Landlord damages for early lease termination subject to 18% GST as taxable supply facility

AAR Karnataka ruled that damages received by a landlord from tenant for early termination of sub-lease before lock-in period constitutes consideration for supply of facility under GST Act. The authority held that such payments, though termed as damages or penalty, are actually consideration for taxable supply of services. Following CBIC circular 178/10/2022, these amounts are subject to GST as they represent supply of early termination facility ancillary to principal supply of sub-letting commercial property. The services are classified under chapter 9972 - Real Estate Services, attracting 18% GST (9% CGST + 9% SGST).

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Issues Involved:
1. Whether damages received towards termination of sub-lease before the lock-in period constitute supply under Section 7 of the CGST Act, 2017.
2. Applicable rate of GST and classification for the damages received.

Summary:

Issue 1: Whether damages received towards termination of sub-lease before the lock-in period constitute supply under Section 7 of the CGST Act, 2017.

The applicant, a partnership firm engaged in sub-letting commercial property, sought an advance ruling on whether damages amounting to Rs. 1,85,00,000/- received from a tenant for early termination of sub-lease constitute a supply under Section 7 of the CGST Act, 2017. The applicant argued that the damages were compensation for breach of contract and should not be considered as a supply. They referenced Circular No. 178/10/2022, which states that liquidated damages for breach of contract are not taxable as they are mere compensation for loss or damage suffered.

The Authority for Advance Rulings (AAR) examined the sub-lease agreements and observed that the damages were part of the contractual terms agreed upon for early termination. The AAR concluded that the damages received were for tolerating the act of early termination and thus constituted consideration for a supply under Section 7(1) of the CGST Act, 2017. The AAR emphasized that the applicant had agreed to tolerate the breach of contract, which falls under clause 5(e) of Schedule II of the CGST Act, thereby making it a taxable supply.

Issue 2: Applicable rate of GST and classification for the damages received.

The AAR determined that the principal supply in this case was the sub-letting of commercial property, classified under Chapter heading 9972 - Real Estate Services. The damages received for early termination were considered ancillary to this principal supply. Consequently, the applicable GST rate for the damages was 18% (9% CGST and 9% SGST), as per entry No. 16(iii) of Notification No. 11/2017-Central Tax (Rate) dated 26.06.2017.

Ruling:
1. The damages received by the applicant from the tenant towards the termination of sub-lease before the agreed upon lock-in period constitute supply under Section 7 of the CGST Act, 2017, and the amount received is to be construed as consideration for the supply.
2. The services provided by the applicant are classifiable under Chapter heading 9972 and are liable to GST at 18% (9% CGST and 9% SGST).

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