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Service Tax Applicability on Short Recovery Notice

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.

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.

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.

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.

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.
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.

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.
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.
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.


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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