03-Apr-2020 Applicability of GST On Notice Pay Recovery

GST is leviable only when an activity is constituted as a Supply u/s 7 of the CGST Act. In other words, GST is applicable on supply of taxable goods or services. The section 7 of the CGST Act relating to Scope of Supply under the GST Law has been amended on 01-02-2019 retrospectively w.e.f. 01-07-2017. The issue of leviability of GST   on Notice Pay Recovery hence needs to be analysed considering the scope of supply prior to the amendment and post the amendment carried out in section 7 of the CGST Act.  First of all, let us understand the definition of term “Supply”. 

1.   Below is the Relevant Extract of Section 7 prior to the amendments : 

“Section 7(1) - For the purposes of this Act, the expression “supply” includes––

(a) all forms of supply of goods or services or both such as sale, transfer, barter, exchange, licence, rental, lease or disposal made or agreed to be made for a consideration by a person in the course or furtherance of business; 

(b) import of services for a consideration whether or not in the course or furtherance of business; 

(c) the activities specified in Schedule I, made or agreed to be made without a consideration; and 

(d) the activities to be treated as supply of goods or supply of services as referred to in Schedule II” 

2.   Below is the Relevant Entry in Schedule II which is having impact of GST on Notice Pay Recovery. Schedule II is for “ACTIVITIES [OR TRANSACTIONS] TO BE TREATED AS SUPPLY OF GOODS OR SUPPLY OF SERVICES.”

“5- Supply of Services 

The following shall be treated as supply of services, namely:—

(a)   ---

(b)   ---

(c)    ---

(d)   ---

(e)    agreeing to the obligation to refrain from an act, or to tolerate an act or a situation, or to do an act; and

(f)     ----" 

As per the above definition, there are certain transactions which are covered  within the purview of Supply because of inclusion of reference to Schedule II of the CGST Act 2017. Even though the transactions are not in the nature of supply but by virtue of Schedule II, the types of transactions which are mentioned under Schedule II are considered to be Supply and GST could be levied accordingly.

3.   Notice Pay Recovery is considered to be a breach of employment contract in which the employee refrains to serve notice period and the employee shall be compensating the loss due to the breach of contract to the employer by paying an amount, say notice period is of one month and in lieu of service of notice period, employee is supposed to pay one month salary as per contract. 

Prior to the amendment in section 7 of the CGST Act it was conceived that the employer is tolerating an act or situation due to breach of employment contract. Hence, such tolerating an act or situation is covered under Schedule II. Further schedule II is forming part of scope of supply and hence such transaction is liable to GST under GST Law. 

4.   Now let us consider the Relevant Extract of Section 7 Post amendments : 

Section 7(1) For the purposes of this Act, the expression "supply" includes—

[(1A) Where certain activities or transactions constitute a supply in accordance with the provisions of sub-section (1), they shall be treated either as supply of goods or supply of services as referred to in Schedule II.]

5.   Earlier, supply included the activities to be treated as supply of goods or supply of services as referred to in Schedule II. In Schedule II, there is an entry 5(e) which states agreeing to the obligation to refrain from an act, or to tolerate an act or a situation, or to do an act. 

After amendment to the act, the entry  ‘d’ in section 7(1) "the activities to be treated as supply of goods or supply of services as referred to in Schedule II" has been omitted from the scope of Supply.  

And the following sub clause has been added:

(1A) Where certain activities or transactions constitute a supply in accordance with the provisions of sub-section (1), they shall be treated either as supply of goods or supply of services as referred to in Schedule II. 

The above amendments are effective retrospectively from 1/7/2017. 

6.   While dealing with notice pay recovery, it must be noted that it does not fit into the scope of “supply” under clause (a) of sub-Section (1) of Section 7. Furthermore, the above Amendment envisages that where certain activities or transactions constitute a supply in accordance with the provisions of sub-Section (1), they shall be treated either as supply of goods or supply of services as referred to in Schedule II. 

In the normal course of business, employer does not enter into contract with employee for tolerating an act or situation. Notice pay recovery is paid by the employee for non-fulfillment of stipulated conditions mentioned in the employment contract. Such payment cannot be termed as consideration for supply of services as neither the contract was entered for this nor such event is intended. 

7.   Further as notice pay recovery does not fall within the forms of supply i.e. sale, transfer, etc. set out under sub-Section (1) of Section 7, hence the primary conditions of sub-Section (1A) is not satisfied and for that reason the transaction in question in the instant case cannot be termed a “supply” within the meaning of Section 7 and therefore, cannot be subjected to levy. 

Hence, in our view GST is not be leviable on the amount of Notice Pay recovered from Employees based on the above discussions. 

8.   There are couple of recent judgements related to applicability of Service Tax on Notice Pay Recovery under the erstwhile Service Tax Law:

Madras High Court in Ge T & D India Limited v. Deputy Commissioner Of Central Excise, Large Tax Payer Unit, Chennai, 2020-VIL-39-MAD-ST held that employer has merely facilitated the exiting of employees and, hence, notice pay recoveries cannot be considered as taxable services.

The Court elaborated on that Central Board of Excise and Customs (CBEC) in CBECs' Guidance Notes dated 20.06.2012 states that provision of service by an employee to the employer is outside the ambit of service. Accordingly, the employer cannot be said to have rendered any service as he merely facilitated the exiting of the employee by imposing cost upon him for the sudden exit. 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. Hence, notice pay, in lieu of sudden termination, does not give rise to the rendition of service either by the employer or the employee.

As for the department the Court noted that department was wrong in contending that the employer has tolerated the act of immediate quitting from service by the employees and such agreement/toleration results in rendition of a taxable service.

 9.   A similar view was taken by the division bench of Allahabad Tribunal in HCL Learning LimitedCaseM/s. HCL Learning Limited v. Commissioner of Central Goods & Service Tax, Noida, CESTAT Allahabad, 2019-TOIL-3545-CESTAT-ALL wherein the tribunal noted that notice pay recoveries are out of salaries already paid by employer and, hence, service tax should not be charged on such recoveries. The tribunal was of the view that the employment agreement between the taxpayer and employee clearly states that employee shall be paid salary and if employee leaves the job before the term is over then certain amount already paid as salary will be recovered from employee. Hence, such recoveries are out of salary and service tax should not be charged on such recoveries.

Though the above cases belong to the old regime of service tax, they reasoning holds good in the GST regime as well. The government should come out with a clarification to deal with such matter under the Goods & Services Tax (GST) regime.

Conclusion: Based on the above discussion, view can be taken that the essential element to make a transaction taxable is missing and hence the transaction of notice pay recovery cannot be considered as supply. Employee is only making payment for the breach of one of the conditions of employment agreement. In our view, GST shall not be applicable on Notice Pay Recovery after the amendment of Section 7 i.e. scope of supply.

Despite this, the Tax Authorities may contend to levy GST on Notice Pay Recovery. However, a clear perusal of the sections indicate that GST must not be levied upon the same, and hence, a clear clarification to this effect is essential in employer-employee relationships in the present era.

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