The Delhi High Court has set aside a ₹4.5 lakh service tax penalty imposed on a consultancy company, holding that an assessee cannot be treated as having deliberately evaded tax when its understanding about non-taxability was supported by the Service Tax Department’s own contemporaneous communications.
The Bench of Justice Anil Kshetrapal and Justice Manmeet Pritam Singh Arora observed that interpretational uncertainty, coupled with the absence of fraud, suppression, wilful misstatement or intent to evade tax, constituted a “reasonable cause” for waiving the penalty under Section 80 of the Finance Act, 1994.
The company had originally challenged two orders passed by the Customs, Excise and Service Tax Appellate Tribunal. The first order, dated May 15, 2023, upheld the service tax liability for the normal limitation period, while the second order, dated June 30, 2023, reduced the penalty imposed under Section 78 of the Finance Act from ₹65.75 lakh to ₹4.5 lakh.
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During the proceedings before the High Court, the company confined its challenge exclusively to the reduced penalty of ₹4.5 lakh. It did not press its challenge against the service tax demand for the normal period from July 1, 2009, to March 30, 2010.
Consequently, the service tax demand for that period, together with applicable interest, attained finality. The High Court was therefore concerned only with whether the penalty under Section 78 could legally be sustained.
The petitioner/assessee was engaged in providing services relating to the planning, designing, construction, management and supervision of projects for government hospitals, medical colleges and educational institutions.
The company was registered with the Service Tax Department under several taxable categories, including architectural services, erection, commissioning and installation services, scientific and technical consultancy, management consultancy and construction services.
Its position was that the services were supplied to institutions established for educational, charitable and healthcare purposes and not for profit. It therefore believed that the services connected with the construction of such institutions were non-commercial and did not attract service tax.
The dispute originated from a Central Excise Revenue Audit memo issued on January 18, 2006, in which the audit authorities took the view that the services supplied by the company were taxable.
Significantly, the Service Tax Department initially disagreed with the audit objection.
In a communication dated September 11, 2006, the Assistant Commissioner of Service Tax informed the audit authorities that the company was providing construction-related services to medical and educational institutions in accordance with Medical Council of India norms.
Relying on CBEC Circular No. 80/10/2004-ST dated September 17, 2004, the officer stated that construction undertaken for institutions established solely for educational, religious, charitable, healthcare, sanitation or philanthropic purposes—and not for profit—was non-commercial and consequently not taxable.
A similar position was reiterated by the Deputy Commissioner of Service Tax in a letter dated November 20, 2007. That communication referred to payments of approximately ₹1.07 crore made by Guru Ghasidas University to the company during 2004-05 for the construction and supervision of a medical college, dental college, nursing college, hostels and staff quarters.
The Deputy Commissioner maintained that no service tax was payable in light of the CBEC circular and requested the audit authorities to drop the objection.
The audit objection, however, had already been incorporated into a Comptroller and Auditor General report. Subsequently, an internal departmental audit conducted in July-August 2010 once again raised the taxability issue.
A show cause notice was issued on October 22, 2010, proposing to invoke the extended limitation period, recover service tax with interest, deny CENVAT credit and impose penalties.
The Commissioner of Service Tax (Adjudication), through an order dated March 31, 2014, confirmed a service tax demand of ₹65,75,890 with interest for the extended five-year period from April 1, 2005, to March 30, 2010.
The adjudicating authority also ordered the recovery of CENVAT credit of ₹12,360 with interest and imposed total penalties of ₹65,93,250. This included a penalty of ₹65,75,890 under Section 78, ₹5,000 under Section 77 and ₹12,360 under Rule 15 of the CENVAT Credit Rules read with Section 78.
The company challenged the order before CESTAT.
In its May 15, 2023 order, CESTAT set aside the service tax demand relating to the extended limitation period from April 1, 2005, to June 30, 2009.
The Tribunal recorded a finding that the company had not suppressed facts with the intention of evading service tax. It held that the essential condition for invoking the extended limitation period under the proviso to Section 73(1) of the Finance Act was not satisfied.
However, CESTAT sustained the service tax demand for the normal period from July 1, 2009, to March 30, 2010.
Since the Tribunal’s first order did not expressly address the Section 78 penalty, the company filed a rectification application. CESTAT subsequently reduced the penalty from ₹65.75 lakh to ₹4.5 lakh through its miscellaneous order dated June 30, 2023.
The company argued that it had acted under a bona fide belief concerning the classification and taxability of services supplied to government hospitals and educational institutions.
It submitted that this understanding was not unilateral because the Service Tax Department itself had consistently maintained, in its earlier communications, that the services were non-commercial and not taxable.
The company further contended that all relevant agreements, invoices, accounts and other records had been disclosed to the authorities during the audit and investigation. There was therefore no fraud, collusion, wilful misstatement, suppression of facts or intention to evade tax.
It also relied on Section 80 of the Finance Act, which provided that no penalty would be imposed for specified failures if the assessee established that there was a reasonable cause for the failure.
The department on the other hand, argued that the company was essentially supplying architectural, engineering, design and consultancy services rather than construction services.
According to the Department, the agreements and invoices showed that the company’s activities were confined to preparing designs, drawings and estimates, obtaining approvals, conducting site visits and supervising work. It neither incurred expenditure on construction materials nor received payments for undertaking actual construction.
The Revenue maintained that the services were classifiable as architect’s services and, where applicable, management or business consultancy services. It argued that the company had suppressed the value of taxable services and failed to correctly assess and discharge its service tax liability.
Rejecting the Revenue’s case on penalty, the High Court observed that the departmental communications dated September 11, 2006, and November 20, 2007, substantiated the company’s contention.
The letters showed that the Department itself had, at the relevant time, considered the services supplied to government institutions as not liable to service tax. According to the Court, this lent credibility to the company’s claim that it had a reasonable and bona fide cause for not depositing the tax.
The Court also attached considerable importance to CESTAT’s finding that there was no wilful suppression of facts with the intention of evading service tax.
That finding had not been challenged by the Revenue and had therefore attained finality. The High Court held that it had a material bearing on the allegation made in the show cause notice for imposing a penalty under Section 78.
The Bench relied on its earlier decisions in Bharat Hotels Ltd. v. Commissioner of Central Excise (Adjudication) and Bajaj Travels Ltd. v. Commissioner of Service Tax.
It noted that when an assessee acts under a bona fide belief regarding the non-taxability of a service and does not deliberately intend to evade tax, those circumstances may constitute reasonable cause under Section 80 of the Finance Act.
The authorities were required to determine whether the failure to pay tax was deliberate or whether the assessee had established a bona fide and reasonable explanation for the default.
Applying those principles, the Court held that the company’s failure to pay service tax could not be regarded as deliberate or contumacious. The company had acted on a reasonable understanding of the applicable legal position, which was reinforced by the Department’s own initial view.
The High Court observed that the interpretational uncertainty and the absence of any evidence of suppression, fraud, wilful misstatement or intention to evade tax constituted reasonable cause within the meaning of Section 80.
It concluded that the default arose from a bona fide understanding of the law and not from a deliberate attempt to avoid statutory liability. The Court accordingly allowed the appeal and set aside the ₹4.5 lakh penalty.
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