INTRODUCTION
– SERVICE BY EMPLOYEES EXCLUDED FROM GST
GST is a tax on all supplies of
goods or services, or both, made in the course or furtherance of business.
However, Schedule III, Entry 1 treats services by an employee to the employer
in the course of or in relation to his employment as neither a supply of goods
nor a supply of services, effectively resulting in the situation that such
services are excluded from the purview of GST.
HOW TO
DETERMINE EMPLOYER-EMPLOYEE RELATIONSHIP
It,
therefore, becomes important to analyse the scope of the abovementioned entry.
Since the exact tests of determination of employment contract are not
specifically listed in the GST law, it will be important to understand the said
tests from legal precedents under the general law including various labour
legislations. To begin this journey it may be worthwhile to refer to the
decision of the larger Bench of the Supreme Court in the case of Balwant
Rai Saluja & others vs. Air India Limited & others [Civil Appeal No.
10264-10266 of 2013]. In this case, the Court laid down the following
tests which are required to be satisfied to demonstrate the existence of an
employer-employee relationship:
(i) Who appoints the workers?
(ii) Who pays the salary / remuneration?
(iii) Who has the authority to dismiss?
(iv) Who can take disciplinary action?
(v) Whether there is continuity of service?
(vi) What is the extent of control and supervision?
Various legislations have been
enacted to safeguard the interest of employees employed by employers. Some of
the key legislations are the Factories Act, 1948, the Industrial Employment
Act, 1946, the Industrial Disputes Act, 1947, the Contract Labour Regulation
Act, 1970, the Workmen’s Compensation Act, 1923, and so on. Each of these
legislations has defined the term employee, identified as worker, workmen, etc.
However, it is important to note that the definition of employee referred
to in one legislation is restricted only to that legislation and merely because
a person is an employee under one legislation he does not become an employee in
general of the employer. The Supreme Court in the above decision has
held that for matters which are not related to the specific legislations, one
needs to satisfy the above test to establish the existence of an
employer-employee relationship.
WHAT IS THE SCOPE OF THE ENTRY?
The next point that needs to be
analysed is what all will be included within the scope of the consideration /
remuneration paid to an employee. Generally, the consideration paid to an
employee carries two components, one being the monetary component which would
cover payouts like salary, wages, allowances, etc., and the other being
non-monetary components such as perquisites, rent-free accommodation, etc.,
which are made available to employees under the terms of the employment
contract. Some components may be mandated by the legislature and some may be
part of the employment policy of the employer.
The legislations referred to
above also deal with the meaning of ‘consideration’. For example, section 2
(rr) of the Industrial Disputes Act, 1947 defines the term ‘wages’ to mean all
the remuneration capable of being expressed in terms of money and payable to a
workman in respect of his employment or work done in such employment, and also
includes (a) allowances that the workman is entitled to, (b) the value of the
house accommodation or of the supply of light, water, medical attendance or
other amenities, or of any service, or of any concessional supply of food
grains or other articles, (c) any travelling concession, and (d) any commission
payable on the promotion of sales or business, or both. However, it also
excludes certain items such as (i) any bonus, (ii) any contribution paid /
payable by the employer to any pension fund / provident fund / for the benefit
of the workman under any law for the time being in force, and (iii) any
gratuity payable on the termination of service.
Similarly, section 2(v) of the
Payment of Wages Act, 1932 defines the term ‘wages’ as all the remuneration
(whether by way of salary, allowances or otherwise) expressed in terms of
money, or capable of being so expressed, which would be payable to a person
employed in respect of his employment, or of work done in such employment and
includes (a) any remuneration payable under any award or settlement between the
parties or order of a Court, (b) overtime remuneration, (c) additional
remuneration payable under the terms of employment, (d) any amount due on
termination of employment, and (e) any sum which the employee is entitled to
under any scheme framed under any law for the time being in force, excluding
any bonus, value of benefits, such as house accommodation, electricity or water
supply, medical attendance or other amenity, or of any service excluded from
the computation of wages by a general or special order of the appropriate
government, any contribution paid by the employer to any pension or provident
fund and the interest accrued thereon, any travelling allowance or the value of
any travelling concession and any sum paid to the employed person to defray
special expenses entitled to him by the nature of work.
The above two definitions in the
context of specific legislations clearly point towards what shall constitute
‘consideration’ and it generally intends to include within its scope all
payments made to the employees, except for specific items which are also
excluded only for the purpose of the specific legislations. But the general
principle laid down in the said legislations indicates that all payments made
or facilities extended to the employees as a part of employment contracts would
be treated as a part of the consideration to the employee. This principle was
laid down by the Supreme Court in the case of Gestetner Duplicators
(Private) Limited vs. CIT [1979 AIR 607 = 1979 SCR (2) 788] wherein the
Court held as under:
It is thus clear that if under
the terms of the contract of employment, remuneration or recompense for the
services rendered by the employee is determined at a fixed percentage of
turnover achieved by him, then such remuneration or recompense will partake of
the character of salary, the percentage basis being the measure of the salary
and therefore such remuneration or recompense must fall within the expression
‘salary’ as defined in Rule 2(h) of Part A of the Fourth Schedule to the Act.
In the instant case before us, admittedly, under their contracts of employment
the assessee has been paying and did pay during the previous years relevant to
the three assessment years to its salesmen, in addition to the fixed monthly
salary, commission at a fixed percentage of the turnover achieved by each
salesman, the rate of percentage varying according to the class of article sold
and the category to which each salesman belonged. The instant case is,
therefore, an instance where the remuneration so recompense payable for the
services rendered by the salesmen is determined partly by reference to the time
spent in the service and partly by reference to the volume of work done. But it
is clear that the entire remuneration so determined on both the basis clearly
partakes of the character of salary.
In fact, while determining what
shall and what shall not constitute consideration, one should refer to the
principle of dominant intention theory, as laid down by the Supreme Court in Bharat
Sanchar Nigam Limited vs. UoI [2006 (2) STR 161 (SC)]. The Court in the
said decision held that one needs to look into the substance of the transaction
in order to determine how the same would get covered. Once it is established
that any payment made to an employee or any benefit / facility made available
to him is in the course of an employment contract, irrespective of whether the
same is a mandatory requirement or not, it gets covered within the purview of
that contract and cannot be distinguished from it.
Employer and employees are
related persons – Does this impact the tax treatment of the facilities /
benefits provided to employees?
Section 15 provides that an
employer and his employee shall be deemed to be related persons. Further, Entry
2 of Schedule I deems certain activities to be supplies even if the same are
without consideration. The entry reads as under:
Supply of goods or services or
both between related persons or between distinct persons as specified in
section 25, when made in the course or furtherance of business:
Provided that gifts not exceeding
fifty thousand rupees in value in a financial year by an employer to an
employee shall not be treated as supply of goods or services or both.
In the normal course, various
facilities / benefits are provided by the employer to his employees. Let us
first analyse whether or not the same constitute a supply under GST (without
considering the scope of entries under Schedule I and Schedule III). It is
imperative to note that generally when an employer makes available any
facilities / benefits to the employee, it is not mandatory in nature. For
example, commutation facility extended by the employer may not be availed of by
employees who prefer to travel on their own. It is upon the employee to decide
whether he intends to avail of the facility. Similarly, it is not necessary
that all employees might avail the canteen facility. Rather, they might want to
make arrangements on their own. It is only as a part of the employer’s HR
policy / statutory requirement that the employer makes available the facilities
/ benefits.
However, once it becomes part of
the employment policy, which the employee would have accepted, it becomes part
of the employment contract, i.e., the employer has made available the
facilities / benefits in pursuance to the services supplied by the employee to
the employer. However, there is no contrary service supplied by the employer.
The employer has merely undertaken the activity of incurring the cost to make
available the benefits / facilities to its employees. However, merely because a
cost is incurred does not necessarily mean that the employer has supplied the
service. In Kumar Beheray Rathi vs. Commissioner of Central Excise, Pune
[2014 (34) STR 139], the Tribunal held that the assessee was acting
merely as a trustee or a pure agent as it was not engaged in providing any
service but only paying on behalf of various flat-buyers to various service
providers. In this particular case, even though there was recovery of cost, the
Tribunal has held that there was no provision of service. The argument would therefore
get stronger in a case where consideration is not involved. Similarly, in the
case of Reliance ADAG Private Limited vs. CST, Mumbai [2016 (43) STR 372
(Tri.)(Mum.)], the Tribunal has held that merely incurring expenses on
behalf of group companies and recovering them would not amount to provision of
service. The principles laid down in the said case should also apply to the
current case.
Another aspect to be noted is
that in certain cases, such as telephone facilities / insurance services, there
is a legal impediment to the employer providing such service since they are
regulated services and only those people who are authorised by the Department
of Telecommunication (DOT) or the Insurance Regulatory Development Authority of
India (IRDAI) can provide such a service. Therefore, this is one more basis to
say that by merely making available the facilities / benefits the employer has
not made a supply to his employees, but rather it is a cost incurred by him in
the course of receiving services from his employee and, therefore, is nothing
but just an employment cost for him. This aspect has also been discussed in our
previous article ‘Decoding GST: Inter-Mingling of Income tax and GST’ (BCAJ,
April, 2020).
Therefore, once a view is taken
that making available benefits / facilities does not constitute supply, Entry 2
of Schedule I which deems an activity of supply of goods or services between a
distinct person / related person as supply, even if made without consideration,
would not be applicable. This would be because Entry 2 pre-necessitates that
the activity has to be treated as supply u/s 7.
Another point to be noted is that
if a view is taken that by incurring the above expenses / making available the
benefits to the employees, there is a supply made by the employer, it could
result in additional unwarranted compliances on the part of the employer. Let’s
take an example of insurance facilities / benefits extended to the employee. If
a view is taken that the employer has indeed provided these services, then they
would be in violation of the IRDAI guidelines since they would be engaged in
providing insurance services without necessary approvals. Similar would be the
situation in case of telecommunication facilities made available to the
employees where one needs to obtain approval from DOT, or in the canteen
facilities from FSSAI. Further, in some cases such an interpretation would
result in an absurd application from other aspects also. For example, in case
of rent-free accommodation provided by the employer to the employee, if a view
is taken that the same is a supply of service in view of Entry 2 of Schedule I,
while there would be no tax liability on the outward side since the services of
renting of residential accommodation is exempted from tax, correspondingly, the
Department might take a view that the employer is engaged in providing exempt
services, thus triggering the applicability of the provisions of sections 17(2)
and 17(3) of the Central Goods & Services Tax Act, 2017 requiring
compliances under Rules 42 and 43 of the Central Goods & Service Tax Rules,
2017.
Therefore,
it is apparent that whether or not any amount is recovered from the employee
for any facilities / benefits made available to him, it would be wrong to treat
the same as a supply itself under GST. In fact, the next proposition would be
important, which is to say that the facilities / benefits which are made
available to the employees is nothing but a part of the employee cost incurred
in the course of receiving the services of the employee in pursuance of the
employment contract. This view finds support from the decision of the Andhra
Pradesh High Court in the case of Bhimas Hotels Private Limited vs. Union
of India [2017 (3) GSTL 30 (AP)] wherein, in the context of canteen
recoveries, the Court held that such recoveries have to be seen as part of any
pay package that workers have negotiated with employers and therefore cannot be
construed as service falling within the definition of ‘service’ u/s 65B(44) of
the Finance Act, 1994. The logic behind the above conclusion was that under
service tax the definition of service excluded any service provided by the
employee to the employer in the course of employment from its purview. Since
the recoveries were made in pursuance of the employment contract, they were
excluded from the scope of the definition of service. It is imperative to note
that even under GST, Entry 1 of Schedule III provides that services provided by
an employee to the employer in the course of the employment contract shall be
treated neither as supply of goods nor as supply of services. Therefore, it can
be said that under GST,
(a) Any facilities / benefits made available to the employees would not
be liable to GST as they do not amount to supply of service itself
(b) The facilities / benefits made available to the employees even if
not a statutory requirement but part of the employment policy, should be
treated as covered under Entry 1 of Schedule III and therefore excluded from the
scope of supply itself
(c) Even if any amounts are recovered from the employees, the same would
also be covered under Entry 1 of Schedule III in view of the decision in the
Bhimas Hotels case (Supra) and should be treated as nothing short of
reduction in the employee cost.
Readers might also take note of
the contrary AARs under GST on this subject. In the case of Caltech
Polymers Private Limited [2018 (18) GSTL 350 (AAR)] and upheld by the
Appellate Authority in [2018 (18) GSTL 373 (AAR)], the Authority
has held that the employer is liable to pay GST on amounts recovered from
employees for the canteen facilities extended to them. However, in the context
of recovery of insurance premia from employees, the authority has held that as
the same do not constitute an activity incidental or ancillary to their
business activity, they cannot be treated as supply of service. One may refer
to the ruling in the case of Jotun India Private Limited 2019 (29) GSTL
778 (AAR).
Eligibility
of Input Tax Credit on employee-related costs
There are
specific provisions which restrict claim of Input Tax Credit u/s 17(5) as
under:
(b) the following supply of goods or services or
both:
(i) food
and beverages, outdoor catering, beauty treatment, health services, cosmetic
and plastic surgery, leasing, renting or hiring of motor vehicles, vessels or
aircraft referred to in clause (a) or clause (aa), except when used for the
purposes specified therein, life insurance and health insurance:
Provided
that the input tax credit in respect of such goods or services or both shall be
available where an inward supply of such goods or services or both is used by a
registered person for making an outward taxable supply of the same category of
goods or services or both or as an element of a taxable composite or mixed
supply;
(ii) membership of a club, health and fitness
centre; and
(iii) travel benefits extended to employees on
vacation such as leave or home travel concession:
Provided
that the input tax credit in respect of such goods or services or both shall be
available, where it is obligatory for an employer to provide the same to its
employees under any law for the time being in force.
(g) goods
or services or both used for personal consumption;
Building on
the above discussion, it is important to note that while making available the
various benefits / facilities to their employees, the employers incur various
costs on which GST would have been charged by their suppliers. Therefore, the
question that needs consideration is whether or not credit shall be available
on such expenses incurred.
The
specific reason for this query is that section 17(5) lists items on which
credit shall not be allowed. These are termed as blocked credits. For various
expenses while there is a restriction on claim of credit, an exception has been
provided when the expense is incurred as a statutory requirement. For example,
while in general ITC on food and beverages is not allowed, however, vide
an exception it has been provided that if it is a statutory requirement to
provide such facilities, Input Tax Credit shall be available. For instance,
under the Factory Act, 1948 every factory employing more than 250 employees is
required to maintain a canteen for them. As discussed earlier, for the purpose
of this Act the employees also include those who are not on the payroll of the
employer, i.e., while in general, an employer-employee relationship does not
exist, for the purposes of the Factory Act, 1948 they are treated as employees
and therefore the question that needs consideration is whether the eligibility
to claim credit will apply for such an outsourced workforce also. This would be
specifically important in cases such as construction contracts where generally
the labour is outsourced.
The same
applies to rent-a-cab services, insurance services, etc., as well. However, at
times there are inward supplies received which facilitate the making available
of benefits / facilities to employees. For example, equipment / crockery
purchased for a canteen. There is no specific restriction on the claim of
credit on such items. The restriction applies only to food and beverages and
these do not constitute food and beverages. Therefore, credit on such items
could be claimed.
Another
area that would need deliberation is clause (g) of section 17(5) which
restricts claim of credit on goods or services or both used for personal
consumption. The scope of this entry has seen substantial confusion as to
whether it would apply to goods or services used for employee consumption. For instance,
the company organises a picnic for its staff. Will this get covered under this
entry or not? To understand this, one needs to analyse the scope of the term
‘personal consumption’. However, before proceeding further it would be relevant
to refer to the similar entry in CENVAT Credit wherein Rule 2 (l) states that
specific services which were meant for ‘personal consumption of any employee’
shall not constitute input service. It is imperative to note that while the CCR
specified whose personal consumption, the same is apparently silent under GST.
This would indicate that in the absence of a specification, a view can be taken
that the term ‘personal consumption’ is to be seen in the context of the
taxable person and not the employees and, therefore, subject to other clauses
of section 17(5), credit would be available even if they were meant for
consumption of the employees.
However,
the answers would change in the above case where the cost of making available
the benefits / facilities, whether wholly or partly, is recovered from the
employees. In such a case, it would result in a reduction of cost for the
employer and therefore, to that extent, the employer would not be entitled to
claim credit. However, there are instances where employers take a view that in
a case where credit is allowable and the corresponding costs are recovered from
the employees, GST should be paid on the recovery amount to avoid complicating
ITC calculations. However, one should take a view that paying GST on the
recovery would mean that the employer has accepted liability under Entry 2 of
Schedule I and there might be challenges on the valuation of the supply claimed
to be made by the employer to his employees because section 15 of the Central
Goods & Services Tax Act, 2017 requires such a transaction to be valued as
per the Valuation Rules.
Applicability of GST on payments made to
directors of a company
Entry 6 of
Notification 13/2017 – CGST Rate requires that the GST in case of service
supplied by a director of a company or a body corporate to the said company /
body corporate shall be paid by the service receiver, i.e., the company in case
the service provider is a director / body corporate. However, this particular
aspect of the GST law has seen its share of controversy, with conflicting
decisions under the Service Tax regime as well as a ruling issued by the
Authority for Advance Ruling.
However, before proceeding further, it would be
necessary to go through the background of the concept of directors. Directors
are individuals who are appointed on the Board of a company to protect the
interests of the shareholders and manage the affairs of the company. Generally,
there are two types of directors: executive directors who are involved in the
day-to-day activities of the business, and non-executive directors, also known
as independent directors, whose role is mainly to ensure that the interest of
the shareholders and other stakeholders is largely protected. The maximum
remuneration that can be paid to each class of directors is also regulated.
However, when determining whether the directors satisfy the test of an
employer-employee relationship, there would be a different outcome which is
evident from the following:
|
Condition
|
Executive Director
|
Non-Executive / Independent Director
|
|
Who appoints the workers?
|
Shareholders, on the recommendation of Board, or Board, to be
subsequently ratified by the shareholders
|
|
Who pays the salary / remuneration?
|
Company
|
Company
|
|
Who has the authority to dismiss?
|
Shareholders
|
|
Who can take disciplinary action?
|
Shareholders
|
|
Whether there is continuity of service?
|
Generally, appointed till end of next general meeting
|
|
What is the extent of control and supervision?
|
Full control and supervision by shareholders
|
No control / supervision
|
As is apparent from the above, in
the case of Executive Directors, the test of employer-employee relationship
laid down by the Supreme Court in Balwant Rai Saluja (Supra) is
satisfied. However, it is not so in the case of Independent directors as the
key element of existence and control and supervision is missing. It is
therefore sufficient to say that while Executive Directors satisfy the test of
the employer-employee relationship, the same is not so in the case of
Non-executive / Independent directors. Therefore, in case of directors, while
admittedly notification 13/2017 – CT (Rate) imposes a liability on the company
to pay tax on reverse charge, the issue that remains is whether the payment
made to directors who are in an employer-employee relationship will get covered
within this entry or will it be excluded from the purview of Entry 1 of
Schedule III.
Therefore,
since Schedule III itself excludes transactions where an employer-employee
relationship exists from the purview of supply itself, notification 13/2017 –
CT (Rate) imposing the liability to pay tax on the service recipient is ultra
vires of the provisions of the Act and, therefore, not maintainable. This
aspect has already been considered by the Gujarat High Court in the recent
decision in Mohit Minerals Private Limited vs. UoI & others [2020 VIL 36
Guj.].
In fact, it
is imperative to note that a similar entry requiring payment of tax under RCM
was applicable even under the Service Tax regime where there were two
conflicting decisions. The Division Bench of the Mumbai Tribunal in the case of
Allied Blenders & Distillers Private Limited vs. CCE & ST,
Aurangabad [2019 (24) GSTL 207 (Tri.)(Mum.)] held that directors’
salary would be excluded from the purview of service tax and therefore no tax
would be liable to be paid under Reverse Charge. However, the Kolkata Tribunal
(SMB) has, in the case of Brahm Alloy Limited vs. Commissioner [2019 (24)
GSTL 616 (Tri.)(Kol.)] held otherwise and confirmed the liability to
pay tax on directors’ remuneration, described as salary by concluding that an
employer-employee relationship didn’t exist on account of two reasons; firstly,
the resolution of the company confirming the appointment of the directors did
not cover the terms of appointment / hiring of services and also the action to
be taken for non-performance of specified duties without which it cannot be
construed as to whether an individual was appointed as Promoter-Director or an
employee director; and secondly, payments made in a quarterly and not monthly
manner. It is apparent that the decision in the case of Brahm Alloy
Limited is contrary to the established principles and might not survive
if appealed before a higher authority.
It is also
important to note that under the GST regime, the AAR has, in the case of Clay
Craft India Private Limited [Raj/AAR/2019-20/33] also held to the
contrary, that tax is payable under Reverse Charge. The Authority has concluded
that the services rendered by the director to the company are not covered under
Entry 1 of Schedule III as the directors are not employees of the company.
The next
issue relating to directors is the applicability of reverse charge in case of
directors deputed on behalf of investing companies, in which case the
remuneration is paid to the company and not to the representative directors.
The issue revolves around whether such transactions would be covered under
notification 13/2017 – CT (Rate) or not? It is imperative to note that in this
transaction structure, the transaction is between two different companies /
body corporates wherein one body corporate has deputed a person as a director
on the Board of the other company. In other words, both the supplier and the
recipient of service are a body corporate / company. The notification requires
that the service provider must be an individual, being a director of the
company. However, that is not so in the case of the current set of
transactions. In other words, Entry 6 does not get triggered at all and,
therefore, no reverse charge would be applicable on such transactions.
Is GST applicable on notice period
recoveries / claw-back of payments to employees?
Before
looking into the tax implications of notice period recovery / claw-back, let us
understand the background of these transactions.
Notice
period recovery: Generally, the employment contracts have a clause that if an
employee intends to leave the organisation or an employer intends to
discontinue the services of an employee, each party will be required to give a
notice to the other of their intention to do so, and once the notice is served,
the party giving the notice will be required to serve a notice period, i.e., if
the employee is serving notice, he will be required to continue in employment
for a pre-decided period to enable the employer to make alternate arrangements.
Similarly, if the employer has served notice to the employee, he will have to
allow the employee to continue in employment for a pre-decided period to enable
the employee to find new employment, or prepare for transition. This is
generally treated as serving notice period. However, there are times when the
party giving the notice does not intend to honour the commitment in which case
they are required to compensate the other person monetarily. In case the
employee refuses to serve the notice period, he would be required to pay
compensation to the employer, which would be either adjusted from his full and
final settlement or recovered from him, and vice versa; if the employer
abstains from honouring the notice period clause, he would monetarily reimburse
the employee.
Similarly,
claw-back refers to recovering the amounts already paid to the employees. In
case of senior management employees, there are generally clauses in the
agreement which provide that in case of non-satisfaction of certain conditions
of the employment contract, the payments made to the employees shall be
recovered back from them. For example, if a top level employee is joining a
company from another company, in order to lure him to accept the employment he
is offered ‘joining bonus / incentive’ with the condition that if he does not
continue the employment for a specified period, the same would be liable to be
recovered from him. Similarly, even in case of incentives / bonus, there are
clauses for claw-back of the bonus if there is some action on the part of the
employee which is detrimental to the employer.
The issue
that needs consideration is whether recoveries such as the above would
constitute a supply and therefore liable for GST? It is imperative for the
readers to note that the applicability of GST on notice period recoveries has
been a burning issue right from the service tax regime wherein the following
service was declared to be a deemed service u/s 66E: agreeing to the
obligation to refrain from an act, or to tolerate an act or a situation, or to
do an act;…
A similar
entry has continued even under the GST regime with Entry 5(e) of Schedule II of
the Central Goods & Services Tax Act, 2017 which declares the above to be
treated as supply of service under the GST regime as well, thus keeping the
issue alive. Let us analyse the same.
Whether such recoveries would be covered under Entry 1 of Schedule III?
However,
what needs to be noted is that the above recoveries emanate from a contract of
employment which is covered under Schedule III as neither being supply of goods
nor supply of services. A contract is the logical starting point for any
transaction. In any contractual obligation, the contracting parties are under
an onus to perform the contract. The contracting terms determine the
responsibility and enforce the performance on each contracting party. In case
of non-performance by any party, resort has to be taken to the contractual
relationship to determine the scope of recovery, if any. Hence, the contract is
in toto the binding force in any relationship.
A Latin
maxim, Nemo aliquam partem recte intelligere potest antequam totum perlegit,
says that no one can properly understand a part until he has read the whole.
Hence, it is important to analyse the entire transaction matrix, the
contractual relationship between the employer and the employee, the relevant
contracts / documents before diving into a discussion on the applicability of
service tax. An employment contract is a written legal document that lays out
binding terms and conditions of an employment relationship between an employee
and an employer. An employment contract generally covers an overview of job
responsibilities, reporting relationships, salary, benefits, paid holidays,
leave encashment benefits, details of employment termination and also provides
that in case an employee wants to quit, the employee should provide one month’s
notice before resigning or compensation in lieu of notice period.
The
employment contracts are long-term contracts with the employees. The
understanding and expectations from the employer are that the employee should
provide his services on a continuous basis. The employees are working on
important client projects or certain functions important for the operation of
the business; if any employee resigns in between, that impacts the progression
of the project adversely. To avoid such a situation and give sufficient time to
the employer to make alternative arrangements, the mandatory notice period is
prescribed under the employment contract. However, if the employee wishes to
leave without serving the notice period, the contract provides for recovery of
a certain amount which is generally deducted from the amounts due to the
leaving employee earned in the course of employment.
The ‘notice
period recovery’ is a provision for an eventuality that may arise as per
mutually-agreed terms of the employment contract. Notice period recovery is a
condition of the employment contract agreed mutually and hence is intricately
linked with the employer-employee relationship and arises out of an employment
contract only.
In the case
of Lakshmi Devi Mills Limited vs. UP Government [AIR 1954 All. 705, 714]
it has been held that ‘terms and conditions of service’ not only include the
recruitment or appointment but also all aspects like disciplinary matters,
removal from service, dismissal, etc. Therefore, termination or quitting the
organisation on notice or notice period recovery in lieu thereof is an
integral part of the employment contract. Thus, notice period recovery is just
another condition of the contractual relationship of an employer and employee
just like other terms of the same employment agreement. Hence, the notice
period recovery in lieu of not adhering to the notice period emanating
from the employment contract should get covered under Entry 1 of Schedule III
and therefore excluded from the scope of supply itself.
Is there
any service provided by the employer?
Another
point to be noted is that merely because there is recovery would not convert
the same into consideration. In permitting the employee to leave the
organisation, there is nothing that the employer has done to qualify as
service. For treating something as service, there has to be an activity which
requires doing something for another person. In case of notice period
recoveries, there is no rendition of service from the employer in the case of
permitting the employee to leave the organisation before the completion of the
notice period. The events which precede the employee leaving the organisation
are:
(a) The decision to leave is that of the
employee
(b) The request for termination is made by
the employee
(c) The employer has no choice to retain the
employee if he really wants to leave
(d) If the employer decides not to insist on
the notice period, even then he cannot insist on the recovery of the notice pay
if the employee wants to serve the notice period; he will be required to
continue the employment till that period
(e) Therefore, the employer has no choice to
decide on whether the employee should stay back for the notice period or
whether he should leave early against recovery of notice pay. This choice is
also made by the employee.
From the
above it is evident that all the activities and decisions are actually carried
out by the employee. And the employer does nothing. He neither decides nor is
in a position to decide. Hence, there is no provision of service by the
employer. Merely because the employee is permitted to leave by the employer
does not by any stretch of the imagination get covered by ‘activity performed
for the employee’.
Would mere recovery of amounts characterise it as consideration?
Another
aspect which would need deliberation is whether or not the amounts recovered on
account of notice period recovery / claw-back clauses can be treated as
consideration? Merely because money is received would not give it the
characteristic of consideration. In the case of Cricket Club of India vs.
Commissioner of Service Tax, Mumbai [2015 (40) STR 973] it was held
that mere money flow from one person to another cannot be considered as
consideration for a service. The relevant observations of the Tribunal in this
regard are extracted below:
‘11.
…Consideration is, undoubtedly, an essential ingredient of all economic
transactions and it is certainly consideration that forms the basis for
computation of service tax. However, existence of consideration cannot be
presumed in every money flow. The factual matrix of the existence of a monetary
flow combined with convergence of two entities for such flow cannot be moulded
by tax authorities into a taxable event without identifying the specific
activity that links the provider to the recipient.
12. …Unless
the existence of provision of a service can be established, the question of
taxing an attendant monetary transaction will not arise.’
Even in the celebrated case of UoI
vs. Intercontinental Consultants and Technocrats Pvt. Limited
[2018-TIOL-76-SC-ST], the Apex Court upheld the decision of the Delhi
High Court that observed that ‘…and the valuation of tax service cannot be
anything more or less than the consideration paid as quid pro quo for
rendering such a service’.
In the case of HCL Learning
Limited vs. Commissioner of CGST, Noida [2019-TIOL-3545-CESTAT-All.],
the Hon’ble Tribunal of Allahabad has categorically held as under:
‘1… From
the record, we note that the term of contract between the appellant and his
employee are that employee shall be paid salary and the term of employment is a
fixed term and if the employee leaves the job before the term is over then
certain amount already paid as salary is recovered by the appellant from his
employee. This part of the recovery is treated by Revenue as consideration for
charging service tax… terms of contract between the appellant and his
employee are that employee shall be paid salary and the term of employment is a
fixed term and if the employee leaves the job before the term is over then
certain amount already paid as salary is recovered by the appellant from his
employee. This part of the recovery is treated by Revenue as consideration for
charging service tax.
2. We hold
that the said recovery is out of the salary already paid and we also note that
salary is not covered by the provisions of service tax. Therefore, we set aside
the impugned order and allow the appeal.’
Therefore,
whether recovery is from salary due / retained or salary already paid, the fact
remains that salary is excluded from service tax and such recovery cannot be
termed as consideration.
Will notice period recovery be covered under Entry 5(e) of Schedule II
to treat the same as supply of service?
The
decision to quit the organisation by the employee is a unilateral decision. The
same is forced upon the employer and he has to accept it. The employer cannot
make any employee work without his consent. Article 23(1) of the Indian
Constitution prohibits forced labour in any form. In other words, statutorily
no employee can be forced to work against his wish. In case the employee wishes
not to serve the notice period and opt to leave the organisation before
completion of the notice period, in such a situation the employer can only
recover the notice period dues.
Further,
the employer would not be tolerating any act in such a case. If the employer
has the option to tolerate or not to tolerate, then it can be said to be a
conscious decision. In such cases, in view of the above discussion, the decision
to quit is thrust upon the employer without any option. Therefore, it cannot be
said that the employer has agreed to tolerate the said act of the employee.
A breach of
contract cannot be said to be ‘tolerated’ and that is why an amount is imposed
to deter breach in contracts. The contract of employment is for receipt of
services from the employee and not for the breach. The Court of Appeal (UK) in
the case of Vehicle Control Services Limited [(2013) EWCA Civ 186],
has noted that payment in the form of damages / penalty for parking in wrong
places / wrong manner is not a consideration for service as the same arises out
of breach of contract with the parking manager.
The Madras
HC has critically analysed the levy of service tax on notice period recoveries
in the case of GE T&D India Limited vs. Deputy Commissioner of
Central Excise, Large Tax Payer Unit, Chennai [2020-VIL-39-Mad-ST] wherein
the OIO had confirmed the demand treating the recoveries as consideration for
providing declared service u/s 66E. In this case, the Court held as under:
‘11. The
definition in clause (e) of section 66E as extracted above is not attracted to
the scenario before me as, in my considered view, the employer has not “tolerated”
any act of the employee but has permitted a sudden exit upon being compensated
by the employee in this regard.
12. Though
normally a contract of employment qua an employer and employee has to be read as a whole, there are
situations within a contract that constitute rendition of service such as
breach of a stipulation of non-compete. Notice pay, in lieu of sudden termination, however, does not give rise to the
rendition of service either by the employer or the employee.’
The above
judgment clearly lays down the principle that notice period recovery cannot be
treated as ‘service’ by an employer, more so a ‘declared service’. Some
monetary recovery by an employer from an employee on account of breach of
contract cannot be said to be consideration for any different service. Breach
of contract leading to recovery does not lead to the creation of a new contract
of tolerating any act of the employee. The notice period recovery, at best,
represents nothing but reduction in salary payable which is due to the employee
which emanates only from the employment agreement. To draw an analogy, for
breach of contracts, certain companies recover liquidated damages from the
amounts due to the opposite party who fails to execute his duties as stipulated
under the contract. In case of notice period recoveries, the employer recovers
notice period recovery from the employee for breach of contract conditions as
stipulated in the employment agreement. The Tribunal has in the case of Reliance
Life Insurance Company Limited [2018-TIOL-1308-CESTAT-Mumbai = 2018 (19) GSTL
J66 (Tri.)(Bom.)] held that the surrender / discontinuance charges
represent penalty or liquidated damages and cannot be considered as a
consideration for any services. On a similar footing, in another case of Gondwana
Club vs. Commissioner of Customs & Central Excise, Nagpur
[2016-TIOL-661-CESTAT-Mum.] the club had recovered certain charges from
the employees for the accommodation provided to them. In this case also, the
Tribunal held as under:
‘7… The
contractual privileges of an employer-employee relationship are outside the
purview of service tax and this activity of the appellant does not come within
the definition of the taxable service of “renting of immovable property” sought
to be saddled on the appellant in the impugned order. Accordingly, the demand
under the head “renting of immovable property service” does not sustain.’
In a very
recent decision, the Hon’ble High Court of Bombay had the opportunity to
analyse the concept of ‘supply’ in relation to violation of legal right and
claim of compensation / damages in the context of the Central Goods &
Services Tax Act, 2017. The Hon’ble High Court in the case of Bai Mamubai
Trust & Ors vs. Suchitra Wd/O. Sadhu Koraga Shetty & Ors
[2019-VIL-454-Bom.] observed as under:
56. I am in
agreement with the submissions of the Learned Amicus Curiae that where a dispute concerns price / payment for a
taxable supply, any amount paid under a court’s order / decree is taxable if,
and to the extent that, it is consideration for the said supply or a payment
that partakes that character. In such cases, the happening of the taxable event
of ‘supply’ is not disputed, but the dispute may be in regard to payment for
supplies already made. This could be, for example, where the defendant denies
the liability to pay the price forming consideration for the supply. The order
/ decree of the court links the payment to the taxable supply and the requisite
element of reciprocity between supply and consideration is present.
57.
However, where no reciprocal relationship exists, and the plaintiff alleges
violation of a legal right and seeks damages or compensation from a Court to
make good the said violation (in closest possible monetary terms), it cannot be
said that a ‘supply’ has taken place.
58. The
Learned Amicus Curiae correctly submits that
enforceable reciprocal obligations are essential to a supply. The supply
doctrine does not contemplate or encompass a wrongful unilateral act or any
resulting payment of damages. For example, in a money suit where the plaintiff
seeks a money decree for unpaid consideration for letting out the premises to
the defendant, the reciprocity of the enforceable obligations is present. The
plaintiff in such a situation has permitted the defendant to occupy the premises
for consideration which is not paid. The monies are payable as consideration
towards an earlier taxable supply. However, in a suit, where the cause of
action involves illegal occupation of immovable property or trespass (either by
a party who was never authorised to occupy the premises or by a party whose
authorisation to occupy the premises is determined) the plaintiff’s claim is
one in damages.
The above
judgment of the Hon’ble High Court clearly explains that a contractual
obligation forced out of a contract for legal violation cannot be said to be an
activity on which tax is applicable. Although the context is under the Goods
& Services Tax law, but the same can be very well correlated with the
Service Tax laws. Violation of contractual terms by way of monetary
compensation does not result into a ‘contract’ between the parties on which tax
is payable. Reciprocal relationship is a must, which is missing in the case of
notice period recovery as succinctly explained in the grounds above.
Based on the
above judgments, analogies and justification as to why notice period recovery
cannot be said to be a ‘declared service’, it is apparent that the recoveries
made from employees on account of non-serving of notice period / claw-back
clauses should not be liable to GST.
INTERPLAY WITH PROFESSION TAX ACT
Each
business having a presence in a particular state and employing a specified
number of employees is required to deduct Profession Tax from the salary
payable to the employees and deposit it with the respective State Profession
Tax Authorities of the branch where the employees are based.
In the
pre-GST regime, entities engaged in providing services in multiple states had
an option to take single registration and, therefore, had limited exposure to
the state authorities. In many cases, it was observed that the Profession Tax
deducted from employee’s salary was deposited in only one state though the
employee was based in a branch in a different state. While under the pre-GST
regime the state had no overview over such cases, with the introduction of GST
such entities are under the radar of the authorities of multiple states and
issues such as non-registration under Profession Tax, non-payment of profession
tax in the correct state and so on might start coming to the fore. In case of
non-compliance, there might be repercussions which might need to be taken care
of.
CONCLUSION
In view of the specific exclusion for services
rendered by employees to employers, it may be important to ensure that the said
exclusion is interpreted in the context of the precedents set under other
legislations.
