Recovery of notice period pay will not be subjected to services tax, Madras High Court has ruled. Now, the government is expected to come out with a clarification to deal with such matter under the Goods & Services Tax (GST) regime.

The case belongs to the old regime of service tax. The petitioner GE T&D India Limited (formerly Alstom T&D India) received certain amount in lieu of notice period from outgoing employees.

The Assessing Officer was of the view that this amount would attract Service Tax since the petitioner is deemed to have facilitated the termination of employment and thus a category of service entailed and described as 'facilitation of termination of employment' was carved out by the Assessing Officer. Accordingly show cause notices were issued against which the petitioner moved to the court.

During the hearing, the tax department said that payment in lieu of notice constitutes payment to an employee by the employer for the notice period or vice versa where the employer/employee desires an immediate exit from the organization. “This arrangement would attract the provisions of Section 66E (e) of the Finance Act 1994, whereby agreement by an entity to the obligation to refrain from an Act or to tolerate an Act or a situation, or to do not act, would constitute taxable service,” the department said while adding that the company has tolerated the act of immediate quitting from service, by the employees and such agreement/toleration results in the rendition of a taxable service.

Meanwhile, Guidance Note date June 20, 2012, by then Central Board of Excise and Custom or CBEC (now known as Central Board of Indirect Taxes and Custom or CBIC) made it clear that Provision of service by an employee to the employer is outside the ambit of service. Also, it replied in negative when asked would amounts received by an employee from the employer on premature termination of contract of employment be chargable to service tax.

After hearing both sides, the court said that the employer cannot be said to have rendered any service per se much less a taxable service and has merely facilitated the exit of the employee upon imposition of a cost upon him for the sudden exit. “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,” it said.

According to Rajat Mohan, Senior Partner at AMRG the Court held that in case of recovery of notice pay, an employer does not 'tolerate' any act of the employee but permits a sudden exit upon being compensated and thereby ruled that such recoveries are not exigible to service tax. “This ruling would only have persuasive value for the taxpayer under GST regime also, as the charging section under GST is “Supply”, which is a far broader term than “service”. Also, words “Supply” has been defined in an inclusive manner which gives tax authorities a stronger reason to tax notice pay recoveries,” he said.

Parag Mehta, Partner at N A Shah said that the judgement will bring a lot of relief to various taxpayers to whom such notice has been issued. Further it is hoped that to close all other open cases on the said issue, the authorities accept the said judgement. “Clarity on the same should also be issued under the present GST regime as the facts and position remains the same. In absence of any clarification from the department, the said litigation is bound to continue even under GST Regime,” he said.