No Service Tax on Notice Pay Recovery

Since the inception of a negative list introduced in July 2012 under the erstwhile regime of Service Tax, the taxability of transactions between employer and employee(s) has been a matter of innumerable interpretations, and there have been various disputes between taxpayer(s) and revenue authorities.

Notice pay recovery is one of such transactions on which the services tax authorities are demanding service tax for a long time. The said issue continues under the GST regime as well.

Generally, the employee(s), after tendering their resignations, are required to serve a notice period, anywhere between 1 to 3 months, before they are relieved of their employment duties. The concept of notice period intends to safeguard the interest of the employer(s), while they search for a new employee to replace the vacant position.

In case the employee does not intend to serve a notice period, the employer is entitled to recover a pre-agreed amount from the employee (i.e., notice pay recovery), which is adjusted against the full & final settlement to be made by the employer.

Recently, in a landmark ruling, the Madras High Court in the case of GE T & D India Ltd.[i] (formerly Alstom T&D India) has held that service tax is not payable on notice pay recovery made by the employer from the employees.

In this case, the taxpayer had received certain amounts instead of notice period from its outgoing employees.

The service tax authorities had issued a show-cause notice concerning notice pay recovered by the employer from the employees. The service tax authorities confirmed the demand of service tax on the ground that the taxpayer had tolerated the act of immediate quitting of the employee from service and such an agreement would result in a rendition of taxable service as per Section 66(e) of the Finance Act, 1994 (i.e., agreeing to the obligation to refrain from an act, or to tolerate an act or a situation, or to do an act).

The taxpayer filed a writ petition before the Madras High Court and argued that no service tax is payable on notice pay recovery.

The High Court, after considering the provisions of Sections 65B (44) and 66(e) of the Finance Act, 1994, observed as under:

• The definition of ‘declared service’ is not attracted in this scenario as the employer has not ‘tolerated any act’ of the employee but has permitted a sudden exit upon being compensated by the employee. Hence, Section 66(e) is not attracted.
• Para 2.9.3 of Taxation of Services - An Education Guide: states that no service tax is payable when an employee receives any amount from its employer because of premature termination of employment. The present transaction is contra to the clarification provided.
• For chargeability of service tax on notice pay recovery, the contract of employment has to be read as a whole. There are situations in a contract that constitute rendition of service, such as breach of a stipulation of a non-compete. However, in case of notice pay (instead of sudden termination), the rendition of service does not arise either by the employer or by the employee.

Based on the above, the High Court held that notice pay recovery made by an employer from its employees is outside the scope of levy of service tax.

It is also pertinent to note that the Allahabad CESTAT, in the case of HCL Learning Ltd.,[ii] has also adopted a similar view while quashing the demand raised on notice pay recovery.

This decision is a welcome move providing relief to various taxpayers to whom such notices have been issued.  Further, it provides clarification on whether notice pay recovery can be regarded as toleration of an act. The said decision should also be applicable in the current GST law since the provisions remain the same.

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[i] 2020 (1) TMI 1096  (Mad)

[ii] 2019 (12) TMI 558 (Allahabad CESTAT)