CESTAT Quashes Rs. 17 Lakh Service Tax Demand on Hindustan Zinc for Liquidated Damages and Penalties
Pranav B Prem
The Customs, Excise and Service Tax Appellate Tribunal (CESTAT), New Delhi, has set aside a service tax demand of ₹17.10 lakh imposed on Hindustan Zinc Ltd. for sums collected under heads such as liquidated damages, penalties, and forfeiture of earnest money from contractors. The Tribunal, comprising Ms. Binu Tamta (Judicial Member) and Mr. Rajeev Tandon (Technical Member), ruled in favor of the appellant, holding that these amounts do not constitute consideration for any taxable service under Section 66E(e) of the Finance Act, 1994.
Background of the Case
Hindustan Zinc Ltd., a manufacturer of high-grade zinc, cadmium, and sulphuric acid, was registered under the Service Tax Department for various services, including goods transport, manpower supply, works contract, and legal consultancy. During the audit of its records, the department found that the company had collected approximately ₹1.39 crore as liquidated damages, penalties, and forfeited amounts from contractors who failed to perform as per contractual terms.
Following this audit, the department initiated proceedings alleging that the recoveries constituted a “declared service” under Section 66E(e) of the Finance Act, which includes “agreeing to the obligation to refrain from an act, or to tolerate an act or a situation, or to do an act.” Based on this classification, the department confirmed a demand of ₹17,10,532, alleging that Hindustan Zinc had effectively tolerated the poor performance or non-compliance of contractors in exchange for these payments.
Tribunal’s Analysis and Findings
The Tribunal framed the core question as whether the amounts collected as forfeiture of security deposits, penalties, and liquidated damages are taxable under the “declared services” category, particularly Section 66E(e).
The Tribunal emphatically held that there was no agreement wherein Hindustan Zinc had agreed to tolerate substandard performance in exchange for payment. Referring to the statutory definition under Section 65B(44), the Tribunal reiterated that for a transaction to be considered a “service,” there must be an activity carried out for a consideration. It emphasized that these damages were not voluntary or agreed payments in lieu of a service but were compensatory in nature, arising out of contractual breaches.
Reliance on Judicial Precedents
The Tribunal noted that this issue was no longer res integra (open to doubt or reinterpretation), having been conclusively settled in earlier decisions:
South Eastern Coalfields Ltd. v. CCE & ST, Raipur [(2021 (55) GSTL-549 (Tri. Delhi)]: In this landmark ruling, the Tribunal had held that liquidated damages and penalties for breach of contract are not consideration for tolerating an act and hence not liable to service tax. The Supreme Court had permitted the withdrawal of the Revenue's appeal in this case, thereby cementing its authority as a binding precedent.
Earlier Orders in Hindustan Zinc’s Own Case [Service tax Appeal No. 51497 of 2019-CESTAT]: The Tribunal had already decided in favor of Hindustan Zinc in two earlier appeals (Final Order No. 50025/2025 and 59733/2024), which involved similar facts and legal issues.
Other Tribunal Rulings:
Oil & Natural Gas Corporation Ltd. v. CGST [Service Tax appeal No. 52596 of 2019-CESTAT, New Delhi], Dehradun
Bharat Aluminium Company Ltd. v. Principal Commissioner [Service Tax Appeal No. 50800 of 2020 (DB) CESTAT,New Delhi], Raipur
Sarda Energy & Minerals Ltd. v. Principal Commissioner [Service Tax Appeal No. 51699 of 2017 CESTAT, New Delhi], Raipur
In all these cases, it was consistently held that such recoveries are compensatory in nature and not a payment for any service.
CBIC Clarifications
Further strengthening the appellant’s case, the Tribunal referred to CBIC Circular No. 214/1/2023-ST dated 28.02.2023, which categorically clarified that compensation for breach of contract, including liquidated damages and forfeiture of earnest money, does not constitute “supply” and is not subject to service tax. The Circular elucidated that:
Liquidated damages are compensation for loss or damage due to breach—not consideration for any tolerable act.
Forfeiture of earnest money or penalty amounts merely reflect the commercial consequences of breach and not an agreement to tolerate such breach.
There must be an explicit agreement for tolerance or forbearance for any payment to qualify as consideration under Section 66E(e).
Tribunal’s Ruling
The Tribunal concluded that: “There is therefore no rendering of service in terms of Section 65B(44) of the Finance Act, 1994 and therefore, no demand in terms of Section 66E(e) of the Act would be maintainable.” It held that such amounts were not paid in return for any service and were purely penal or compensatory in nature. Since there was no quid pro quo or performance of an activity for consideration, the demand could not be sustained. The Tribunal allowed the appeal filed by Hindustan Zinc Ltd., setting aside the entire service tax demand of ₹17,10,532 and granting consequential reliefs as per law.
Appearance
Shri Shivam Bansal and Shri Dhruv Anand, Advocates for the Appellant
Shri Shashank Yadav, Authorized Representative for the Respondent
Cause Title: M/s. Hindustan Zinc Ltd. V. Commr. of CGST & Central Excise, Udaipur
Case No: Service Tax Appeal No.51138 of 2020
Coram: Ms. Binu Tamta [Judicial Member], Mr. Rajeev Tandon [Technical Member]
