Taxability of Notice Pay in GST – A Never-Ending Quagmire

Executive Summary

In this write-up, the paper writer outlines statutory provisions of the Service Tax and GST Regime relevant to Notice Pay Recovery. Thereafter stand of revenue on the said issue is explained.  For a better understanding of this vexed issue, paper writer skims through Indian Rulings, recent developments and International Jurisprudence.  The write-up ends with a conclusion against taxability but with a rider.  

Concept of Notice Pay

As per terms of employment an employee may be required to serve a notice period as mentioned in the letter of appointment before he is officially relieved from his duties. In case an employee could not serve the agreed notice period, then the employer usually recovers pre-agreed amount from the employees. Such recovery is known as ‘notice pay recovery’ or ‘notice period recovery’.

The question for consideration – Whether such notice pay recovery is subject to GST?

Statutory Provisions in Service Tax Regime

Notice pay recovery has always been a contentious issue, whether in Service Tax or GST era. Before we discuss the implication of said issue in the GST regime let us quickly touch base legal provisions that existed during the Service Tax regime.

In Service Tax law any services provided by an employee to an employer in the course of the employment¹ was outside the purview of Service Tax.  However, a Draft Circular²raked up the taxability issue of various transactions between employer and employee. Draft Circular clarified that activities carried out by the employer for the employees fall within the definition of “service” and are liable to be taxed unless specified in the Negative List or otherwise exempted. Further, it was explained that facilities provided by an employer to employees for a consideration or deduction of amount from salary etc. will fall under the definition of “service” and shall be taxable in the hands of the employer. Further “declared services” ³ covers under its ambit “agreeing to the obligation to refrain from an act, or to tolerate an act or a situation, or to do an act”

Statutory Provisions in GST law

In GST law⁴, services by an employee to the employer in the course of or in relation to his employment is not treated as a supply of goods or services. Further, supply of goods or services or both between related persons when made in the course or furtherance of business is deemed as a supply⁵ even when made without consideration. Gifts exceeding Rs 50,000/- in value in a financial year by an employer to an employee is also deemed as a supply of goods or services or both. As a paradigm shift, the employer and the employees are deemed as related persons⁶ in GST law.

Further agreeing to the obligation to refrain from an act, or to tolerate an act or a situation, or to do an act is classified as a service⁷ in GST law. Moreover in the case of related party transactions invoice value shall not be accepted and such transactions are to be valued in terms of CGST rules.

Having broadly understood applicable legal provisions let us understand the stand of revenue on notice pay recovery.

Arguments made by Revenue in favour of taxability

Revenue holds the view that notice pay recovery is taxable as a declared service in service tax law. Further taxability continues even in GST as such transaction is covered under Schedule II of GST law (agreeing to the obligation to refrain from an act, or to tolerate an act or a situation, or to do an act etc). Arguments were put forth by the revenue that the employer is tolerating the act (allowing an employee to resign without serving notice period) of an employee. Further, by relieving the employee on acceptance of notice pay, the employer refrains from taking any legal action against the employee for not serving the prescribed notice period. Such an act of employer was argued as falling within the ambit of declared service/deemed supply and thus transaction is subject to Service Tax/GST. Further, it was also argued that services by an employee to the employer are outside the ambit of Service Tax/GST and not vice versa.

Service Tax era has witnessed a good amount of litigation on this topic and recently catena of judgments have been delivered by Hon’ble High courts and CESTAT clarifying legal position. Let us run through judgments to understand the view of the judiciary in this regard.

Emerging Indian Jurisprudence on Notice Pay Recovery

GE T & D India Limited⁸

Hon’ble Madras High Court relying on Service Tax Education Guide held that the employer cannot be said to have rendered any service per se much less a taxable service and has merely facilitated the exit of the employee upon imposition of a cost upon him for the sudden exit. High Court made a significant finding that the employer has not ‘tolerated’ any act of the employee but has permitted a sudden exit upon being compensated by the employee in this regard. Finally, High Court ruled that notice pay, in lieu of sudden termination does not give rise to the rendition of service either by the employer or the employee.

HCL Learning Limited Vs Commissioner of CGST Noida⁹

Hon’ble Allahabad CESTAT held that notice pay recovery is out of the salary already paid and since salary is not covered by the provisions of service tax, therefore even notice pay recovery is outside taxability of service tax.

Nandinho Rebello v. DCIT¹⁰

In the context of Income Tax, the tribunal took a view that notice pay recovery is nothing but an adjustment of salary and therefore, only the actual salary received after deduction of notice pay recovery is taxable in the hands of the employee.

J. P. Morgan Services India Private Limited¹¹

Advance Ruling Authority (Service Tax) held that making available vehicles to employees during the course of employment does not amount to the provision of “service”. Further, it was held that the mere option given to the employee to ultimately purchase the leased car at a certain value at the end of his employment is also a service provided in the course of employment and therefore outside the ambit of the term “services”.  On a similar analogy, it can be very well argued that notice pay recovery at the end of employment is also outside the ambit of the “services”.

GST Advance ruling in Amneal Pharmaceuticals (P.) Ltd¹²

Advance Ruling Authority has ignored pro-taxpayer Service Tax decisions cited by the applicant and took a view that said decisions relate to the disputes of the Service Tax regime and therefore not relevant. Authority finally held that notice pay recovery is subject to 18% GST under the entry of “services not elsewhere classified.

QX KPO Services Pvt Ltd & Gujarat State Fertilizers & Chemicals Ltd¹³

Commissioner Appeals in QX KPO Services Pvt Ltd relying on the Service Tax Education Guide formed a view that Notice Pay Recovery does not fall within the ambit of ‘services’ and therefore not subject to GST. A similar decision was followed in Gujarat State Fertilizers & Chemicals Ltd Vs AC, CGST¹⁴

Recent developments

In the opinion of the paper writer following recent developments have brought a sea change in the taxability of notice pay recovery /damage compensation recovery.

• Retrospective introduction of Section 7(1A) and deletion of 7(1)(d) in CGST Act. With this amendment, the concept of “supply” has undergone a 360-degree change. GST law has been amended retrospectively w.e.f. 1^st July 2017 to provide that merely coverage of a transaction in Schedule II will not make it supply. Such transaction should first pass the test of supply on its own and thereafter schedule II shall be referred to for deciding whether the transaction is of goods or services.
• Of late, taxpayers have successfully argued that the payment of damages is a consequence of a breach of the contract and therefore, cannot form consideration for a service agreed to be provided viz. tolerating the breach etc¹⁵. It, therefore, appears that the judiciary has concurred with this view in series of judgments it is now held that such transactions are outside the ambit of services/supply.
• CBIC in the recent Service Tax Circular¹⁶ categorically accepted what professionals were shouting about for a long that Section 66E of the Finance Act, 1994 (declared services) has to be read along with other provisions of that Act. A declared service cannot, therefore, be assumed to have an overriding or omnibus character over other provisions. Thus one cannot apply the concept of “declared service” to remove a service from the Negative list and make it a taxable service

International Jurisprudence

Though the relevance of International Jurisprudence to Indian GST is a matter of debate, let us run through a few landmark and international judgments to understand the international scenario in this regard.

• In the case of Société Thermale¹⁷ case, the European Court of Justice (ECJ) held that a hotelier’s retention of a client’s deposit as a fixed cancellation charge as compensation for the loss suffered had no direct connection with the supply of any service for consideration. Accordingly, such cancellation charges were held as not subject to tax.
• In AstraZeneca¹⁸, the ECJ held that where the company purchased retail vouchers at less than face value before passing these on to employees at that discount under a salary-sacrifice scheme, such salary sacrifice is treated as a supply for VAT purposes
• In Vehicle Control services limited¹⁹, the Court of Appeal held that penalties charged by a car park management company to drivers who infringed its terms represented damages for trespass and were not liable to VAT.
• In HMRC v Pertemps Ltd²⁰, it was held that applicants operation of the salary sacrifice scheme is not a business activity and therefore applicant was not liable to account for VAT in relation to the operation of a salary sacrifice scheme for temporary workers

Above ruling suggests that even internationally law on the taxability of damages/compensation is still at the evolution stage.

Paper writer’s view on Notice Pay recovery

Basis above arguments it is possible to hold a view that in case of notice pay recovery employer is not providing any services to the employee. Quid pro quo (reciprocal promise) is missing while employer collects/deducts notice pay recovery from the outgoing employees and therefore amount collected is toward recovery of damage or compensation. Further notice pay recovery is not a separate consideration flowing from any independent contract.

On a conjoint reading of the above legal provisions and rulings, taxpayers can safely assume that notice pay recovery is not liable to Service Tax/GST with a caveat that there is no final word in taxation laws.

Disclaimer

The views expressed herein are strictly personal to the authors and should not be construed as advice/ legal opinion. The contents of this article are based on the interpretation of the facts, relevant legislation, rules, notifications, circulars, judgments/rulings, etc. on the date of publishing of this article.  One should not act upon the information in this article without obtaining specific professional advice. The authors are not responsible or liable for any loss or damage caused to anyone due to any interpretation, error, or omission pertaining to this article. Further, the said article is only for information and guidance purposes and should not be construed as any kind of advertisement or solicitation of work.

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1. Section 65B(44) of the Finance Act r.w. 1994, TRU Circular dated 16-3-2012.
2. Draft Circular F. No 354/127/2012-TRU dated 27.07.2012.
3. Section 66E(e) of the Finance Act, 1994.
4. Entry no. 1 of Schedule III of the Central GST Act.
5. Entry No.2 of the Schedule I to the CGST Act.
6. Clause 5 (e) of Schedule II to the CGST Act.
7. Explanation to Section 15 of the CGST Act.
8. 2020-TIOL-183-HC-MAD-ST.
9. 2019-TIOL-3545-CESTAT-ALL.
10. [2017] 80 taxmann.com 297 (Ahmedabad – Trib.).
11. 2015-TIOL-12-ARA-ST.
12. [2021] 123 taxmann.com 191 (AAR – GUJARAT).
13. AHM-EXCUS-001-APP-0107-1718 dated 29-09-2017.
14. VAD-EXCUS-003-APP-392/2016 dated 20-10-2016.
15. Commissioner of Service Tax, Chennai V. Repco Home Finance Ltd 2020-VIL-309 CESTAT-CH-ST; South Eastern Coalfields Limited V. Commissioner Of Central Excise & Service Tax, Raipur 2020-VIL-559-CESTAT-DEL-ST; Amit Metaliks Limited V. Commissioner of CGST, Bolpur 2019 (11) TMI 183- CESTAT Kolkata; Bai Mamubai Trust v. Suchitra [2019] 109 taxmann.com 200 (Bom.), K.N. Food Industries Pvt. Ltd Vs Commissioner Of CGST & C. Ex., Kanpur 2020 (38) G.S.T.L. 60 (Tri. – All.).
16. Circular 212/2/2019 dated 21st May, 2019.
17. European Court Reports 2007 I-06415.
18. AstraZeneca UK Ltd v HMRC Case C-40/09 ECJ.
19. Vehicle Control Services Limited v HMRC [2013] EWCA (Civ 186).
20. [2019] UKUT 234 (7 August 2019).