2024 (2) TMI 1054 - AAR - GST

Compensation amounts for contract breaches constitute taxable supply of services under GST at 18%

In Re: M/s. South India Krishna Oil & Fats Pvt. Ltd.

AAR held that compensation amounts including liquidated damages, trade settlements, and damages collected from customers for non-performance or breach of ... Levy of GST - Supply or not - compensation amounts such as liquidated damages/trade settlement/damages collected from the customers for non-performing of contractual obligations or breach of the contract - HSN Code applicable and the rate of GST applicable - restriction of input tax Credit of common services under 42 & 43 of CGST/APGST Rules, 2017 - HELD THAT:- In the present case the customers are paying certain amount to the applicant. The amount so paid is neither ad-hoc, unconditional nor at the whims of any customer nor the appellant. There is a clear mathematical formula as to calculation of such amount and the conditions/scenarios contingent upon which the amounts are payable are clearly narrated in the agreement itself. The circular issued by CBIC vide circular No. 178/10/2022-GST Dtd. 03/08/2022 is only meant to clarify the position of law and shall be applied reasonably having regard to the facts of the case. The circular had clearly mentioned, Inter alia, vide para 7.1.6 that “Therefore, such payments, even though they may be referred to as fine or penalty, are actually payments that amount to consideration for supply, and are subject to GST, in cases where such supply is taxable. Since these supplies are ancillary to the principal supply for which the contract is signed, they shall be eligible to be assessed as the principal supply, as discussed in detail in the later paragraphs. Naturally, such payments will not be taxable if the principal supply is exempt. In the light of section 7 read with definition of consideration u/s 2(31) compensation amounts paid by defaulting party to the non-defaulting party for tolerating the act of non performance or breach of contract have to be treated as consideration for tolerating of an act or a situation under an agreement and hence such an activity constitutes supply of service and the compensation amounts such as liquidity damages are exigible to tax under CGST @ 9% and SGST @9% each under the chapter head 9997 at serial no. 35 of Notification No. 11/2017- Central/State tax rate. Issues Involved:1. Whether GST is leviable on compensation amounts such as liquidated damages/trade settlement/damages collected from the customers for non-performing of contractual obligations or breach of the contract.2. If GST is leviable on the said activity, what is the HSN Code applicable and the rate of GST applicable for the said activity.3. If GST is not leviable on the said activity, does the restriction of input tax Credit of common services under 42 & 43 of CGST/APGST Rules, 2017 will attract.Summary:Issue 1: GST on Compensation Amounts for Breach of ContractThe applicant, M/s. South India Krishna Oil & Fats Pvt Ltd, engaged in manufacturing edible oils, collects compensation amounts such as liquidated damages/trade settlement from customers for breach or non-performance of contracts. The applicant initially discharged GST liability under the entry heading 9997 - Agreeing to tolerate an act. However, after the issuance of CBIC Circular No. 178/10/2022-GST, the applicant discontinued collecting GST on these amounts, arguing that the activity does not satisfy the definition of 'Supply' under Section 7 of CGST/APGST Act, 2017.The applicant contends that liquidated damages are not consideration for any supply of goods or services but compensation for breach of contract. Several legal precedents and the CBIC Circular support the view that such compensation is not taxable as it does not constitute consideration for a supply.Issue 2: HSN Code and GST RateThe Authority for Advance Ruling examined the definition of 'consideration' under Section 2(31) of the GST Act, which includes any payment made in respect of, in response to, or for the inducement of the supply of goods or services. The Authority concluded that compensation amounts paid by the defaulting party to the non-defaulting party for tolerating the act of non-performance or breach of contract constitute consideration for a supply of service. Therefore, such compensation amounts are exigible to tax under CGST @ 9% and SGST @ 9%, each under chapter head 9997 at serial no. 35 of Notification No. 11/2017-Central/State tax rate.Issue 3: Restriction of Input Tax CreditSince the activity of collecting compensation amounts for breach of contract constitutes a taxable supply, the question of restriction of input tax credit under Rules 42 & 43 of CGST/APGST Rules, 2017 does not arise.Ruling:1. GST is leviable on compensation amounts such as liquidated damages/trade settlement/damages collected from the customers for non-performing of contractual obligations or breach of the contract.2. The activity would be covered within chapter head 9997 - 'Other Services' and is taxable at 18% (9% CGST and 9% SGST) rate of tax.3. The question of restriction of input tax credit does not arise.