The recent decision of CESTAT, Allahabad in the case of K.N. Food Industries Private Limited v. Commissioner, 2019-VIL-731-CESTAT-ALH-ST.

In this case, the Appellant was performing manufacturing job-work for a client (‘Principal’) for consideration. In some cases, the Principal allotted work lesser than mutually agreed quantum of work to the Appellant. As a compensation for allotting lesser work, Principal paid ‘ex-gratia job charges’ (calculated on variable factors) to the Appellant to cover up the latter’s losses.

The Revenue alleged that ‘ex-gratia job charges’ were exigible to Service Tax being a declared service under Section 66E(e) of the Finance Act, 1994 as ‘agreeing to  the  obligation  to  refrain  from  an  act,  or  to  tolerate  an  act  or  a  situation, or to do an act.’

The Tribunal observed that the ‘ex-gratia job charges’ is not fixed and is in the nature of compensation. It further held Section 66E(e) of Finance Act, 1994 requires concurrence of an obligation between both the parties at the first instance. In the instant case, ‘ex-gratia job charges’ were  to make  good  the  damages,  losses  or  injuries  arising  from unintended events from the Principal to the Appellant and did not stem from any obligation on the part of any of the parties to tolerate an act or a situation. Thus, no Service Tax was payable in the instant case.

NITYA’s Comments: The jurisprudence vis-à-vis taxability of a transaction under the ambit of ‘toleration of an act’ is in an evolving stage. The instant case rightly lays down an important principle that an agreement should have an express concurrence of toleration of an act / situation to attract levy of Service Tax. Another important criterion is that the amount paid should be in the nature of ‘consideration’ and not ‘compensation’. The decision has rightly characterized that the expression ‘toleration of an act’ will not cover damages, losses or injuries arising from unintended events.

This decision will be equally relevant under GST regime which contains similar provisions specifically relating to taxability of compensations and damages. If payment of GST on such amounts results in a revenue neutral situation (namely the other party being in a position to claim ITC), the issue may not be worth litigation else the taxpayers can litigate the issue.