Liquidated damages under concession agreement are compensatory, not supply; GST not payable on these pre-estimated genuine losses

AAR held that liquidated damages paid by the Applicant to the other contracting party for breaches or non-performance under the Concession Agreement are compensatory flows, not consideration for supply, and therefore not subject to GST. The agreement contains no element of toleration or quid pro quo, and the damages are pre-estimated genuine losses; CBIC guidance on penal charges was found applicable by analogy. GST is not payable on those liquidated damages; ancillary issues were left unanswered.

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1. ISSUES PRESENTED AND CONSIDERED

1. Whether GST is payable on liquidated damages/compensation payable by the operator under the Concession Agreement for material defaults, breaches or non-performance of contractual obligations.

2. If GST is payable, what is the applicable rate of GST and the corresponding Service Accounting Code (SAC)?

3. If GST is payable, whether the operator is eligible to avail input tax credit (ITC) of GST so paid on liquidated damages.

4. Whether the applicant (registered person who is payor of damages) has locus standi to seek an advance ruling concerning taxability of amounts claimed by the counterparty (recipient) under the agreement.

2. ISSUE-WISE DETAILED ANALYSIS

Issue 4 - Locus standi to seek advance ruling

Legal framework: Advance ruling jurisdiction is confined to queries "in relation to the supply of goods or services or both being undertaken or proposed to be undertaken by the applicant." The statutory definition of "applicant" includes persons registered under the Act.

Precedent treatment: A prior High Court decision remanding a West Bengal AAR matter held that a registered recipient meets the statutory definition of applicant and can seek an advance ruling; that approach was applied to determine eligibility in the present matter.

Interpretation and reasoning: The Authority examined the definition of advance ruling and Section 95, observed the applicant is GST-registered, and followed the High Court's interpretation permitting registered recipients to seek rulings on supply/taxability issues affecting them.

Ratio vs. Obiter: Ratio - the Authority's decision that the registered applicant had locus standi to seek the advance ruling is a necessary jurisdictional finding.

Conclusion: The applicant (being registered under GST) has sufficient locus standi to file the advance ruling application and the Authority will decide the merits.

Issue 1 - Taxability of liquidated damages/compensation under the Concession Agreement

Legal framework: GST is leviable on "supply" of goods or services for consideration; whether a payment constitutes "consideration" depends on whether it is received for an act or for tolerating/undertaking a supply. Contract Act provisions (Sections 73-74) and CBIC administrative clarifications (Circular No. 178/10/2022-GST dated 03.08.2022 and Circular No. 245/02/2025-GST dated 28.01.2025) provide guidance on characterisation of liquidated damages/penalties as either compensation (non-taxable mere flow of money) or as consideration for a supply (taxable ancillary supply).

Precedent treatment: The Authority reviewed earlier advance-ruling and appellate decisions that held similar liquidated damages/settlement/penalty payments to be non-taxable where they merely compensate for loss arising from breach and are not consideration for an independent supply or for tolerating an act (decisions of appellate AARs and Tribunals cited in the record were followed in principle).

Interpretation and reasoning: Examination of the Concession Agreement showed: (a) damages/penalties are pre-estimated, stipulated sums for breach or non-performance (Interpretation clause describing damages as genuine pre-estimated loss); (b) the scope of the contract is supply, operation and maintenance of buses and associated obligations; (c) various clauses (Articles 16, 17, 20, 30 and Schedule-I/Annex-1) impose obligations and specify damages for failures (delays, defects, operational infractions, reduced availability, accidents etc.); (d) there is no clause showing the aggrieved party is agreeing to tolerate breaches or to supply any additional service in consideration of receiving the damages; (e) CBIC Circular No.178 draws the key distinction that where payments are only compensatory for loss/damage and not paid for tolerating an act or receiving any independent facility, they are not consideration for a supply and thus not taxable; (f) Circular No.245 dealing with penal charges by regulated entities was applied by analogy to operational penalties aimed at maintaining contractual discipline.

Ratio vs. Obiter: Ratio - where contractual liquidated damages are genuine pre-estimated compensation for loss due to breach and there is no express or implied agreement by the recipient to tolerate or perform any supply in return, such payments are not "consideration" and are not taxable under GST. Obiter - observations on analogous application of bank/NBFC penal-charge circular may be viewed as illustrative rather than necessary.

Conclusion: Liquidated damages/compensation payable by the operator under the Concession Agreement are pre-estimated compensation for breach and do not constitute consideration for a supply; therefore GST is not payable on such liquidated damages.

Issue 2 - Applicable GST rate and SAC if amounts were taxable

Legal framework: If a payment constitutes consideration for a supply, the GST rate and SAC classification follow the nature of the supply and ancillary/principal supply principles under GST law.

Interpretation and reasoning: Having concluded that the liquidated damages are not consideration for any supply and therefore not taxable, it was unnecessary to determine the rate or SAC. The Authority noted that where characterisation as consideration is absent, classification questions do not arise.

Ratio vs. Obiter: Obiter - procedural observation that rate and SAC questions become relevant only when taxability is established.

Conclusion: Not answered as GST is held not payable on the liquidated damages.

Issue 3 - Entitlement to input tax credit (ITC) on GST paid on liquidated damages

Legal framework: ITC is available only on tax paid on inputs/services used in the course or furtherance of business and only where GST is actually leviable and paid.

Interpretation and reasoning: Since liquidated damages are held to be non-taxable (no GST leviable), the question of ITC does not arise. The Authority therefore did not address eligibility for ITC.

Ratio vs. Obiter: Ratio - denial of need to decide ITC follows logically from conclusion of non-taxability; no separate ratio on ITC entitlement is laid down.

Conclusion: Not answered because GST is not payable on the liquidated damages; therefore ITC question is not applicable.

Overall Disposition

The liquidated damages/compensation payable under the Concession Agreement are genuine pre-estimated compensation for loss arising from breach and, in the absence of any agreement by the recipient to tolerate breaches or to provide any supply in return, do not constitute consideration for a supply under GST and are not taxable; consequential questions on rate, SAC and ITC are not answered. The applicant was found to have locus standi to seek the advance ruling.

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