In a major relief to Chennai Metro Rail, the Chennai CESTAT quashed the demand for service tax on the monies received through encashment of performance Guarantee/Bank Guarantee and that collected/ retained as liquidated damages for non-performance and failure to comply with the agreed obligation by various contractors/sub-contractors.

The appellant, M/s Chennai Metro Rail Ltd (CMRL) is a joint venture between the Government of India and the State Government of Tamil Nadu with equal partnership. It builds and operates Chennai Metro, the elevated & underground rail network in the city of Chennai towards fulfilling its mission of meeting the modern transportation needs of the citizens of Chennai. CMRL engages various companies as contractors to execute specified works for CMRL given the high cost of the project involved and in public interest. The contracts entered into between CMRL, and the contracting entities require clear and strict clauses on performance and provision for compensation and even termination in the event of breaches by the contracting parties. The contracts inter alia stipulated scheduled time for the completion of each activity of the work and any delay in execution shall attract liquidated damages. 

Since certain contractors failed to execute work as per the terms of contract, CMRL retained some amount towards liquidated damages and invoked bank guarantees for the slippage of the scheduled performance on the civil contracts. 

The Service Tax Department has sought to recover service tax on the amount retained by CMRL as damages from the contractor on the basis that the amount retained as damages was consideration for tolerating breach of contract and was allegedly liable to service tax under section 66E(e) of Finance Act 1994. The Appellants are now in Appeal before the Tribunal.

A breach of contract by the contractors/ sub-contractors, whenever it occurred, was tolerated by the appellant and accordingly they have received consideration in two ways, one by way of collection/ retention of liquidated damages and secondly by way of encashment of performance guarantees. Hence the main issue to be decided is the legality of demand for service tax under section 66E(e) of Finance Act 1994, on the monies received for allegedly tolerating breach of contract through encashment of performance Guarantee or Bank Guarantee and that collected/retained as liquidated damages for non-performance and failure to comply with the agreed obligation by various contractors/sub-contractors.

Section 65B(44) defines ‘service’ to mean any activity carried out by a person for another for consideration and includes a declared service. The contract entered into by the appellant with the contractors/ sub-contractors is not aimed at any activity to receive compensation by a breach of contract, similarly it cannot be said that it was the intention of the contractors to breach or violate the contract and incur a loss. Hence there is no agreement/ contract between the parties involving a consideration to be received for a service provided by the appellant which will attract service tax. We find that the issue is no longer res intigra and has been clarified by the CBIC itself as per the Circulars cited by the appellant. 

The tribunal held that The amounts retained towards liquidated damages and also invoked as bank guarantee are not a consideration for tolerating breach of contract. Any amount, which is not a consideration for provision of service, cannot be subjected to service tax.

Case Title: Chennai Metro Rail Ltd. V/s Commissioner of GST & Central Excise