The Chandigarh Bench of the Customs, Excise and Service Tax Appellate Tribunal (CESTAT) has held that late payment surcharge (LPS) collected from electricity distribution companies (DISCOMs) for delayed payment of electricity bills is not liable to service tax as a ‘declared service’ under Section 66E(e) of the Finance Act, 1994.

The bench of S. S. Garg (Judicial Member) and P. Anjani Kumar (Technical Member) has extensively relied upon the decision in Madhya Pradesh Poorva Kshetra Vidyut Vitran Co. Ltd., which in turn followed the Gujarat High Court’s landmark judgment in Torrent Power Ltd., recognising that ancillary activities closely connected with electricity supply form part of a composite bundled supply and inherit the exemption applicable to the principal supply of electricity. 

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The appellant/assessee, a public sector undertaking engaged in the generation and supply of electricity, sells power to various DISCOMs across India under long-term Power Purchase Agreements (PPAs). Apart from charging energy charges for electricity supplied, assessee also collected late payment surcharge whenever buyers delayed payment beyond the prescribed due dates under the PPAs. 

Following an investigation by the Directorate General of GST Intelligence (DGGI), the Department alleged that the late payment surcharge was not merely compensation for delayed payment but represented consideration received by assessee for tolerating the customers’ default in payment, thereby constituting a “declared service” under Section 66E(e) of the Finance Act, 1994. 

Based on this reasoning, a show cause notice dated 22 October 2018 proposed recovery of ₹101,00,08,680 as service tax together with interest and penalties. 

The Additional Director General (Adjudication), DGGI, rejected the Department’s allegations and dropped the entire proceedings.

The adjudicating authority held that generation and supply of electricity are exempt under the service tax law; late payment surcharge is merely interest on delayed payment for the exempt supply of electricity; LPS cannot be treated as an independent taxable service; it forms part of the tariff structure prescribed by the Central Electricity Regulatory Commission (CERC); and assessee had not rendered any taxable “declared service” by recovering such surcharge. 

The Department challenged the order before the Tribunal contending that Assessee had consciously chosen not to discontinue or reallocate power supply despite payment defaults by DISCOMs.

According to the Revenue, by permitting customers to continue receiving electricity upon payment of late payment surcharge, Assessee had agreed to tolerate the act of delayed payment, making the surcharge taxable under Section 66E(e), which covers agreeing to refrain from an act, tolerate an act or situation, or do an act for consideration. 

The Department further argued that the surcharge was pre-determined under the PPAs and therefore represented consideration for tolerating contractual breaches rather than mere compensation. 

The appellant/assessee contended that electricity is recognised as goods and its supply is outside the scope of service tax.

The company argued that late payment surcharge is inseparably connected with the principal supply of electricity and merely compensates for delayed payment. It relied upon CBIC Circular No. 214/1/2023-ST adopting GST Circular No. 178/10/2022-GST, which clarifies that late payment charges naturally bundled with the principal supply take the same tax treatment as the principal supply.

Assessee also relied upon earlier Tribunal decisions and Rule 6(2)(iv) of the Service Tax (Determination of Value) Rules, 2006, which excludes interest on delayed payment from taxable value. 

The Tribunal agreed with assessee and affirmed that late payment surcharge is an integral component of electricity tariff rather than an independent service.

It observed that LPS becomes payable only when electricity has already been supplied and payment is delayed. Therefore, it is intrinsically linked to the exempt supply of electricity and cannot be artificially separated to tax it under the category of “tolerating an act.” 

The Bench further relied upon the CBIC’s 2023 circular adopting the GST clarification, noting that late payment surcharge is an ancillary supply naturally bundled with the principal supply, which must receive the same tax treatment as the underlying supply. 

The Tribunal also referred to earlier CBIC circulars issued before the negative list regime treating such charges as penal in nature and compensatory for delayed payment rather than consideration for any separate service. 

CESTAT noted that the controversy was no longer res integra, as several Tribunal decisions had consistently held that late payment surcharge collected in relation to electricity transmission or distribution is exempt.

According to the Tribunal, services directly connected with transmission and distribution of electricity are naturally bundled with the principal activity and cannot be artificially carved out for separate taxation. 

Finding no infirmity in the adjudicating authority’s order, the Tribunal dismissed the department ‘s appeal and upheld the dropping of the entire ₹101 crore service tax demand against assessee.

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