A recent ruling of the principal bench of the Customs, Excise and Service Tax Appellate Tribunal (CESTAT), New Delhi, stating that service tax is not applicable on penalty arising out of a commercial contract in certain cases of “declared service” could affect tax claims of a similar nature under GST.

The service tax department in April 2017 in a show cause notice to Coal India subsidiary — South Eastern Coalfields — stated that the company had evaded the payment of service tax worth Rs 35.26 crore on Rs 266 crore collected as earnest money deposit forfeitures, penalty and liquidated damages from the buyers of coal, contractors and material suppliers during the period July 2012 till March 2016.

The penalty is applicable on the buyers of coal for short lifting/non lifting of the contracted quantity of coal and non-compliance of the terms and conditions of the fuel supply agreement. Penalty is also applicable on contractors for the breach of terms and conditions of contract.

Justifying the levy, the service tax department said the penalty amount falls under the category of “declared service” and is tantamount to tolerating an act on the part of the buyers of coal/contractors, for which service tax would be levied under section 66 E(e) of the Finance Act.

“Under the declared service entry, the scope of levy of service tax would apply to even a situation where the actual activity is nonexistent and consequently a person would be required to pay tax even for not doing anything. Even if a person refrains from doing a particular activity for which a consideration is received or receivable, such consideration would be taxed,” the principal commissioner had said in its order.

The CESTAT, however, differed with the views of the service tax authorities and allowed the appeal filed by SECL. It set aside the service tax demand along with penalty and interest as raised by the service tax department.

“The recovery of liquidated damages/penalty from other party cannot be said to be towards any service per se, since neither the appellant is carrying on any activity to receive compensation nor can there be any intention of the other party to breach or violate the contract and suffer a loss.”

Tax practitioners said that the GST has similarly worded clauses as that of the service tax regulation. “This is a very important judgment and will have significant ramifications in the present GST regime as well, wherein identically worded provisions exist,” Sanjay Dixit, partner, Rajeev Agarwal & Co, told The Telegraph he said.

“The purpose of imposing compensation or penalty is to ensure that the defaulting act is not undertaken or repeated and the same cannot be said to be towards toleration of the defaulting party. The expectation of the appellant is that the other party complies with the terms of the contract and a penalty is imposed only if there is non-compliance," the tribunal said in its order.

Under Schedule 2, clause 5 of CGST Act, subclause (e) specifies agreeing to the obligation to refrain from an act, or to tolerate an act or a situation, or to do an act, to be treated as a service.

Sanjay Dixit, partner, Rajeev Agarwal & Co, told the Telegraph that the provisions in the erstwhile service tax regime and current GST regime are more or less the same.

"This is a very important judgement and will have significant ramifications in the present GST regime as well, wherein identically worded provisions exist," he said.