GST on liquidated damages for contract breach under Circular 178/10/2022; notice quashed and refund with 6% interest ordered

GST liability on liquidated damages for breach/non-performance was examined in light of Circular No. 178/10/2022. The HC held that under the service agreement the amounts received were compensatory in nature, falling within para 7 (including paras 7.1 and 7.1.6) of the Circular and Sections 73-74 of the Contract Act, and therefore did not constitute a taxable supply; consequently, the impugned show cause notice levying GST on such liquidated damages was quashed. On refund of amounts paid under protest, applying its prior ruling on non-voluntary collections during enforcement actions, the HC held the collection lacked authority of law and directed refund with 6% interest; the petition was allowed.

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1. ISSUES PRESENTED AND CONSIDERED

(i) Whether amounts received by the petitioner from its Lending Service Providers (LSPs) under the relevant service agreements, described as compensation/liquidated damages for breach or non-performance, were exigible to GST and could be treated as consideration for a taxable supply (including as "tolerating an act or a situation" under Schedule II) as alleged in the show cause notice.

(ii) Whether the impugned show cause notice demanding GST on such receipts was liable to be quashed for ignoring the applicable portion of the departmental circular dealing with liquidated damages.

(iii) Whether the amount paid under protest during the dispute was required to be refunded with applicable interest, and within what time.

2. ISSUE-WISE DETAILED ANALYSIS

Issue (i) & (ii): Taxability of amounts termed "liquidated damages/deficiency service fee" and validity of the show cause notice

Legal framework (as discussed by the Court): The Court considered the departmental circular dated 03.08.2022, particularly paragraphs 7.1 to 7.1.6 dealing with "liquidated damages", and also examined the revenue's reliance on Schedule II (para 5(e)) to treat the receipts as consideration for "tolerating" an act/situation. The Court also referred to the contractual stipulations showing that, on breach by the LSPs, the petitioner would be entitled to claim liquidated damages as compensation.

Interpretation and reasoning: On a perusal of the service agreement, the Court found that breach by the LSPs entitled the petitioner to claim liquidated damages. The Court held that the impugned show cause notice proceeded on the basis that the receipts were consideration for tolerating deficiency in services, but it failed to apply the specific part of the circular governing liquidated damages. The Court treated paragraphs 7.1 to 7.1.6 as directly applicable and determinative for the petitioner's case, and accepted the contention that those paragraphs specifically cover compensation received due to breach/non-performance under the contract. The Court rejected the revenue's attempt to characterise the amounts as taxable merely by describing them as "deficiency service fee" in accounts/ledgers, holding that, in substance, the receipts arose from breach-related compensation covered by the circular and therefore fell outside GST.

Conclusion: The Court conclusively held that the amounts received from the LSPs by way of liquidated damages/compensation for breach, as covered by paragraphs 7.1 to 7.1.6 of the circular, were not amenable to GST as demanded in the show cause notice. Consequently, the show cause notice demanding GST on these receipts was quashed.

Issue (i) (ancillary): Effect of alleged similar transactions with other entities on GST liability for the present receipts

Interpretation and reasoning: The show cause notice alleged that, for similar services to other entities, GST was charged under different nomenclature and that the petitioner could not adopt different methodologies. The Court held that the existence of other transactions could not be the basis to fasten liability here, because the taxability had to be determined from the terms of the specific agreement with the LSPs and the express coverage of liquidated damages under the applicable portion of the circular.

Conclusion: The Court rejected the revenue's reliance on other transactions as a ground to sustain the impugned demand in the present case.

Issue (iii): Refund of amount paid under protest and interest

Legal framework (as applied by the Court): The Court relied on its approach in an earlier decision under "identical circumstances" to order refund with interest, and issued directions for repayment within a fixed timeframe.

Interpretation and reasoning: Having quashed the show cause notice and held the demand unsustainable, the Court directed refund of the amount paid under protest, together with applicable interest.

Conclusion: The Court directed the respondents to refund the entire amount of Rs. 5 crores along with applicable interest within eight weeks from receipt of the order.

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