Liquidated damages not taxable as declared service — CESTAT

The CESTAT (Tribunal) ruled that liquidated damages/penalty clauses in commercial contracts — imposed as compensation for breach or delay — do not constitute a declared service attracting service tax under the pre-GST regime (Finance Act provisions read with Section 66E(e)). The Tribunal characterised such liquidated amounts as compensatory in nature (designed to secure performance) rather than payment for a taxable service. The order analyses the legislative intent behind “declared services” and distinguishes contractual penalties from consideration for a service. It also grapples with limitation and extended levy issues where revenue sought tax plus interest/penalty. For businesses and litigators, the ruling provides an important precedent to resist retrospective service-tax demands on contractual penalties and argues for substance-based classification. Entities providing goods or contracting services must nonetheless carefully draft contracts and maintain contemporaneous records to establish the compensatory (and non-service) nature of such sums to rebut revenue claims and avoid unwarranted liabilities.