Liquidated damages for commissioning delays by electricity producer not subject to GST under CBIC Circular 178

The AAAR Telangana ruled that liquidated damages received by an electricity producer from a contractor for commissioning delays are not subject to GST. The authority relied on CBIC Circular No. 178/10/2022-GST, which clarifies that when the principal supply (electricity production and distribution) is GST-exempt, ancillary activities remain non-taxable. The damages constituted mere compensation for breach of contract without any reciprocal obligation, representing a flow of money rather than consideration for supply. The appeal was disposed of in favor of the applicant.

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Issues Involved:
1. Whether liquidated damages recoverable by the applicant qualify as a 'supply' under the GST law, thereby attracting the levy of GST.
2. If the answer to the first question is affirmative, what should be the time of supply when the liability to pay GST is triggered.

Detailed Analysis:

Issue 1: Whether Liquidated Damages Qualify as 'Supply' Under GST Law
Arguments by Applicant:
- The applicant contended that liquidated damages received towards breach and non-compliance cannot be construed as 'consideration' for 'refraining or tolerating an act'.
- It was argued that there is no contractual reciprocity or concurrence to assume an obligation to refrain from an act or tolerate an act between the applicant and the contractor.
- The liquidated damages are not in lieu of any activity/obligation agreed to be performed at the behest of the service recipient but are on account of breach of contract (delay in compensation of project timelines).
- The applicant's case does not fall under clause 5(e) of Schedule II of the CGST Act, 2017.
- The recovery of liquidated damages can be viewed as mere renegotiation of the price of the original contract and not a separate transaction.
- The recovery of liquidated damages is in the nature of an 'actionable claim', outside the ambit of GST.

Observations and Findings:
- The CBIC Circular No. 178/10/2022-GST dated 3.8.2022 was referenced, which clarifies that when the principal supply is exempt, ancillary activities to such principal supply would not attract GST.
- Since the applicant's principal supply is the production and distribution of electricity, which is exempt from GST, the liquidated damages received by the applicant towards such supply are considered a flow of money without GST implications.
- It was observed that where the amount paid as 'liquidated damages' compensates for injury, loss, or damage suffered by the aggrieved party due to a breach of contract, and there is no agreement, express or implied, by the aggrieved party to do or abstain from doing anything for the party paying the liquidated damages, such payments do not constitute consideration for a supply and are not taxable.

Conclusion:
- The amount recoverable by the applicant in the form of liquidated damages does not qualify as a supply under the GST law.

Issue 2: Time of Supply When Liability to Pay GST is Triggered
Arguments by Applicant:
- Since the applicant argued that liquidated damages do not qualify as a supply, the question of determining the time of supply does not arise.

Observations and Findings:
- Given the conclusion that the liquidated damages do not qualify as a supply, the question of the time of supply and the triggering of GST liability does not arise.

Conclusion:
- The question of the time of supply does not arise as the liquidated damages do not qualify as a supply under the GST law.

Final Order:
1. Question 1: Whether liquidated damages recoverable by the applicant from Belectric India on account of delay in commissioning qualify as a 'supply' under the GST law, thereby attracting the levy of GSTRs.
- Answer: No. The amount recoverable by the applicant in the form of liquidated damages does not qualify as a supply, as seen from the agreement.

2. Question 2: If the answer to Question No. 1 is in the affirmative, what should be the time of supply when the liability to pay GST is triggeredRs.
- Answer: Does not arise.

The ruling of the lower authority is set aside, and the subject appeal is disposed of accordingly.

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