No GST should be levied on notice pay received from employees in lieu of notice period

The Hon'ble Gujarat AAR, in the matter of M/s Amneal Pharmaceuticals Pvt. Ltd. [Advance Ruling No. GUJ/GAAR/R/51/2020, dated July 30, 2020] recently held that GST at the rate of 18% is applicable on recovery of notice pay from the employees who leave the company without completing the notice period as per the appointment letter.

Facts

M/s Amneal Pharmaceuticals Pvt. Ltd. ("Applicant" or "the Company") is a 100% Export Oriented Unit engaged in the manufacturing of pharmaceuticals products. The Applicant, at the time of appointing any employee at their factory, enters into contract with employees by issuing appointment letter which clearly mentions that, either parties shall serve a three months mandatory notice to terminate the contract. Thus, three months' notice is mandatory for all employees. In case, if any employee doesn't serve the notice period after tendering the resignation, then, the Company is entitled to recover the notice pay from the agreed portion of salary to compensate the loss to the Company.

Issue

Whether the Applicant is liable to pay GST on recovery of notice pay from the employees who leave the Company without completing the notice period as specified in the appointment letter?

Held

The Hon'ble Gujarat AAR, in Advance Ruling No. GUJ/GAAR/R/51/2020, dated July 30, 2020 held as under:

· Observed that, notice pay is nothing but the amount stipulated in the employment contract for breach in serving (not serving) the stipulated notice period. In other words, notice pay is a sum mutually agreed between the employer and the employee for breach of contract. It can be regarded as a consideration to the employer for "tolerating the act" of the employee to not serve the notice period, which was the employee's agreed contractual obligation.

· Noted that, GST is applicable on supply of taxable goods or services under Section 7(1) of the Central Goods and Services Tax Act, 2017 ("CGST Act"), which includes activities referred to in Schedule II of the CGST Act in the scope of supply. Acceptance of offer letter for employment means that the employee has understood and accepted the condition that in the contingency of his inability to provide the prescribed notice period, he can exercise the option of paying the notice pay as the consideration for the employer to agree to the obligation of letting him go, which the employer is bound to do as it is part of the terms and conditions already agreed to and settled between them.

· Held that, the transaction of the employer agreeing to the obligation of tolerating an act i.e., to agree to let go an employee without any advance notice for payment (notice pay), will be covered under Clause 5(e) to Schedule II to CGST Act, as a declared service. Hence, the Applicant is liable to pay GST @18% under the entry of "services not elsewhere classified" (Entry No. 35 of the Notification No. 11/2017- Central Tax (Rate) dated June 28, 2017), on recovery of notice pay from the employees who leave the Company without completing the notice period as per the appointment letter.

Our Comments: No GST should be levied on notice pay received from employees in lieu of notice period

In the service tax regime, the Hon'ble Madras High Court in Ge T & D India Limited v. Deputy Commissioner of Central Excise [W.P. No. 26292 of 2018 dated December 13, 2019] in a similar case has held that no service tax is payable on notice pay. Relevant portion is reproduced below:

"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.

……Notice pay, in lieu of sudden termination however, does not give rise to the rendition of service either by the employer or the employee."

However, in the present matter, the Hon'ble AAR, Gujarat has distinguished the cases of service tax regime as not applicable in respect of levy of GST.

In our view, the levy of GST on notice pay recovery depends upon the "test of supply" i.e., one has to satisfy that notice pay in itself is a supply, then only GST could be levied on it. After the insertion of sub-clause (1A) in Section 7 of the CGST Act and omission of sub-section (d) of Section 7(1) of the CGST Act (vide Central Goods and Services Tax (Amendment) Act, 2018 w.e.f. July 1, 2017) which read as under:

"Scope of supply.

7. (1) For the purposes of this Act, the expression "supply" includes– -

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

(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 Schedule II of the CGST Act is confined to define as to what constitute supply of goods or supply of services and does not defines supply per se. Schedule II of the CGST Act has to be read along with Section 7 of the CGST Act, which means if an activity does not constitute a "supply" in itself as per Section 7(1) of the CGST Act, mere coverage of the same under the entry Schedule II ibid cannot make it liable to GST.

Further, there is no positive act of supply of services by employer to employee for quitting the organization. It is merely recovery of compensation from the employee on account of their failure to fulfil the terms of contract/appointment letter and tantamount to liquidated damage.

Furthermore, there is no agreement between employer and employee to cause loss or damage by quitting early for a consideration. The expression ‘to tolerate an act' relates to situations where a person commissions another person to do or commit a particular act for a consideration. The payment of damages is a condition of contract and not a consideration for any service in the nature of forbearance or tolerating an act.

Relevant Provision

Clause 5(e) to Schedule II of the CGST Act:

"Activities or transactions to be treated as supply of goods or supply of services-

5. Supply of services

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