GST is applicable on Notice Pay Recovery from Employees

Brief Facts of the case:

• The applicant is a 100% Export Oriented Unit engaged in Manufacturing of pharmaceutical products.
  
  1. At the time of appointing an employee, they enter into a contract with the employee by issuing “Appointment Letter”.
     
  2. The letter specifies that either party shall serve a three-month mandatory notice to terminate the contract and in case employee doesn’t serve the notice period, then the company is entitled to recover Notice pay from the agreed portion of salary to compensate the loss.

Issue Raised before the AAR:

• Whether the applicant is liable to pay GST on recovery of Notice Pay from the employees who are leaving the company without completing the notice period as specified in the Appointment Letter issued as per the contract entered between Employer and the Employee?

Discussions & Findings of the AAR

• Notice pay is a sum mutually agreed between the employer and the employee for breach of contract.
• It can be regarded as a consideration to the employer for “tolerating the act” of the employee to not serve the notice period, which was the employee’s agreed contractual obligation.
• Section 7(1) of the CGST Act, 2017, includes activities referred to in Schedule II in the scope of supply.
• Clause 5(e) to Schedule II to CGST Act 2017, declares that ‘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 as supply of service.

• The employee has understood and accepted the condition that if he is unable to provide the prescribed notice period, he can exercise the option of paying the notice pay as the consideration for the employer to agree to the obligation of letting him go, which the employer is bound to do as it is part of the terms and conditions already agreed between them.
  
•  Therefore, transaction of the employer agreeing to the obligation of tolerating an act (quitting without any advance notice) on the part of the employee, for payment of a sum (notice pay), will be covered under Clause 5(e) to Schedule II to CGST Act 2017, as a declared service.

Ruling:

The applicant is liable to pay GST @ 18% under the entry of “services not elsewhere classified, on recovery of Notice Pay from the employees who are leaving the company without completing the notice period as specified in the Appointment Letter issued as per the contract entered between them.

Source: Advance Ruling No. GUJ/GAAR/R/51/2020 

– Abhinav Nagpal
Indirect Tax Associate
SW India