Is service tax leviable on refraining from an act?

The Union Budget 2012 had ushered in a completely new system of levying service tax. Earlier, the tax was levied on certain specified services only. From 01 July 2012, the tax will be levied on all services rendered for a consideration, except 17 specified services mentioned in what is known as “the Negative List”. However, another substantial change had been brought around in the same budget, which was over shadowed by the incorporation of the “Negative List”.

According to this amendment refraining from an act is also taxed under service tax.

Refraining from an act falls under declared services.

According to section 66(E)e of the Finance Act 1994, as inserted   by Finance Act 2012,  agreeing to the obligation to refrain from an act, or to tolerate an act or a situation, or to do an act shall be a declared service and  liable to service tax.

In terms of this entry, the following activities if carried out by a person for another for consideration would be treated as provision of service.

• Agreeing to the obligation to refrain from an act.

• Agreeing to the obligation to tolerate an act or a situation.

• Agreeing to the obligation to do an act.

This is a new entry which was not taxable in erstwhile provisions prior to Finance Act 2012.

In case a company or any other person enters into a non-compete agreement with another person for a consideration, then it would be considered to be a declared service and attract service tax.

This entry covers cases where cases where a transaction may involve rendering of a service or even non-rendering of a service but consideration is involved – an entry where a non-action or non-service event also becomes taxable because consideration is involved.

Examples –

(a) Non-compete fees for agreeing not to compete.

(b) Compensation on termination of business agreements.

(c) Advance forfeited for cancellation of agreement to provide a service.

(d) Forfeiture of security deposit for damages done by service receiver in course of receiving of services.

(e) Cancellation charges being charged by airlines, hotels etc.

(f) Consideration for non-appearance in a court of law or withdrawal of suit.

(g) Demurrage charges or detention charges.

The above are only examples and one can visualize and imagine any more actions or inactions which Department may seek to impose service tax on, according to the definition given by the department.

Scope

The services shall be of:-

a)      An obligation to refrain from an act

b)      To tolerate an act or a situation

c)      To do an act

Analysis

As per section 66E(e), obligation to refrain from an act or to tolerate an act or a situation, or to do an act, has been declared as a service.

Refrain means to keep oneself from one act or feeling from a particular thing that somebody does.

To sum up:

After referring to the aforementioned definitions the said clause can be broken in to three parts which read as follows:-

1)      Obligation to refrain from an act:-

It means any act, which binds a person, for not doing a particular act in the given circumstance.

For example – Non Compete fees for not doing a particular business or not to practice a particular profession.

2)      Obligation to tolerate an act or a situation

It means to accept the occurrences or existence of an act or a particular thing, which is imposed by a condition or circumstances, in a contract, agreement or any other document which is legally enforceable by law

a)      Penalty on early termination of rental or lease agreement.

b)      Prepayment charges on early payment of loan installment.

c)      Demurrage charges paid to the port authorities for not clearing the goods within a specified period of time.

3)      Obligation to do an act

It means to perform or to do something, necessarily, prescribed in an agreement, contract, or any other document which is required under any law for the time being in force.

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