No GST should be levied by employer on recovery of notice period payment

Recently, the Hon’ble AAR, Gujarat held that GST@18% is applicable on recovery of notice pay as it can be regarded as a consideration for “tolerating the act” of the employee for not serving the notice period and will be covered under Clause 5(e) to Schedule II to CGST Act.

It is to be noted that notice pay is merely a compensation received by the employer on account of failure of employee to fulfill the terms/conditions of the employment contract and there is no positive act of supply from the employer to the employee.

Further, there is no contract between the employer and the employee to cause loss/damage by quitting early 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. Therefore, no GST should be levied on notice pay recovery by the employer.

Furthermore, in GST, the taxable event is supply therefore, in order for a transaction to be taxable, it has to fall under the scope of supply as given under Section 7 of the Central Goods and Services Tax Act, 2017 (CGST Act). For the purpose of our discussion, Section 7(1)(a) of the CGST Act is relevant, which states as under:

“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;”

Further, Para 5(e) of Schedule II of the CGST Act (i.e., activities or transactions to be treated as supply of goods or supply of services) states following as a supply of service:

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

Moreover, vide Central Goods and Services Tax (Amendment) Act, 2018, sub-clause (d) of Section 7(1) of the CGST Act was omitted and sub-section (1A) was inserted with retrospective effect w.e.f. July 1, 2017, to state that in order for a transaction to constitute supply, it should fall under Section 7(1) ibid. Further, the scope of Schedule II of the CGST Act is now restricted to categories supply either as supply of goods or services.

Therefore, “tolerating the act” of the employee for not serving the notice period may fall under 5(e) of Schedule II of the CGST Act but, should not be chargeable to GST as there is no contract between the employer and the employee to cause loss/ damage by quitting early for a consideration. This is only a penalty levied for violation of terms of employment contract and cannot be termed as “Supply” under Section 7(1) of the CGST Act.

(The writer is Executive Director, A2Z Taxcorp LLP)

(The views expressed are personal. The contents of this article are solely for informational purpose. It does not constitute professional advice or recommendation of firm. Neither the author nor firm and its affiliates accepts any liabilities for any loss or damage of any kind arising out of any information in this article nor for any actions taken in reliance thereon)