2025 (10) TMI 710 - AAR - GST

MGO charges are liquidated damages, not consideration under Section 2(31)/7(1A) read with Schedule II(5)(e) - not taxable

AAR held that Minimum Guaranteed Off-take (MGO) charges are liquidated damages, not 'consideration' under Section 2(31)/Section 7(1A) read with Schedule ... The amount received is 'Consideration' as defined under Section 2(31) of CGST Act, 2017 or not - Amount charged and collected as MGO towards non-performance of the conditions of the contract - act of amount charged and collected is towards ‘tolerating an act’ or not - supply or not - HELD THAT:- The description of the declared service in question, namely, agreeing to the obligation to refrain from an act or to tolerate an act or a situation, or to do an act in para 5 (e) of Schedule II of CGST Act is strikingly similar to the definition of contract in the Contract Act, 1872. As per the Contract Act, ‘Contract’ is defined as “a set of promises, forming consideration for each other”. Promise’ has been defined as “willingness of the ‘promisor’ to do or to abstain from doing anything”. ‘Consideration’ has been defined in the Contract Act as “what the ‘promisee’ does or abstains from doing for the promises made to him”. Thus, the service of agreeing to the obligation to refrain from an act or to tolerate an act or a situation, or to do an act is nothing but a contractual agreement. A contract to do something or to abstain from doing something cannot be said to have taken place unless there are two parties, one of which expressly or impliedly agrees to do or abstain from doing something and the other agrees to pay consideration to the first party for doing or abstaining from such an act. There must be a necessary and sufficient nexus between the supply (i.e. agreement to do or to abstain from doing something) and the consideration. The amount of MGO charges which is paid as ‘liquidated damages’ is an amount paid only to compensate for injury, loss or damage suffered by the applicant due to breach of contract and shall not be construed as the activity of refraining from or tolerating an act or to do anything. In this case, MGO Charges are merely a flow of money from GAIL who causes breach of the contract to the applicant who suffers loss or damage due to such breach. The activity of the applicant would not fall within the scope of supply under Section 7(1A) of the Act, read with serial No. 5(e) of Schedule-II of the Act. Accordingly, such payments do not constitute consideration for a supply and are not taxable. Whether the impugned payments constitute consideration for tolerating an act or situation or refraining from doing any act or situation or simply doing an act? - HELD THAT;- Since the MGO charges for failure to off-take required quantity as agreed, does not constitute ‘supply’ within the meaning of the Act, the amount shall not be treated as ‘consideration’ - If a payment constitutes a consideration for a supply, then it is taxable irrespective of by what name it is called. It must be remembered that a “consideration” cannot be considered de hors an agreement/contract between two persons wherein one person does something for another and that other pays the first in return. If the payment is merely an event in the course of the performance of the agreement and it does not represent the ‘object’, as such, of the contract then it cannot be considered ‘consideration’. The product supplied by the applicant is natural gas which is subjected to Central Excise duty and VAT and it is out of the purview of GST. Naturally, such payments will not be taxable if the principal supply is exempt - To obviate this confusion, CBIC came up with Circular No. 189/10/2022-GST dated 03-08-2022 has clarified that liquidated damages for breach of contract is not a consideration for tolerating an act and hence not a supply. Minimum Guaranteed Off-take (MGO) Charges is in the nature of Liquidated Damages and therefore is not liable to GST. ISSUES PRESENTED AND CONSIDERED 1. Whether amounts charged and collected as Minimum Guaranteed Off-take (MGO) charges for failure to off-take contracted quantities constitute 'consideration' within the meaning of Section 2(31) of the Act. 2. Whether MGO charges amount to the act of 'agreeing to the obligation to refrain from an act, or to tolerate an act or a situation, or to do an act' as described in paragraph 5(e) of Schedule II. 3. Whether imposition and receipt of MGO charges constitute a 'supply' under Section 7 (including sub-section (1A) and Schedule II) of the Act and therefore attract GST. ISSUE-WISE DETAILED ANALYSIS Issue 1: Whether MGO charges are 'consideration' under Section 2(31) Legal framework: Section 2(31) defines 'consideration' to include any payment made in respect of, in response to, or for the inducement of a supply of goods or services, and includes the monetary value of any act or forbearance in respect of a supply; a deposit is excluded unless applied as consideration. Precedent treatment: Applicant relied on decisions from earlier indirect tax jurisprudence to argue that payments arising from breach do not amount to consideration for supply because consideration must flow as bargained reciprocity. The Authority considered such jurisprudence and administrative guidance referenced by parties. Interpretation and reasoning: The Authority analysed the contractual nature of MGO charges-liquidated damages stipulated to compensate for breach or non-performance under the Gas Sales and Transportation Agreement. It emphasized that consideration presupposes a contractual reciprocity where an activity is undertaken at the desire of the recipient in exchange for payment. Liquidated damages are a measure of loss when a promise is broken; they are a consequence of non-performance, not the object of a contractual promise to perform or to tolerate an act. Ratio vs. Obiter: Ratio - MGO charges paid as liquidated damages to compensate for breach do not satisfy the nexus required between a contractual activity and consideration under Section 2(31). Obiter - observations on accounting treatment and characterisation as 'other income' or 'deposit' are ancillary. Conclusion: MGO charges, being liquidated damages for breach/non-performance, do not qualify as 'consideration' under Section 2(31) because they are not payment for an agreed supply or inducement to supply but are compensatory for an event of breach. Issue 2: Whether MGO charges amount to 'agreeing to the obligation to tolerate an act' under Schedule II(5)(e) Legal framework: Schedule II(5)(e) treats as supply of services 'agreeing to the obligation to refrain from an act, or to tolerate an act or a situation, or to do an act.' The provision contemplates an agreement/contract in which one party undertakes to do/abstain/tolerate something in return for consideration. Precedent treatment: The Authority referred to pre-GST principles that an 'activity for consideration' requires express or implied contractual reciprocity; administrative circulars clarifying treatment of liquidated damages were also considered. Interpretation and reasoning: The Authority parsed entry 5(e) into three distinct activities and held that each requires (i) an agreement/contractual obligation by one party to do/abstain/tolerate, and (ii) consideration flowing from the other party specifically for that obligation. Where a payment arises only as compensation consequent to breach (i.e., the aggrieved party does not tolerate the act but seeks redress), there is no contractual act of toleration performed in return for payment. The MGO mechanism here is designed to ensure performance and penalise non-performance; acceptance of liquidated damages is not acceptance of or payment for toleration of breach but a compensatory/penal consequence of breach. Ratio vs. Obiter: Ratio - Payments that are liquidated damages for non-performance are not payments for 'agreeing to tolerate an act' under Schedule II(5)(e) because the element of contractual supply (obligation performed in return for consideration) is absent. Obiter - comparison of the Schedule II wording with the Contract Act's concepts of promise and consideration. Conclusion: MGO charges do not fall within Schedule II(5)(e) as consideration for agreeing to tolerate an act or situation, since they represent compensation for breach and not a contractual obligation performed in exchange for payment. Issue 3: Whether receipt of MGO charges constitutes a 'supply' under Section 7 (and so taxable) Legal framework: Section 7 defines 'supply' to include all forms of supply of goods or services for a consideration in the course or furtherance of business, and sub-section (1A) directs that activities treated as supply are to be characterised as goods or services per Schedule II. Schedule II(5)(e) lists contractual toleration/forbearance as a service where consideration exists. Precedent treatment: The Authority considered prior tribunal and judicial reasoning presented by the applicant and administrative circulars delineating when liquidated damages are taxable as consideration for supply versus when they are compensatory and not taxable. Interpretation and reasoning: Applying the analyses under Issues 1 and 2, the Authority concluded that the essential ingredients of 'supply' are absent: there is no independent activity of providing a service (refraining/tolerating/doing) performed in return for consideration; rather, the matter concerns a primary contract for sale of natural gas, with liquidated damages as a contractual consequence of breach. The payments are therefore incidental to the primary principal supply (sale of gas) and are compensatory rather than constituting a separate supply. The Authority additionally noted that the principal supply (natural gas) presently falls outside GST levy (pre-GST levies applicable), reinforcing that the MGO payments, being consequential and not forming consideration for a separate supply, are not taxable under GST. Ratio vs. Obiter: Ratio - MGO charges, being liquidated damages arising from breach of the primary contract, do not amount to a 'supply' under Section 7 and are not taxable under GST. Obiter - remarks on the interaction between principal supply exemption/status and ancillary payments; reference to administrative clarification supporting this position. Conclusion: MGO charges do not constitute a supply for GST purposes under Section 7 (read with Schedule II) and are not leviable to GST; they are liquidated damages/compensation for breach and outside the taxable ambit. Cross-references and Administrative Guidance 1. The Authority's reasoning cross-references the definitions in Sections 2(31) and 7, Schedule II(5)(e), and principles of contract law regarding liquidated damages and compensation for breach. 2. The Authority aligned its conclusion with administrative circulars that treat liquidated damages for breach as not constituting consideration for toleration and therefore not a supply, noting such guidance supports the present ruling. Final Ruling (Ratio) On the facts and contractual scheme presented, amounts collected as Minimum Guaranteed Off-take charges are liquidated damages for breach/non-performance, do not constitute 'consideration' as defined under Section 2(31), do not amount to 'agreeing to tolerate an act' under Schedule II(5)(e), and therefore do not constitute a 'supply' under Section 7; consequently, such MGO charges are not liable to GST.