Service Tax Not Payable on Liquidated Damages for Delayed Performance: Key Takeaways from CESTAT Mumbai in Bharat Heavy Electricals Limited PSWR Vs Commissioner of Central Excise and Service Tax

Background and Context

The Customs, Excise and Service Tax Appellate Tribunal (CESTAT), Mumbai, in the matter of Bharat Heavy Electricals Limited PSWR Vs Commissioner of Central Excise and Service Tax, examined whether liquidated damages and penalties recovered by an assessee from its contractors and suppliers, due to delay in supply of goods or completion of contractual work, can be subjected to service tax as “declared service” under the Finance Act, 1994.

The appeal arose from an adjudication order dated 24 December 2018, where the Commissioner, CGST & CX, Nagpur, had confirmed a substantial service tax demand, along with interest and penalties, on such recoveries.

Before addressing the core legal issue, the Tribunal first dealt with a miscellaneous application filed by the assessee seeking an early hearing of the appeal.

Early Hearing Application and Admission of Appeal

The assessee moved a miscellaneous application requesting an out-of-turn hearing of the appeal.

  • The Tribunal examined the grounds mentioned in the application.
  • Considering the nature of the controversy and in the interest of justice, the Tribunal agreed that the matter warranted priority hearing.
  • Accordingly, the miscellaneous application was allowed.

With the consent of both sides, the Tribunal proceeded to hear and dispose of the appeal on merits on the same day, noting that the controversy was confined to a narrow legal point.

Nature of Dispute: Service Tax on Liquidated Damages

Transactions Under Scrutiny

The Department scrutinised the assessee’s trial balance and identified an accounting head (No. 5380/81) described as “Recovery from suppliers/contractors towards penalty damages”. These entries represented:

  • Amounts deducted or recovered from suppliers and contractors for:
    • Delay in supply of materials, or
    • Delay in execution/completion of assigned works, in terms of the contractual provisions.

The Department formed a view that such recoveries represent “consideration” for a “declared service”, specifically the activity of agreeing to tolerate an act or situation under Section 65E(e) / Section 66E(e) of the Finance Act, 1994.

Department’s Allegation

Based on this interpretation:

  • The Department alleged that when the assessee recovered liquidated damages/penalties, it was effectively tolerating the delayed performance or breach by the contractor/supplier, for a consideration.
  • It treated the amount so recovered as taxable value for “declared service”.
  • An adjudication order dated 24.12.2018 was passed confirming:
    • Service tax demand of Rs. 6,52,76,360/-,
    • Interest on the said demand, and
    • Penalties under Section 77 and Section 78 of the Finance Act, 1994.

Aggrieved, the assessee filed the present appeal before CESTAT Mumbai.

Business Operations and Contractual Structure of the Assessee

Services Provided by the Assessee

The assessee is engaged in activities such as:

  • Erection and commissioning services,
  • Works contract services,
  • Repair and maintenance services relating to power plants.