Service Tax Applicability on Short Recovery Notice

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INTRODUCTION
In the present day corporate world, an employee is expected
to possess challenging skill sets to perform the duties expected as per his job
profile due to which there is a high demand for talented human resource.
Employees generally opt to change jobs from the existing company to the new
company in pursuit of better prospects but, before shifting over to the new
company one has to serve notice period for a period of two to three months, as
per the prevailing practice in the industry.


CONCEPT OF SHORT
NOTICE RECOVERY
An employee is expected to give a notice to the company, at
least two to three months before quitting the job and shall continue to work in
the same role till completion of such period and this period is called as ‘notice
period’
. In case of employee not serving the mandated notice period, the
company could rightfully recover an amount called as short notice period
recovery as per the company’s policy or terms of employment contract.
We shall examine, whether service tax is applicable / payable
by company on amount collected towards short notice recovery from the parting
employees in this article.
SERVICES IN COURSE
OF EMPLOYMENT
Under the negative list based taxation, all the services
covered under the definition of service w.e.f. July 2012 shall be taxable,
except the services listed in Negative list or services exempted vide mega
exemption notification.
As per Section 65B
(44), definition of service reads as under:
“Service” means any
activity carried out by a person for another for consideration
, and
includes a declared service, but shall not include;
“A provision of service by an employee to the employer in the
course of or in relation to his employment; “
In other words, the
service provided by employee to employer in course of employment is excluded
from service tax levy.
SERVICE TAX
IMPLICATION ON SHORT NOTICE RECOVERY
Now it is clear that, there is no exclusion or exemption to
the services provided by employer to employee. The same is also not covered in
the exclusion limb of the service definition either and covers declared
services in the definition of service, and declared services, as per section
66E (e) sets out as under:
‘agreeing to the obligation to refrain from an act, or to
tolerate an act or a situation, or to do an act’
Companies collect money from the resigning employees for
tolerating early termination from the employment, without serving notice period
and such receipts could be liable to service tax in the hands of company, at
the limb-to tolerate an act or a
situation
and service tax could be demanded.
At same time, it should not be lost sight that under negative
list based taxation, the Service tax levy is an activity tax. Service tax is
leviable on service being ‘any activity’ for a consideration. Though the
company is receiving a consideration, there is no activity done by company to
the employee in exchange for consideration of notice period recovery. A view is
possible that the fundamental premise of ‘activity for a consideration’ itself
is not satisfied, in which case the Service tax levy may not be applicable.
Even though it is not liable, as of date there is no
clarification/circular clarifying non applicability of service tax on notice
period recovery, erring on caution the service tax could be decided to be paid
by the company as under.
WHETHER SERVICE TAX CAN BE COLLECTED FROM THE EMPLOYEE?
As per Section 68(1), service tax is payable by the provider
of taxable services, except in some specified instances where the service
receiver is liable. As service tax is destination based levy the service tax
could also be collected from the service receiver and paid to Government by the
service provider. This view was also held in All India Federation of Tax
Practitioners and others v/s Union of India 2007 (8) – Supreme Court
An employer, who is recovering amount towards short notice,
could collect and pay the service tax at 12.36% from the employee. As a tax
planning, company could insert a clause in the employment agreement, stating
that service tax payable extra by employee as applicable. If company does not
collect service tax extra.
If company does not collect extra service tax, then it shall
bear the service tax out of pocket by calculating the service tax on inclusive
basis as per Sec 67(2) of the Act.
An illustration is provided below for the benefit of readers
for clear understanding of the concept.
ILLUSTRATION:
Mr. Vijay, a professional software programmer, employed in
M/s. ABC Software Pvt. Ltd. having an experience of 2 years, drawing a salary ₹ 75,000 p.m. and wish to leave the company
as he has got some better opportunity elsewhere. So he decides to leave M/s.
ABC and as per the terms of employment he shall serve notice period for
a period of 3 months. Compute the amount of service tax payable by the company.
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SOLUTION:
In the given case
assuming that Mr. Vijay has served only one month of notice period and did not
serve other two months and agreed to pay off his short notice.
SITUATION 1:
No separate clause
in the employment agreement, with respect to service tax and the company did
not collect service tax from Mr. Vijay. Amount
received as short notice recovery for 2 months
Rs.1,50,000 (Rs. 75,000 * 2
months).
Service tax included in ₹ 1,50,000
Rs. 16,501 (Rs.
150,000*12.36/112.36)
Therefore
in the current situation M/s. ABC shall pay a service tax of ₹
16,501 from
this receipt.
SITUATION 2:
A separate clause in
the employment agreement is inserted saying ‘that the amount recovered would
be in addition to the applicable service tax’ Amount received as short notice
recovery for 2 months
Rs. 1,50,000 (Rs.
75,000 * 2 months)
Service tax on in ₹ 1,50,000
Rs. 18,540 (Rs.
150,000 * 12.36%)
Therefore in the
current situation M/s ABC shall pay a service tax of ₹ 18,540 from this receipt, which shall be
collected from the Employee.
CONCLUSION

Though there is no
activity of service, there is a flow of consideration from employee to employer
and also at present there is no clarity in the law. Since, service tax law is
new and developing with grey areas, erring on caution the recovery towards
short notice could be levied to service tax and it is advisable to remit
service tax by the employer either by collecting it from the employee or shall
be paid by employer by calculating service tax on inclusive basis as
illustrated above.
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