Suo Motu Adjustment of Erroneously Paid Tax: Limitation and Penalties Set Aside

Facts

The Audit Instruction: The assessee, a nationalized bank, was directed by an audit team to pay service tax on its share of profit from foreign exchange transactions.
The Payment: Following these instructions, the bank paid the tax but later realized, upon internal verification, that such profit-sharing did not constitute a “taxable service” under the Finance Act.
Refund Rejection: The bank filed a refund claim for the erroneous payment, which the Department rejected solely on the grounds of being time-barred under Section 11B.
The Adjustment: After the refund rejection, the bank adjusted the amount suo motu (on its own) against its service tax liability in a subsequent return.
Departmental Action: The Department objected to this self-adjustment. The Assessing Officer confirmed a demand for the adjusted amount along with interest and a penalty, arguing that suo motu adjustment after a refund rejection was impermissible.

Decision

Final Verdict: In favour of the Assessee.
Ratio Decidendi:
- Duty to Refund: The Court held that since the share of profit was not liable to service tax, the Department should have refunded the amount at the first instance. The Department cannot retain money that was never due to it as tax.
- Nature of Error: The Court characterized the suo motu adjustment as a “technical error” lacking any mala fide (bad faith) intent.
- Anti-Unjust Enrichment: It was ruled that the Department cannot approve its own “unjust enrichment” by relying on the statute of limitations or the fact that the assessee did not appeal the original refund rejection.
- Penalty Quashed: When an adjustment is made to recover an amount erroneously paid under audit pressure, the process cannot be termed improper or illegal for the purpose of imposing penalties.

Key Takeaways

Audit Pressure vs. Legality: Payments made solely based on audit instructions do not necessarily validate the taxability of a transaction. If a transaction is inherently non-taxable, the right to recover those funds remains legally protected.
Substance Over Formality: This ruling emphasizes that “limitation periods” should not be used as a shield by the Revenue to retain collections that are not backed by law.
Self-Correction Rights: While suo motu adjustments are generally scrutinized heavily, this case provides a strong precedent for banks and large institutions to claim that technical adjustments made to correct an obvious error should not attract penalties or interest.
Defense Against Unjust Enrichment: Professionals can cite this ruling to argue that the Department’s retention of non-taxable amounts is unconstitutional, even if procedural timelines for a formal refund claim have lapsed.

HIGH COURT OF MADRAS

State Bank of India

Deputy Commissioner Service tax Cell^*

Dr. G. Jayachandran and Shamim Ahmed, JJ.

CMA No. 1925 of 2019

APRIL 8, 2026

Joseph Prabakar for the Appellant. B. Satish Sundar for the Respondent.

JUDGMENT

Dr. G. Jayachandran, J. – The Civil Miscellaneous Appeal is preferred by the Assessee, being aggrieved by the order of the Customs, Excise and Service Tax Appellate Tribunal (CESTAT), Chennai, dismissing the appeal.

2. The facts of case is as below:

2.1. The appellant is a Nationalised Bank. During an audit conducted by the Central Excise and Service Tax Department, the audit team has instructed the appellant to pay service tax to the tune of Rs.20,23,916/-, on the premise that the share of profit in transactions related to foreign exchange was tantamount to a taxable service. However, based on their advice and instructions, the appellant paid the said amount on 22.12.2006. Subsequently, on verification, it was found that the said share of profit cannot be levied with service tax and therefore, claim for refund was filed, stating that the remittance of Rs.20,23,916/- had been made in error. The said request was rejected on the ground that the claim was barred by limitation. Meanwhile, the appellant suo motu adjusted the said amount in the subsequent return. This was found fault, leading to passing the order in original, which reads as below:

“I confirm the demand of Service Tax of Rs.19,87,688/-(Service Tax Rs.19,48,713/- and Edn, cess Rs.38,975/-) (Rupees Nineteen Lakhs Eighty Severn Thousand Six Hundred and Eighty Eight Only) proposed in the show cause notice dated 27.02.2008, under Section 73(1) of the Finance Act, 1994.

I demand appropriate interest under Section 75 of the Finance Act, 1994 and

I impose a penalty of Rs.1,00,000/- (Rupees One Lakh Only) for non-payment of Service Tax under Sections 76 of the Finance Act, 1994.”

3. This was challenged by the appellant before the Commissioner (Appeals), but same was rejected. Being aggrieved, an appeal before the CESTAT was preferred. However, the tribunal rejected the appeal for the following reasons:

“4.2. The dispute in the present appeal relates to the legal issue as to whether the profit earned by the appellant on Foreign Exchange remuneration is a taxable service or not. The taxability of the same stands considered by the adjudicating authority in the adjudication, relatable to the refund claim filed by the appellant and the same stands upheld by the adjudicating authority and having not been appealed against holds the field. In as much as the taxability has already been held against the assessee and the refund claim filed on the said ground of non-taxability stands rejected, the action of the assessee taking suo motu credit of the tax paid cannot be appreciated and held in accordance with law. It may not be out of place once again to mention that the provision of Rule 6(3) of STR, 1994, do not relate to dispute on the taxability and simplicitor allow the credit of the service tax already paid in respect of the services which are subsequently not provided by an assessee.

4.3. In a nutshell, the assessee’s refund claim filed under Section 11 B of Central Excise Act, 1944, having been rejected and not challenged the appellant’s claim of suo motu credit involved in the present appeal cannot be accepted. The impugned orders are upheld. Appeal is rejected.”

4. The learned counsel appearing on behalf of the appellant would submit that, in a case involving the very same appellant, another Bench of the CESTAT held that the share of profit earned by a branch in foreign exchange transactions does not fall within the purview of the service tax. While so, the finding of the CESTAT holding that the appellant ought to have challenged the rejection of the refund claim is not legally sustainable.

5. We find that the payment of service tax been made by the appellant solely on the instructions of the audit team of the Central Excise Department. While so, having now found that the share of profit is not liable to be taxed under Service Tax, the respondent ought to have refunded the amount at the first instance.

6. Having failed, when the assessee himself has suo motu adjusted the amount, it cannot be termed as an improper or impermissible process for imposing penalty. Therefore, the unjust enrichment of the department cannot be given a seal of approval on the ground of limitation or the failure to prefer an appeal against the order rejecting the refund request. This was a technical error or mistake made without any mala fide intention.

7. In our view the order in original has to be set aside. Consequently, the State Bank of India v. Commissioner [Final Order No. 43138/2017, dated 18-12-2017] passed by the CESTAT, is hereby set aside and Civil Miscellaneous Appeal stands allowed. No costs.