Tribunal Reiterates That Compensation for Breach of Contract is Not Taxable as ‘Declared Service’
The Customs, Excise and Service Tax Appellate Tribunal (CESTAT), New Delhi, has allowed the appeal filed by M/s Hindustan Zinc Ltd., setting aside a service tax demand of Rs. 17.10 lakh that had been imposed on liquidated damages, penalties, and forfeiture of earnest money recovered from contractors.
The bench of Binu Tamta (Judicial Member) and Rajeev Tandon (Technical Member) held that the amounts in question were not payments for any service rendered.
“There is no rendering of service in terms of Section 65B(44) of the Finance Act, 1994,” the Tribunal noted, emphasizing the lack of any agreement where Hindustan Zinc agreed to tolerate poor performance in exchange for payment.
The case stemmed from the Service Tax Department’s classification of these recoveries—collected from vendors for failure to meet contractual obligations—as “consideration” for tolerating an act, under Section 66E(e) of the Finance Act, 1994. The department alleged that such recoveries constituted a “declared service,” and hence, were taxable.
The short question that arises for consideration in the present appeal is concerned with amounts collected by the appellant in the form of fines/penalties, liquidated damages, forfeiture of earnest money/security deposits etc. from the contractors who failed to provide the services within the agreed stipulated time/standards.
During the course of audit of the appellant’s records, an amount of Rs. 1,39,59,368/- was found to be collected by the appellants towards the said heads. The department alleged that the said amount was collected in lieu of ‘tolerating the act’ of service providers/contractors for poor performance or not meeting the obligations in full i.e. lesser than the contractual obligations/requirements. Out of the aforesaid amount confirmed by the authority below, a demand of Service Tax for Rs.5,90,451/- pertains to such retained/collected amounts on account of fines/penalties, security deposit/earnest money forfeited and liquidated damages as recovered from the contractors.
The Tribunal heavily relied on earlier precedents including its own decisions in the appellant’s previous appeals and the landmark ruling in South Eastern Coalfields Ltd. v. CCE & ST, Raipur. That decision had clarified that liquidated damages and penalties arise due to breach of contract and are compensatory—not consideration for any tolerable or agreed act. Importantly, the Supreme Court had permitted the withdrawal of the Revenue’s appeal against the South Eastern Coalfields decision, solidifying its precedent value.
The Tribunal also cited CBIC Circular No. 214/1/2023-ST, which clarified that compensation for breach of contract does not constitute “supply” and is not taxable under service tax law.
The Tribunal ruled that penal recoveries are not taxable and allowed Hindustan Zinc’s appeal with consequential reliefs as per law.
Case Details
Case Title: M/s. Hindustan Zinc Ltd. Versus Commr. of CGST & Central Excise, Udaipur
Case No.: Service Tax Appeal No.51138 of 2020
Date: 17.07.2025
Counsel For Appellant: Shivam Bansal and Dhruv Anand
Counsel For Respondent: Shashank Yadav
Read More: Refund Proceedings Are Execution Proceedings; No Refund Without Challenging Final Assessment: CESTAT
