6.
Dear Suresh Sathyamaurthy Ji
It is very easy to call an activity as a supply, thereby either inter-state supply or intra-state supply to invoke levy of GST. But it is equally important to put forth certain aspect of another school of thought on the taxability of compensation received. So, I hereby would like to share some thoughts on non-taxability of “Compensation for breach of contract” and “damages” though present query does not revolve around award of damages.
Non-taxability of “Compensatory damages” as there is no Enforceable Reciprocal Obligation and it is for loss suffered but not for supply affected
- The requirement of a 'supply' is essential. It is the taxable event under the GST Act. If there is no supply, there can be no liability for payment of tax (or any interest or penalty thereon). This is clear from Article 246A of the Constitution of India which deals with the legislative competence of the Union and the States to make laws with respect to goods and services tax imposed by the Union or such State and Article 366(12A) of the Constitution of India which defines 'goods and services tax' as 'any tax on Supply of Goods or Services or both except taxes on the supply of the alcoholic liquor for human consumption'.
- Enforceable reciprocal obligations are essential to a supply. The supply doctrine does not contemplate or encompass a wrongful unilateral act or any resulting payment of damages. For example, in a money suit where the plaintiff seeks a money decree for unpaid consideration for letting out the premises to the defendant, the reciprocity of the enforceable obligations is present. The plaintiff in such a situation has permitted the defendant to occupy the premises for consideration which is not paid. The monies are payable as consideration towards an earlier taxable supply. However, in a suit, where the cause of action involves illegal occupation of immovable property or trespass (either by a party who was never authorised to occupy the premises or by a party whose authorization to occupy the premises is determined) the plaintiff's claim is one in damages.
- Payment ordered in an action for damages arising out of property damage, illegal trespass, negligence causing loss of profits, wrongful use of trade name, breach of copyright, termination or breach of contract or personal injury is made to compensate loss suffered, and is not a payment towards any supply and hence no GST liability would arise.
- Liability to pay GST would arise only where the payment received can be linked to a supply. In case of compensatory damages, the payment is for loss suffered and not supply effected. While the process of determining loss suffered may be the value of the consideration receivable if the contract had been performed, such process of computing damages will not alter the character of the payment, namely a compensation for loss suffered. This is premised on the principle that the supply doctrine does not encompass a wrongful unilateral act or any act resulting in payment of damages.
[Ref: Bombay High Court decision in the case of BAI MAMUBAI TRUST VERSUS SUCHITRA (2019 (9) TMI 929) wherein it has been held that GST is not payable on damages /compensation paid for a legal injury.]
Learnings from Indian Contract Act, 1872
- Kindly note that as per Section 73 of Indian Contract Act, when a contract has been broken, the party who suffers by such breach is entitled to receive, from the party who has broken the contract, compensation for any loss or damage caused to him thereby, which naturally arose in the usual course of things from such breach, or which the parties knew, when they made the contract, to be likely to result from the breach of it. Such compensation is not to be given for any remote and indirect loss or damage sustained by reason of the breach.
- Compensation for failure to discharge obligation resembling those created by contract.-When an obligation resembling those created by contract has been incurred and has not been discharged, any person injured by the failure to discharge it is entitled to receive the same compensation from the party in default, as if such person had contracted to discharge it and had broken his contract.
- Section 74 of Indian Contract Act: When a contract has been broken, if a sum is named in the contract as the amount to be paid in case of such breach, or if the contract contains any other stipulation by way of penalty, the party complaining of the breach is entitled, whether or not actual damage or loss is proved to have been caused thereby, to receive from the party who has broken the contract reasonable compensation not exceeding the amount so named or, as the case may be, the penalty stipulated for.
From the above provisions of Indian contract act, it can fairly be said that compensation for damages is not a consideration. It also lacks reciprocity. The element of reciprocity is essential to trigger the definition of Supply under GST law. Therefore, in cases where there is no reciprocity, there is no supply.
If Compensation is pre-agreed – whether toleration?
Pre-estimated sums to be paid in the event of a breach of contract by one of the parties should not qualify as ‘benefit’ to the other party. The amount could either be set figure or determined by formula. If compensation is received, then recipient is not receiving payment for a supply and no GST is due on that amount.
Answer to rest of the queries is as under:
(b) No effect on the ITC availed as the goods are with exporter only which can be used for further export.
(c) Normal Export procedure would be followed I.e. export with IGST or without IGST.
Disclaimer: The views on non-taxability of present type of receipts is just a food for thought. It should be noted that these views are prone to litigation at higher levels though while deciding the taxability of mesne profits in BAI MAMUBAI TRUST VERSUS SUCHITRA (2019 (9) TMI 929), Hon'ble Bombay High Court has discussed the concept of this taxability. Therefore, learnings can be taken therefrom the decide taxability.
In case anything further to be discussed, comments and views are invited.