Employer-Employee Relationship Does Not Constitute Supply of Service Under GST Law, Court Holds in TASMAC Supervisor's Case
In a significant judgment delivered on August 14, 2026, the Madras High Court (Madurai Bench) has clarified that Goods and Services Tax (GST) cannot be levied on penalties imposed on employees by their employers within the framework of the employer-employee relationship. The ruling came in an intra-court appeal filed by the Managing Director of Tamil Nadu State Marketing Corporation Limited (TASMAC) against K.R. Subramanian, a supervisor at a TASMAC outlet, who challenged the imposition of GST on a penalty for alleged stock shortage.
The appellant, TASMAC, had imposed a penalty of Rs. 1,41,435 along with GST and interest on the respondent following an inspection that revealed a shortage in liquor stock at TASMAC Shop No.6547, Kiranur, Pudukkottai District. The penalty was imposed after a show-cause notice was served on the respondent, who contested the GST component by filing a writ petition. The Single Judge, in December 2020, directed TASMAC to conduct a fresh enquiry regarding the GST collection on the penalty.
TASMAC contended that the GST levy was justified under Section 7 of the Central Goods and Services Tax Act, 2017, and Schedule II, Paragraph 5(e), which addresses obligations involving refraining from or doing acts as part of supply of services. The company argued that penalty collection along with GST was lawful.
However, the Division Bench comprising Justices M. Dhandapani and N. Dilip Kumar disagreed. The Court examined the nature of the employer-employee relationship and distinguished it from a supply of goods or services. It held that the penalty imposed was an internal disciplinary measure within the employment relationship and did not amount to a supply of service capable of attracting GST.
The Court emphasized that Paragraph 5(e) of Schedule II, which deals with agreements to refrain from or tolerate acts, applies only in the context of a supply of services. Since the penalty was imposed for alleged stock shortage during the discharge of employment duties, it cannot be construed as a taxable supply. Therefore, imposing GST on such penalty amounts is contrary to the provisions of the CGST Act.
Consequently, the Madras High Court dismissed TASMAC's appeal, upholding the Single Judge's order that quashed the GST component on the penalty and directed a de novo enquiry concerning GST collection. The Court's decision provides clarity on the non-applicability of GST on penalties arising from employer-employee disciplinary actions.
This judgment reinforces the principle that the employer-employee relationship is distinct from commercial transactions involving supplies and that GST cannot be arbitrarily extended to penalty charges within this relationship. The ruling also offers guidance to government and private organizations regarding the limits of GST applicability in employment contexts.
Bottom Line:
GST cannot be imposed on the penalty charged against an employee during the course of an employer-employee relationship, as the relationship does not constitute a "supply of service" under the Central Goods and Services Tax Act, 2017.
Statutory provision(s):
Central Goods and Services Tax Act, 2017 Section 7, Schedule II Paragraph 5(e)
