The Customs, Excise & Service Tax Appellate Tribunal set aside two orders imposing service tax on airline cancellation charges, holding that such amounts constitute liquidated damages for breach of contract, not a separate service under Section 66E(e) of the Finance Act, 1994. The decision reinforces the principle that tax liability arises only when the agreement’s purpose is to tolerate an Act, not to compensate for default.
Background & Facts
The Dispute
The core dispute was whether amounts collected by an airline from passengers as cancellation, refund or no-show fees constitute a separate ‘service’ under Section 66E(e) of the Finance Act, 1994, thereby attracting service tax, or whether they are merely liquidated damages for breach of the contract of carriage.
Key Facts
- The appellant, M/s Lufthansa German Airlines (Deutsche Lufthansa AG), is an airline selling air tickets to passengers and paying service tax on the air transport service after availing applicable abatement.
- When passengers cancel tickets or do not show up, the appellant charges cancellation fees, refund fees, no-show fees, etc., treating these amounts as consideration for the service rendered and paying service tax thereon.
- The Directorate General of GST Intelligence (DGGI) investigated and concluded that the penal charges collected for cancellation or no-show are a separate service covered as a declared service under Section 66E(e) of the Finance Act, 1994, and that service tax must be paid on the full amount of such charges, not on the abated value.
- Accordingly, a show cause notice (SCN) dated 08.01.2018 was issued proposing to recover service tax of Rs. 6,07,62,939/- on the value of the cancellation penalty collected by the appellant, invoking the extended period of limitation under the proviso to Section 78(1) of the Act, together with interest and penalties.
- The Additional Director General (Adjudication), DGGI passed an order-in-original (OIO) No. 24/2019-ST dated 24.09.2019 confirming a demand of Rs. 5,07,87,202/- and dropping a demand of Rs. 99,75,737/-; penalty was imposed under Sections 78 and 77(1) of the Act.
- A second OIO No. 26/AK/Pr. COMMR/CGST/DSC/2023-24 dated 29.08.2023 passed by the Principal Commissioner of Central Goods & Service Tax, Delhi South, raised a similar demand on cancellation charges for a later period.
- The appellant relied on the judgments in South Eastern Coalfields Ltd. v. Commr. of C. Ex. & S.T., Raipur and Dy. G.M. (Finance), Bharat Heavy Electricals Ltd. v. Commissioner of Customs & Central Excise, Bhopal to argue that Section 66E(e) applies only where the agreement’s purpose is to tolerate an Act, not where compensation is charged for breach.
- The respondent contended that the cancellation charges constitute a distinct service, that passengers are aware of such fees at the time of booking, and that service tax must be levied on the full amount without abatement.
- A Circular dated 28.02.2023 issued by CBEC accepted the interpretation that ‘tolerating of an Act’ under Section 66E(e) does not cover compensation for breach of contract.
Procedural History
- 08.01.2018: Show cause notice issued by DGGI proposing service tax recovery on cancellation charges.
- 24.09.2019: OIO No. 24/2019-ST passed by Additional Director General (Adjudication), DGGI confirming demand of Rs. 5,07,87,202/- and imposing penalty.
- 29.08.2023: OIO No. 26/AK/Pr. COMMR/CGST/DSC/2023-24 passed by Principal Commissioner, CGST, Delhi South on cancellation charges for a later period.
- Appeals were filed challenging the respective OIOs (Service Tax Appeal No. 50004 of 2020 and Service Tax Appeal No. 50849 of 2025).
- 18.08.2026: Date of hearing before the Customs, Excise & Service Tax Appellate Tribunal, New Delhi, Principal Bench.
- 13.10.2026: Date of decision (final order).
Relief Sought
The appellant sought to set aside the demands of service tax, interest and penalties confirmed in the OIOs, and to obtain consequential relief including refund of any amounts paid under protest.
The Legal Issue
The central question was whether cancellation charges collected by an airline from passengers for breach of the contract of carriage constitute a ‘service’ under Section 66E(e) of the Finance Act, 1994, thereby attracting service tax, or whether they are merely liquidated damages for breach of contract outside the tax net.
Arguments Presented
For the Appellant
The appellant relied on South Eastern Coalfields Ltd. v. Commr. of C. Ex. & S.T., Raipur and Dy. G.M. (Finance), Bharat Heavy Electricals Ltd. v. Commissioner of Customs & Central Excise, Bhopal to submit that Section 66E(e) of the Finance Act, 1994 can be invoked only if the purpose of the underlying agreement is to tolerate an Act. Where the agreement is to perform an Act (carriage of passengers) and compensation is charged for default by the other party, the provision does not apply. The appellant further argued that the cancellation charges are in the nature of liquidated damages intended to compensate the airline for the loss suffered due to the passenger’s breach, not a separate service.
For the Respondent
The authorized representative for the Revenue contended that the cancellation fees, being amounts charged for the passenger’s failure to perform, constitute a distinct service in themselves. Since such service is expressly declared under Section 66E(e) of the Act, service tax must be paid on the full amount of the compensation collected, without the benefit of abatement applicable to the air transport service. The respondent emphasized that passengers are aware of the cancellation fee at the time of booking, making it an integral part of the agreement.
The Court's Analysis
The Tribunal began by noting that a contract under the Indian Contract Act consists of reciprocal promises: the airline’s promise to carry the passenger and the passenger’s promise to pay the fare. When the passenger fails to perform (by cancelling the ticket), the airline may sue for damages. If the contract pre-determines the amount payable for such breach, those are liquidated damages. The Tribunal observed that the intention behind a liquidated damages clause, like a prenuptial agreement, is not to encourage breach but to provide a standby remedy should the contract fail. Similarly, the parties to an airline ticket do not intend that the passenger will cancel so the airline can earn compensation; the intention is that the passenger will fly and the airline will carry them to destination. However, when a cancellation occurs, the airline suffers a loss (having to find another passenger at short notice) and the cancellation charge is meant to compensate for that loss.
The Tribunal then examined the language of Section 66E(e), which taxes ‘services consisting of the tolerating of an act’. It held that the expression ‘tolerating of an Act’ contemplates a situation where one party agrees to put up with or allow another to perform an act, not a scenario where one party pays compensation for the other’s failure to perform an act. The Tribunal found support in the judgments cited by the appellant and in the CBEC Circular dated 28.02.2023, which expressly accepted that interpretation of ‘tolerating of an Act’ does not extend to compensation for breach of contract.
"We find that the demand of service tax on the cancellation fees collected by the appellant cannot be sustained."
Accordingly, the Tribunal concluded that the impugned orders demanding service tax on cancellation charges were unsustainable in law and required to be set aside.
The Verdict
The appeals were allowed. The Tribunal set aside the order dated 24.09.2019 confirming a service tax demand of Rs. 5,07,87,202/- and the associated penalties under Sections 78 and 77(1) of the Finance Act, 1994. It also confirmed that the dropped demand of Rs. 99,75,737/- remains dropped. The order dated 29.08.2023 was similarly set aside. The appellant was granted consequential relief, including refund of any amounts paid under protest, with interest at the applicable rate from the date of payment until refund.
What This Means For Similar Cases
Liquidated Damages Do Not Attract Service Tax
Where amounts charged for breach of contract are genuine liquidated damages intended to compensate for loss suffered, they do not constitute a separate service under Section 66E(e) of the Finance Act, 1994. Practitioners should characterise such charges as compensation and argue that no service tax liability arises.
Purpose of Agreement Determines Applicability of Section 66E(e)
The provision applies only when the underlying agreement’s purpose is to tolerate an Act. If the agreement is to perform an Act (e.g., carriage of passengers) and the charged amount is compensation for default, the provision is not attracted. This distinction must be pleaded and evidenced at the outset of any tax dispute.
Reliance on Administrative Circulars
The Tribunal’s reliance on the CBEC Circular of 28.02.2023 underscores that administrative instructions clarifying the scope of taxing provisions can be determinative. Taxpayers should monitor and cite such circulars when challenging tax demands on analogous grounds.
