Airline Cancellation Charges Are Compensation For Breach Of Contract, Not Taxable Service: CESTAT Delhi

The Customs, Excise and Service Tax Appellate Tribunal (CESTAT), New Delhi, has ruled that cancellation fees collected by Lufthansa German Airlines as compensation for passengers failing to honour their travel commitments are not taxable as consideration for a separate service under Section 66E(e) of the Finance Act, 1994.

“In short, the cancellation charges are in the form of a compensation for failure of a contract entered into that the passenger would fly and the airlines would carry him to his destination. It is not a consideration and there is no separate agreement with an intent that the passenger would default so that airline would get some compensation,” the tribunal observed.

A Bench comprising Officiating President Dr. Rachna Gupta and Technical Member P.V. Subba Rao set aside the service tax demand against Lufthansa and allowed both appeals with consequential relief.

Lufthansa collects cancellation fees, refund fees, and no-show fees from passengers who cancel their tickets or fail to report for travel. The airline paid service tax on its air transport services after availing the applicable abatement. It also paid tax on these charges, treating them as consideration for services rendered.

The Directorate General of GST Intelligence investigated the matter and concluded that cancellation and no-show charges constituted a separate declared service under Section 66E(e) of the Finance Act, which covers the service of tolerating an act. The Department argued that tax was payable on the full value of these charges, without the abatement available for air passenger transport services.

A show-cause notice proposed recovery of ₹6,07,62,939 in service tax, along with interest and penalties, by invoking the extended period of limitation. The adjudicating authority confirmed a demand of ₹5,07,87,202, dropped the remaining ₹99,75,737 and imposed penalties under Sections 77(1) and 78 of the Act.

Before the tribunal, Lufthansa argued that the charges were compensation or liquidated damages for passengers failing to honour their commitment to travel. It contended that Section 66E(e) applies when an agreement is intended to tolerate an act, not when one party compensates the other for failing to fulfil a contractual obligation.

The Revenue maintained that passengers knew at the time of booking that cancellation fees could be charged. It argued that the charges constituted a separate service and were taxable on their full value.

Examining the contractual relationship, the tribunal observed that the airline promises to carry the passenger to the destination, while the passenger agrees to pay the fare. When a passenger cancels a ticket, the airline may suffer a loss because it has to find another passenger at short notice. The cancellation charges are intended to compensate the airline to some extent.

The tribunal also observed that including a cancellation charge in the contract does not mean the parties intend that the passenger will default so that the airline can collect compensation.

It further held that Lufthansa's earlier payment of service tax on these charges after claiming abatement did not change their legal character.

“In view of the above, we find that the demand of service tax on the cancellation fees collected by the appellant cannot be sustained. It will make no difference to this legal position even though the appellant had, wrongly paid service tax on the compensation received by it after availing some abatement. Once there is no charge of service tax at all, it is irrelevant whether the appellant had taken abatement or not taken abatement,” the tribunal observed.

The tribunal accordingly set aside the impugned order and allowed both appeals with consequential relief.

For Appellant: Advocate P.K. Sahu, 

For Respondent: Rajeev Kapoor, Authorised Representative