CESTAT Chandigarh Rules Notice Pay Recovery Not Liable to Service Tax

Overview of the Dispute

The Chandigarh Bench of the Customs, Excise and Service Tax Appellate Tribunal (CESTAT) in Neel Metal Products Ltd Vs Commissioner of Central Excise (CESTAT Chandigarh) decided a key controversy on the service tax treatment of “notice pay” recovered from employees who leave employment without serving the agreed notice period.

The Tribunal, by Final Order No. 60469/2026 dated 23.07.2026, allowed the appeal filed by M/s Neel Metal Products Ltd and quashed the demand of service tax, interest and penalty raised on such notice pay recoveries.

The appeal arose from Order-in-Appeal No. 119/ST/CGST-APPEAL-GURUGRAM/SG/2018 dated 30.08.2018, by which the Commissioner (Appeals), CGST, Gurugram had affirmed the Order-in-Original dated 16.03.2018 confirming the demand.

This decision fits into a growing line of judicial pronouncements and CBIC clarifications which hold that recovery of notice pay from employees represents compensation under an employment contract and not consideration for a taxable service under Section 66E(e) of the Finance Act, 1994.

Factual Matrix and Proceedings

Business and Registration Profile

  • The appellant, M/s Neel Metal Products Ltd, is engaged in manufacturing auto components.
  • During the relevant period, the appellant was registered under:
    • Central Excise Act, 1944, and
    • Finance Act, 1994 (service tax provisions).

Audit and Departmental View

  1. An audit of the appellant’s records for the period 2015-16 was carried out in January 2017.
  2. During this scrutiny, the Department observed amounts received by the appellant from employees as “notice pay” when such employees did not serve the agreed notice period before leaving employment.
  3. The Department treated these receipts as consideration towards a “declared service” under Section 66E(e) of the Finance Act, 1994, namely:

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

Show Cause Notice and Original Order

  • A Show Cause Notice dated 25.04.2017 was issued invoking the extended period of limitation.
  • The SCN proposed:
    • Service tax demand of Rs. 13,53,012/- on notice pay receipts aggregating to Rs. 1,02,02,702/- for the period August 2012 to December 2016.
    • Recovery of applicable interest.
    • Imposition of equal penalty.

After following adjudication procedures, the Original Authority, vide Order-in-Original dated 16.03.2018, confirmed:

  • The full service tax demand of Rs. 13,53,012/-,
  • Interest thereon, and
  • Penalty equal to the tax amount.

First Appeal and Order-in-Appeal

Aggrieved, the assessee preferred an appeal before the Commissioner (Appeals), CGST, Gurugram. The Commissioner (Appeals), through Order-in-Appeal dated 30.08.2018, rejected the appeal and upheld the Original Authority’s findings in totality.

This led to the second appeal before CESTAT Chandigarh.

The Tribunal identified the central question as follows:

Whether the amount recovered by an employer from a departing employee as “notice pay” (salary in lieu of the contractually stipulated notice period) is chargeable to service tax as consideration for a “declared service” under Section 66E(e) read with Sections 65B(44) and 66B of the Finance Act, 1994?

Thus, the controversy turned on whether such notice pay is:

  • A contractual compensation linked to the employer–employee relationship (thus outside the scope of “service”), or
  • A consideration paid for the employer’s alleged activity of “tolerating” the employee’s premature termination of employment, satisfying the conditions of a declared service under Section 66E(e).

Assessee’s Contentions Before the Tribunal

1. Exclusion for Services by Employees Under Section 65B(44)(b)

The assessee’s counsel emphasised the specific exclusion contained in Section 65B(44)(b) of the Finance Act, 1994. This clause provides that:

Services provided by an employee to the employer in the course of or in relation to his employment are excluded from the definition of “service”.

Based on this:

  • Terms relating to notice period and notice pay form part of the employment contract itself.
  • Any financial consequence arising from these terms, including recovery of notice pay, flows purely from the employment relationship.
  • Therefore, activities and obligations governed by the appointment letter—including conditions on separation or resignation—fall outside the ambit of “service” as defined in Section 65B(44).

2.