2024 (2) TMI 1054 - AAR - GST

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

AAR held that compensation amounts including liquidated damages, trade settlements, and damages collected from customers for non-performance or breach of ... Definition of supply under Section 7 - definition of consideration under Section 2(31) - liquidated damages as consideration for tolerating an act - ancillary or incidental payments to the principal supply - classification under chapter heading 9997 (Other Services) - applicability of input tax credit reversal under Rules 42 & 43Definition of consideration under Section 2(31) - definition of supply under Section 7 - liquidated damages as consideration for tolerating an act - GST leviable on compensation amounts such as liquidated damages/trade settlement collected for breach or non-performance of contract - HELD THAT: - The Authority examined Section 7 (supply) read with the wide definition of consideration in Section 2(31) and concluded that amounts recovered under contractually stipulated formulas for breach are payments made 'in response to' or 'in respect of' the contractual relationship. Such payments are not mere gratuitous flows but arise from an agreement and confer an economic advantage or avoid disadvantage to the payor. While Government circulars and certain decisions were noted which treat some compensatory payments as mere flow of money not constituting supply, the Authority held those are not universally determinative. Applying the statutory definitions, the Authority found that recovery of liquidated damages/trade settlement falls within the ambit of consideration for tolerating an act or situation under an agreement and therefore constitutes a supply of service.Yes; compensation amounts such as liquidated damages/trade settlement collected for breach/non-performance are exigible to GST.Classification under chapter heading 9997 (Other Services) - ancillary or incidental payments to the principal supply - Tax classification and rate applicable to the said compensation amounts - HELD THAT: - Having held the compensatory receipts to constitute consideration for a supply of service, the Authority classified the activity under the residual chapter heading 9997 for 'Other Services'. The Authority applied the principle that such payments, being incidental to the principal contractual relationship and constituting supply, attract tax at the standard rate prescribed for that heading. Accordingly, the levy was determined at combined tax of 18% (9% CGST and 9% SGST).Classified under chapter head 9997 (Other Services) and taxable at 18% (9% CGST + 9% SGST).Applicability of input tax credit reversal under Rules 42 & 43 - Whether reversal of input tax credit under Rules 42 & 43 applies if the compensation amounts are not leviable - HELD THAT: - The third question was rendered consequential. Since the Authority has held that the compensation amounts constitute taxable supply, the hypothetical alternative-non-levy-was not accepted. Consequently, any consideration of reversal of common input tax credit under Rules 42 & 43 was unnecessary.Doesn't arise.Final Conclusion: Advance ruling: amounts recovered as liquidated damages/trade settlement for breach or non-performance of contracts constitute consideration for a supply of service, are taxable and are classifiable under chapter heading 9997 as 'Other Services' at a combined rate of 18% (9% CGST + 9% SGST); the question of ITC reversal under Rules 42 & 43 is not applicable. 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.