Liquidated damages recovered from vendors constitute taxable supply under GST attracting 18% tax under HSN 9997

AAR Uttarakhand ruled that liquidated damages recovered from vendors constitute taxable supply under GST. The Authority examined contractual terms stipulating 0.5% weekly charges for delayed delivery, capped at 10% of delayed stores value. Since quantum was predetermined without uncertainty element and contract explicitly stated it was not penalty/compensation, the amount qualified as consideration for tolerating breach of timely delivery. This falls under Schedule II entry 5(e) as supply of service, attracting 18% GST under HSN 9997 per Notification 11/2017.

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Issues Involved:
1. Determination of the liability to pay tax on services.
2. Taxability of Liquidated Damages (LD) under GST.

Summary:

Issue 1: Determination of the liability to pay tax on services
The applicant, M/s India Optel Limited, sought an advance ruling u/s 97(2)(e) of the CGST/SGST Act, 2017 regarding the liability to pay tax on services, specifically on Liquidated Damages (LD) recovered from vendors for delayed delivery of goods.

Issue 2: Taxability of Liquidated Damages (LD) under GST
The applicant entered into contracts with vendors, including a clause for LD in case of delayed delivery. The ambiguity in Board Circular 178/10/2022-GST dated 03.08.2022 regarding the taxability of LD prompted the applicant to seek clarification. The circular presents two viewpoints: one suggesting LD is not taxable as it ensures performance, and the other suggesting LD is taxable if it constitutes consideration for a supply.

Discussion and Findings:
The Authority examined the definitions of "Supply" and "Consideration" u/s 7 and 2(31) of the CGST/SGST Act, 2017. It was noted that the contract pre-determined the LD amount, indicating a reasonable belief that such delays could occur. The Authority concluded that the LD amount is not ad-hoc or unconditional but a pre-agreed consideration for tolerating the act of delayed delivery.

The Authority found that all conditions for taxability (agreement, consideration, and independent contractual arrangement) were present. The mention of specific rates for LD in the contract implied that the cost of damages was factored in, and there was no surprise element. Therefore, the LD amount is considered a consideration for tolerating an act and is taxable under the CGST/SGST Act, 2017.

Ruling:
GST is applicable on Liquidated Damages recovered from the vendors. The activity constitutes a supply of service as per entry at serial 5(e) of Schedule II and is exigible to tax at 18% under HSN 9997.

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