2024 (7) TMI 155 - AAR - GST

Liquidated damages recovered from suppliers for contract breach constitutes taxable service under GST law per Para 5 Schedule II

The AAR, Andhra Pradesh ruled that liquidated damages recovered by an applicant from suppliers/contractors for breach of contract or non-performance ... Levy of GST - Liquidated Damages - supply or not - amount recovered by the Applicant from the Suppliers or the Contractors as part of breach of contract or for Non-performance of Contract within the stipulated period, as represented by the penalty - HELD THAT:- The empowerment to levy liquidated damages is for the reason that there had been a delay and the same would be tolerated, but for a price or damages. The income though presented in the form of a deduction from the payments to be made to the contractor was the income of the applicant and would be a supply of ‘service’ by the applicant in terms of clause (e) of Para 5 of Schedule II appended to the Central Goods and Services Tax Act, 2017”. The nature of “damages” for the purpose of GST the reciprocal obligations are essential to constitute supply and accordingly any payment in the nature of damages to balance equities between parties, in the presence of enforceable reciprocal obligations, would constitute supply and would attract GST - The purpose of imposing compensation or penalty is governed by the provisions of Indian Contract Act to ensure the defaulting act is not undertaken or repeated. The same maybe equated as receipt of consideration on account of toleration of an act. Supply or not - HELD THAT:- 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 GST Act. Issues Involved:1. Applicability of GST on liquidated damages collected for breach of contract or non-performance of contract.Issue-wise Detailed Analysis:1. Applicability of GST on Liquidated Damages:Applicant's Argument:- The applicant, a Licensed Distribution Company, contends that liquidated damages collected from suppliers or contractors for breach of contract or non-performance are compensatory in nature and not for any service rendered.- They argue that such damages are not a consideration for tolerating an act or refraining from an act, as outlined in Entry 5(e) of Schedule II of the CGST Act, 2017.- The applicant cites various judicial precedents under the erstwhile Service Tax regime, including cases like Neyveli Lignite Corporation Ltd. v. CCE & Service Tax, and clarifications from CBIC Circular No. 178/10/2022-GST, which suggest that liquidated damages are not taxable as they are not consideration for any service.Authority's Analysis:- The authority examined the provisions of the CGST Act, 2017, particularly Section 7(1A) and Paragraph 5(e) of Schedule II, which classify 'agreeing to the obligation to refrain from an act, or to tolerate an act or situation, or to do an act' as a supply of service.- It was noted that liquidated damages are pre-determined compensation for breach of contract, as stipulated under Sections 73 and 74 of the Indian Contract Act, 1872.- The authority referred to various rulings under the GST regime, including Maharashtra State Power Generation Company Ltd. and Fastrack Deal Comm (P.) Ltd., which held that liquidated damages are subject to GST as they are considered consideration for tolerating non-performance or breach of contract.Legal Precedents and Circulars:- The authority acknowledged the CBIC Circular No. 178/10/2022-GST, which clarifies that payments referred to as fines or penalties are considered consideration for supply if they are ancillary to the principal supply.- It was emphasized that the circular should be applied reasonably, considering the facts of each case.Conclusion:- The authority concluded that liquidated damages collected by the applicant are indeed consideration for tolerating the breach or non-performance of the contract.- Such amounts are therefore considered a supply of service under Entry 5(e) of Schedule II of the CGST Act and are exigible to GST.Ruling:- The amount recovered by the applicant from suppliers or contractors as liquidated damages for breach of contract or non-performance within the stipulated period is leviable to GST.Summary:The Advance Ruling Authority of Andhra Pradesh examined whether liquidated damages collected by a Licensed Distribution Company for breach of contract or non-performance are subject to GST. The applicant argued that such damages are compensatory and not for any service rendered. However, the authority analyzed the provisions of the CGST Act, 2017, and relevant judicial precedents, concluding that liquidated damages are consideration for tolerating non-performance and thus constitute a supply of service. Consequently, such amounts are exigible to GST.