The tax implications of liquidated damages under the Goods and Services Tax (GST) regime in India. It analyzes the relevant legal provisions, industry practices, and judicial pronouncements to determine whether liquidated damages collected for breach of contract attract GST.

Introduction

Contracts often contain clauses that specify liquidated damages, a pre-determined amount payable by a party for breaching the contract's terms. This post examines the question of whether GST applies to liquidated damages collected by a company from its suppliers or contractors for delayed deliveries or non-performance of services.

Background

The CGST Act (Central Goods and Services Tax Act) forms the bedrock of the GST regime in India. It defines "supply" as any activity involving the sale, transfer, barter, or provision of services or goods undertaken for consideration in the course of business. Schedule II to the Act further clarifies that "agreeing to the obligation to refrain from an act, or to tolerate an act or situation, or to do an act" constitutes a taxable service.

Arguments for GST Applicability

• Consideration for Tolerance: Some argue that liquidated damages compensate the aggrieved party for tolerating the breach of contract. This "toleration" could be seen as a service provided by the non-defaulting party, attracting GST under Schedule II, clause (e).
• Precedents under Service Tax Regime: The pre-GST service tax regime held similar views. In cases like Maharashtra State Power Generation Co. Ltd., liquidated damages were considered a payment for tolerating non-performance, attracting service tax.

Arguments Against GST Applicability

• Penalty, Not Consideration: Opponents argue that liquidated damages are a penalty for a breach, not a consideration for a service. They are meant to deter breaches and compensate for actual losses, not to pay for tolerating non-performance.
• Recent Circular Clarification: CBIC (Central Board of Indirect Taxes and Customs) issued a clarification in 2022 (Circular No. 178/10/2022-GST) differentiating between consideration and penalty. The circular states that liquidated damages are not paid for tolerating a breach but for deterring it. They may not fall within the scope of Schedule II (e).

Conclusion

The applicability of GST on liquidated damages remains a debated topic. While some judicial pronouncements under the service tax regime supported GST, recent CBIC clarifications suggest a different approach. Businesses should stay updated on further developments and consult tax professionals for specific guidance.

GST Case law Transmission Corporation of Andhra Pradesh Limited

Citation-2024 TAXONATION 1446 (ANDHRA PRADESH-AAR)

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