Notice period recovery or notice pay is nothing but the amount that is to be paid by the employee to the employer who is resigning from the job, if it doesn’t give due notice period as stipulated in the employment contract. In other words, notice pay is a sum mutually agreed between the employer and the employee for breach of contract. Applicability of GST on notice period recovery has been a grey area since long.
On the issue of applicability of GST on notice period recovery / notice pay , Gujarat Authority for Advance Ruling (AAR) has recently pronounced it ruling in the case of M/s Amneal Pharmaceuticals Pvt. Ltd has adjudged that 18% GST will be applicable on the recovery of Notice Pay as per the appointment letter from the employees who are leaving the company without completing the notice period.
Facts of the Case:
- The applicant, M/s Amneal Pharmaceuticals Pvt. Ltd. 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.
- In case the employer signs and leaves without serving the notice period, the company is deducting the notice pay amount for unserved notice period to cover the loss of company for immediate recruitment of new candidates and also to regularize the activities not handed over to upcoming employee.
Issue raised before AAR:
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?
Order of Gujarat AAR: Deliberation and Ruling
- 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.
- GST is applicable on supply of taxable goods or services. Section 7(1) of the CGST Act, 2017, includes activities referred to in Schedule II in the scope of supply. Clause 5(e) to Schedule II to CGST Act 2017, declares that ‘agreeing to the obligation to refrain from an act, or to tolerate an act or a situation, or to do an act’ shall be treated as supply of service. The condition to pay an amount as notice pay in lieu of notice period, for the employer to agree to let go an employee, normally forms part of the terms and conditions of employment. This would mean that the employee while accepting the offer of employment, has not only understood the intent on the part of the employer in prescribing this exit condition, but has also accepted it. In other words, 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.
- In our view, therefore, this transaction of the employer agreeing to the obligation of tolerating an act (quitting without any advance notice) on the part of the employee, for payment of a sum (notice pay), will be covered under Clause 5(e) to Schedule II to CGST Act 2017, as a declared service.
In view of above deliberations the coram consisting of Sanjay Saxena and Mohit Aggarwal held that the applicant is liable to pay GST @ 18% under the entry of “services not elsewhere classified, on recovery of Notice Pay from the employees who are leaving the company without completing the notice period as specified in the Appointment Letter issued as per the contract entered between them.
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Our Comments: GST should not apply on Notice Pay
In our view the above decision of Gujarat AAR is not of right footing as GST should not be levied on notice period / pay recovery due to following reasons:
i) The Gujarat AAR has based its decision on clause 5(e) to Schedule II, ignoring the amendment (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 had rectified the anomaly by providing that merely coverage of a transaction in Schedule II will not make it supply. First, it has to satisfy the test of ‘supply’ within clause (a) to (c) of section 7 (1). If a transaction qualifies as supply then only reference would be made to Schedule II to determine as to whether it ‘supply of goods’ or ‘supply of services.
ii) The notice pay recoveries are paid by the employee in default to compensate the employer who has suffered because of non-fulfillment of the conditions stipulated in the employment contract/agreement. They cannot be termed as a consideration for any service.
iii) 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 thus notice period recovery is not a supply.
iv) 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 Gujarat AAR, has distinguished the cases of service tax regime as not applicable in respect of levy of GST. This view seems to be very harsh as under service tax law , the act of tolerating was regarded as declared service and subject to service tax , whereas under GST law any tolerating of an act will not itself be regarded as supply and such activity should first qualify as supply under clause (a), (b) and (c) of Section 7(1) of the CGST Act, 2017.
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Frah Saeed is a law graduate specializing in the core field of indirect taxes and is the Co-founder of taxwallah.com. She has authored many publications on GST and is into full-time consultancy on GST to big corporates. She as a part of taxwallah.com heads a team comprising of Chartered Accountants and Advocates and plays a key role in our mission to disseminate GST knowledge to all.
