The Kerala Appellate Authority for Advance Ruling (AAAR) has held that recovery of notice pay from employees who leave employment without serving the stipulated notice period does not attract GST, as such recoveries arise out of the employer-employee relationship and are covered under Schedule III of the CGST Act, 2017. A Bench comprising Sh. S.K. Rahman, IRS (Member-Central Tax) and Sh. Patil Ajit Bhagwatrao, IAS (Member-State Tax) allowed the appeal filed by M/s. Manappuram Finance Ltd.

The dispute arose after the Kerala AAR, through Order No. KER 13/2023, held that notice pay recovery constituted a taxable supply under GST. The AAR had treated the recovery as consideration received by the employer for “tolerating an act” under Entry 5(e) of Schedule II of the CGST Act.

Aggrieved by the ruling, the appellant approached the AAAR contending that deduction of notice pay from employees leaving before completion of the mandatory notice period is merely a contractual compensation for breach of employment conditions. It was argued that the transaction remains intrinsically connected with the employer-employee relationship and therefore falls within Entry 1 of Schedule III, which excludes services by an employee to the employer in the course of employment from the ambit of GST.

“Notice pay recovery is only a mechanism to compensate the employer for sudden exit of employees and cannot be treated as an independent supply of service.”

The AAAR observed that notice period clauses are integral parts of employment contracts intended to regulate premature exits and ensure smooth business continuity. The Bench held that the amount recovered from employees cannot be equated with consideration received for tolerating an act or agreeing to an obligation.

The Authority further noted that there was no separate agreement whereby the employer agreed to provide any service in return for payment of notice pay. Instead, the recovery merely represented compensation arising from breach of contractual obligations under employment terms.

“The entire transaction remains within the employer-employee relationship and is covered by Entry 1 of Schedule III of the CGST Act.”

The Bench concluded that notice pay recovery neither qualifies as supply of goods nor as supply of services under Section 7 of the CGST Act. Consequently, GST cannot be levied on such recoveries made from employees at the time of separation from service.

Thus, the Kerala AAAR set aside the findings of the AAR and allowed the appeal in favour of the assessee.

To Read Full Order, Download PDF Given Below.