GST Liability on Notice Pay Recovery from Employees

1.We understand that employees who are leaving any organization have to serve for a certain period of employment known as notice period.?However, there are cases where the employees do not wish to serve the requisite notice period and intend to leave immediately.?In such cases, employer recovers certain amount from the employees known as notice pay recovery.

2. The employer intends to know whether notice pay recovery from the employee are exigible to GST.

Legal proposition:

3. Section 7(1) of the CGST Act, 2017 (“CGST Act”) provides that supply includes

a. all forms of supply of goods and/or services such as sale, transfer, barter, exchange, license, rental, lease or disposal made or agreed to be made for a consideration by a person in the course or furtherance of business;

b. importation of services, for a consideration whether or not in the course or furtherance of business; and

c. a supply specified in Schedule I, made or agreed to be made without a consideration.

4. In terms of Section 2(102) of the CGST Act, ‘service’ means anything other than goods, money and securities but includes activities relating to the use of money or its conversion by cash or by any other mode, from one form, currency or denomination, to another form, currency or denomination for which a separate consideration is charged.

5. As per Section 7(1A) of the CGST Act, where a transaction constitutes to be a supply, then they shall be treated either as supply of goods or supply of services as referred to in Schedule II.

6. As per Para 5(e) of Schedule II, agreeing to the obligation to refrain from an act, or to tolerate an act or a situation, or to do an act is to be treated as supply of services.

7. Further, Schedule III of the CGST Act specifies the transactions that are neither a supply of goods nor a supply of services.

8. Para 1 of the said Schedule covers the services provided by an employee to the employer in the course of or in relation to his employment. The said para does not apply to the services provided by the employer to the employee. Therefore, if any supply is made by the employer to its employee, the same will be chargeable to GST.

9.?It can be said that the notice pay recovery by Employer is not towards any service as it is not undertaking any activity for its employees against the said amount and the amount is only recovered as damages for early termination of the employment contract. Thus, the notice pay money recovered by Employer from its employees should not be chargeable to GST.

10. It can be said that the expression ‘to tolerate an act’ is understood to cover instances where the consideration is being charged in order to allow a person to undertake any particular activity. In such cases, it is clear at the very inception that the intention of one party is to undertake an activity and the other party shall allow the same without any hindrance. Even if such act is repeated in future, there is no intention to deter the happening of the same. There is no intention to penalize the other party for such act so that it is not repeated in future. In such cases, such consideration shall not be even termed as penalty in the normal course.

11. Further, the word ‘obligation’ indicates the need for the existence of the desire in the person for whom the activity is done. In other words, when the service receiver requests the service provider to tolerate an act/situation and the service provider undertakes the desire to tolerate the same provided a consideration is paid for the same, then such a contractual relationship will get covered by para 5(e) of Schedule II.

12. Thus, in order to get covered under the aforesaid entry, there should be a willful desire of the party to tolerate an act. Any amount receivable by a party due to breach of the terms of contracts by the other party would be merely in the nature of compensation / damages incurred by such other party to indemnify/compensate the aggrieved party.

13.?In the instant case, notice pay charges are recovered from the employees for breach of their contractual obligations i.e., non-compliance with the notice period requirement. Such charges are in the nature of compensation towards the loss suffered by company and is not towards tolerating any act.

14. The notice pay recovered from employees are not for entering into obligation to tolerate an act but rather are imposed for deterring the other party to repeat a breach of contract and are in essence not for tolerating the act.

15. Reliance is also placed on the rulings in other countries where a similar legal provision exists. Under the Australian law, GST is levied on ‘supply’ wherein the term ‘supply’ is defined under Section 9(10) of ‘A New Tax System (Goods and Services Tax) Act, 1999’. Clause (g) of Section 9(10)(2) of the said Act provides that supply includes ‘an entry into, or release from, an obligation

(i) to do anything; or

(ii) to refrain from an act; or

(iii) to tolerate an act or situation

16. GST Ruling GSTR 2003/11 has been issued under Australian GST to answer the question as to whether GST is payable on a payment made on early termination of a lease of goods. In the said Ruling, it has been clarified that a payment received to compensate the lessor for damage or loss flowing from early termination as a result of a default by the lessee is not consideration for a supply, even though the lessor brings the lease to an end by exercising the right to terminate the lease. The Ruling further provides that in such cases, there will be no taxable supply because a payment for genuine damages, which is not consideration for any earlier or current supply, cannot be said to be made in connection with any supply.

17. In view of the above discussed rulings, it is submitted that the very purpose of collecting damages such as Notice pay charges is to restitute or make good the loss incurred by a person because of a default, non-compliance, etc. of another person.

18. Thus, in view of the above, it is possible to contend that the amount received by Employer from its employees is in the nature of damages and the same should not be chargeable to GST.

19. At this juncture, it is also pertinent to note that Department may raise a doubt in case of notice pay, it can be said that Employer agrees to tolerate the act of its employees of resigning from his job without serving the notice period or without completing the required time with Employer. Further, by receiving such amount, Employer is also refraining itself from taking any legal action against the employee for not serving the notice period/duration stipulated under the employment contract.

20. In view of the above, Department may contend that the amount of notice pay is consideration for the activity of refraining from an act or tolerating an act by Employer in terms of Para 5(e) of Schedule II of the CGST Act. In such a case, Employer will be liable to pay applicable GST on the amount recovered by it as notice pay from the employees.

21. Also, attention is drawn to the advance ruling for Maharashtra State Power Generation Company Limited reported at 2018-VIL-33-AAR, wherein the issue before the authority was whether liquidated damages deducted from the contactor in case of default in completing the work in time will be treated as service of tolerating an act or not. The authority observed that the levy of liquidated damages is for the reason that there has been a delay and the same would be tolerated, but for a price or damages. The authority has ruled that GST would be applicable on liquidated damages as it is a consideration for supply of service under Schedule II. The said view has been affirmed by the Maharashtra Appellant Authority for Advance Ruling reported at 2018-VIL-12-AAAR.

22. Recently, Madras High Court dated 07.11.2019 in the matter of GE T &D India Limited reported at 2020-VIL-39-MAD-ST has held that the amount of notice pay recovered by an employer in lieu of sudden termination of employment does not give rise to rendition of service of agreeing to the obligation to tolerate the act of the employee under Section 66 (e) of the Finance Act, 1994 and accordingly, would not attract the levy of service tax on the same.

23. Therefore, on the basis of the above decision, it is possible to argue that GST will not be applicable on the amount recovered as notice pay by an employer from an employee on termination of employment without serving the notice period.

24. Though the decision pertains to service tax regime, however, provisions in GST regime are similar to that of Section 66E of Finance Act, 1994, and therefore, underlying principle can be used in GST regime as well where liquidated damages are sought to be taxed by the Department. However, at this stage, the likelihood of further litigation with respect to the impugned issue cannot be ruled out and the issue is yet to attain finality.

25. Recently CBIC has clears the ambiguity surrounding applicability of GST on liquidate damages, compensation and penalties arising out of breach of contract or other provisions of law vide its Circular No.178/10/2022-GST dated 3rd August 2022.

In view of the above discussion, it is clear that GST is not payable on the “notice pay’ recovery amount. However, in case Employer decides not to pay GST on the amount recovered from the employees as notice pay, such a view may be prone to litigation for past period (Prior to circular No. 178/10/2022 dated 3rd Aug 2022) as the department may still contend that the transaction would amount to toleration of an act and will be chargeable to GST. In such a situation, the matter will have to be litigated before an appropriate judicial forum on the basis of grounds discussed above.

The above post was contributed by our guest author Bibhash Deb. Readers can reach him on LinkedIn by clicking?here .

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