amounts were not fixed or guaranteed. They were arrived at using parameters linked to the assessee’s manufacturing capabilities, including:
- Maximum daily output based on installed production capacity
- Monthly packing capacity
- Output ratio derived from the operational time of the plant relative to possible production
On this basis, the assessee raised separate invoices towards ex-gratia job charges, which were honoured and paid by M/s Parle Biscuits Pvt. Ltd.. These payments were essentially designed to neutralise financial loss due to lower utilisation of the plant, not as additional consideration for further manufacturing or any distinct service.
Department’s Stand and Demand of Service Tax
The Department took the view that the receipt of ex-gratia job charges constituted consideration for a taxable service under the Finance Act, 1994.
Show Cause Notice and Adjudication
- A show cause notice dated 11/04/2016 was issued to the assessee.
- The notice proposed a demand of service tax for the period July 2012 to March 2015 on the ex-gratia job charges received.
- The proposed tax demand amounted to ₹45,03,712, along with interest and penalties.
The assessee contested:
- On merits – asserting that the ex-gratia amount was in the nature of compensation for loss and not consideration for any service.
- On limitation – disputing the time bar and invocation of extended period.
Despite these contentions, the adjudicating authority: