It is seen that under GST law, there are some issues that are related to the applicability of GST on the payment to the employee like employee notice period recovery, compensatory damages, which need clarity for taxation. Although many private organizations make a contract with the employee by which, employees shall have to legally serve the office for a specified period which could be varied from 15 days to 3 months or more depending on the designation or role of a particular employee during the termination of employment contract in the organization. If any employee who fails to serve the notice period, then the security amount which has been collected at the time of appointment or amount which could be part of the salary, would be withheld by such organization as ‘Notice period pay’. Now, the question arises that whether such withheld amount which becomes the income of the organization, shall fall in the ambit of GST Although GST has replaced the earlier law, the treatment of GST on notice pay recovery shall continue.
There are certain activities that have been specifically mentioned in Schedule II to CGST Act 2017 and it provides whether the supply shall be treated as goods or services. One of the points in the schedule states that the 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 a service. Based on a general reading of the point, it could be understood that notice period pay is the consideration received by an employer for tolerating the act of an employee who does not serve the notice period and hence GST shall be levied.
Fun fact that UK VAT law is very close to our new GST law in which tax does not levy on termination of a contract subject to certain conditions. Our GST law does not provide for such exemption hence this may not be applicable in India.
Employment services exempted from GST
As per section 7(2) read with Schedule III, Services provided by an employee to employer in course of or in relation to employment would not treat as either supply of goods or as services. By reading this clause, some may think that if the services by the employee are not treated as supply then also recovery of notice period pay in course of employment should not be treated as supply liable for GST. It is to be noted that here the services are being provided by an employer to an employee by way of tolerating the act and not an employee by the employer i.e., here the supplier or service provider is employer and service receiver is an employee. Hence, the view may not be a good reason for levying the tax on such recoveries that the exemption is for services by an employee to employer and not for services by the employer to employee.
Clarification from the department in Old law
As per the Old service Tax Act, after the introduction of the negative list taxation system in the year 2012, tolerating an act was considered as ‘declared service’. After this, there was a lot of confusion came on the applicability of service tax on notice pay recovery. While conducting an audit of an assessee, the Director-General of Central Excise Intelligence (DGCEI) in November 2015 had made the following observation:
- It appears to be covered under the declared services of, “agreeing to the obligation to refrain from an act, or to tolerate an act or a situation, or to do an act” when the activity of entering into an agreement by employer with employee to allow him for paying some charges/expenses/fee or to forfeit the security deposit, etc., in case of his leaving the employment without giving stipulated notice or completing the bond period.
- The Service Tax would be leviable on employers for providing these services because here, the services are being provided by the employers to its employees and consideration in terms of forfeiture of security deposit or other payments is being received by the employers in lieu of these services.
And based on this, many assesses, before the introduction of GST, got show-cause notices for payment of service tax.
Applicability of GST on notice Pay Recovery
GST is applicable to the supply of taxable goods or services. As we already discussed above that in terms of schedule II to CGST Act 2017, agreeing to the obligation to refrain from an act, or to tolerate an act or a situation, or to do an act is deemed as service.
It can be argued that such recoveries are not subject to tax In case of notice pay policy if there is no such agreement for tolerating the act of an employee.
Another argument can be that though there is no agreement such amounts are recovered for tolerating the act of an employee who quits his job without serving the agreed notice period and therefore, it shall be taxable. As this a long-pending issue, there would be a need for clarification by the government. One more argument can be made that since there is no positive act and therefore, there would be no supply liable for GST
In the opposite of recovery of notice pay, there are instances wherein organizations had paid the amounts to an employee for termination of the employment contract before retirement. Such amounts paid would be given as “part of salary” and paid as salary. In such cases, there may not be disputes with regard to GST applicability. This payment is called a voluntary retirement scheme (VRS) under the Income-tax Act, 1961.
In the end, you may rely on the above decisions as made under earlier service tax laws or also could contend that there is no supply of any service to the employees in case of notice pay recoveries. Many Representations has been also been made from the industrial associations to seek clarification from the government on this subject as it is very common to recover amounts in service industries. We hope, this article could provide you some understanding of this. Although, it is always advisable that to pay the GST on notice pay recoveries of for such period by grossing up. For example: if the entity has received Rs.10,000 as the recovery of a notice period, then consider it as inclusive of GST and pay the GST accordingly.