CESTAT Chennai Quashes Service Tax Demand On Proprietorship, Rejects Liability For Erstwhile Firm

On 10 June, the Chennai Bench of the Customs, Excise and Service Tax Appellate Tribunal (CESTAT) held that the Department cannot fasten service tax liability on a proprietorship concern for dues arising from an erstwhile partnership firm without establishing any transfer, amalgamation, or successor liability.

Judicial Member Ajayan T.V. and Technical Member M. Ajit Kumar reiterated that composite works contracts executed prior to 1 June 2007 cannot be subjected to service tax under the then-prevailing legal framework and allowed the appeal filed by Space Associates against interest and penalty confirmed against it for the period April 2006 to June 2007. The Bench held:

“...without evidencing in any manner as to how the appellant firm is held liable for the tax arrears of the erstwhile partnership firm, particularly in the absence of any evidence of a formal transfer or amalgamation of the business entity, when the proprietorship has a fresh registration, transferee liability continues to remains unestablished and thus the show cause notice is ab initio void.”

The dispute arose from service tax liability alleged for services rendered between April 2006 and June 2007. The Department issued the show-cause notice to a proprietorship concern that obtained a fresh service tax registration only in October 2008, even though the activities in question were attributed to an erstwhile partnership firm holding a separate registration and PAN.

The Tribunal noted that the Department failed to place any material showing a formal transfer of business, amalgamation, or legal succession that could justify shifting the liability of the partnership firm onto the proprietorship concern. It also observed that the notice itself relied on activities carried out by the partnership firm but proceeded against a distinct legal entity.

The Bench held that the show-cause notice suffered from a fundamental defect because the Department did not issue it to the entity or persons who actually carried out the earlier business. It ruled that, in the absence of established transferee liability, the entire jurisdictional foundation of the demand collapsed.

On merits, the Tribunal held that the activities involved transfer of property in goods along with service components, thereby constituting composite works contracts. It reiterated that the Department could not subject indivisible works contracts to service tax prior to 1 June 2007, when the law specifically introduced “works contract service” as a taxable category.

Rejecting the Department's classification of the activity as commercial or industrial construction service, it held that the composite nature of the transaction defeated the very basis of the demand. It concluded that both jurisdictional and substantive grounds failed, and it set aside the impugned order while allowing the appeal with consequential relief.

Accordingly, the CESTAT allowed the appeal.

For Appellant: Shri P.R. Balachandar, Advocate

For Respondent: Shri M. Selvakumar, Authorized Representative