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 constitutes a supply of service under GST law. The Authority held that such damages represent consideration for tolerating delay or breach, falling under clause (e) of Para 5 of Schedule II of the CGST Act, 2017. The compensation amounts paid by defaulting parties to non-defaulting parties for tolerating non-performance constitute consideration for tolerating an act under an agreement, making liquidated damages exigible to GST.

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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.

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