Do Liquidated Damages liable to GST?

The Overview

  • Gst, In the present scenario of the COVID 19 pandemic, business entities are struggling and facing challenges to fit and overcome in the economic crisis after the uplifting of Lockdown.
  • The businesses are unable to meet the requirements and contractual obligations that may arise due to non-performance and delay in the performance of the duties and obligations.
  • In such defaults, as a result, the same businesses have borne huge loss and liability for the compensation of damage based on not fulfilling the terms of the agreement agreed before.
  • In this article, the reader shall learn about the taxability criteria of liquidated damages under the prevailing GST law and regime.

Damage Criteria

  • As we all know, damages are always pre-determined inflicted by the person injured or aggrieved party on the breach of the contract or non-performing of obligations.
  • Whereas, these damages does not form a consideration to perform certain activities. They are merely for the sake of compensation of doing wrong.

Statutory Laws

  • For better understanding we must look into the section 7(1) of Central Goods and Service Tax Act, 2017 that provides the supply criteria in an inclusive manner.
  • It includes all types of goods and services and other activities such as barter system, exchange, transfer, rental of goods and services agreed to be supplied in a consideration of carrying on business in future.
  •  On the other hand, Section 7(1) (d) states that all the activities shall be deemed as supply of goods or supply of services after the amendment in year 2019 in Central Goods and Service Tax Act.

Let us understand different interpretations on GST applicability on damages.

  • The first interpretation is in the context of the schedule II clause 5(e) of CGST Act that the damages caused due to non-performance or delay in performance of duties and obligations that shall amount to ‘tolerating the act’ and hence falls under the supply of goods and services liable to GST.
  • However, here question arises in regard to the above interpretation is that what is the scope and quantum of loss of tax to be incurred by the Businesses arising damages during this pandemic.
  • In the second interpretation, it shall be noted that an activity shall be taxable which falls under the scope of supply according to section 7 of CGST Act, 2017.
  • In present time, it might be interpreted that the objective of agreeing to make payment of damages that are liquidated in nature is to make sure performance and it does not involve any activity such as exchange, sale, license, rental, lease in a consideration of Goods and Services.
  • It may be further stated the sum of damages received shall not be classified as consideration for any above stated activities.
  • The same shall be considered as a just compensation payable and does not qualify to be a consideration. This eliminates it from the supply under Section 7(1).
  • In reference to Schedule II of CGST Act, 2017, an activity that does not qualify to be a supply than the damages received for the same shall not be called as consideration on non-performance.
  • On imposing the damages, the person will not tolerate any loss incurred because of non-performance of duties of contract.
  • The motive behind compensation in the form of penalties is to compensate the customer in such a manner that it did not occur again.

Relevant Case Law by Authority of Advance Ruling

  • In the many debates that have taken place in recent times, there have been many conflicts and misconception in this regard. Now let us have glance at various rulings and judgment explained below:
  • In the recent case of Maharashtra State Power Generation Company Limited  (2018-VIL-33-AAR)
  • The Maharashtra Authority of Advance Ruling (AAR) gave a landmark judgment that liquidated damages are considered as an consideration for an unlawful act of tolerance of non-performance and thus falls under the purview of GST and 18% shall be levied on the liquidated damages.

Announcement of relief by the Government

  • Since thousands of contracts and agreements are duly executed and performed by the Private companies with the association of Central and State Governments.
  • In the context, for example, in highway developing sectors there are more than 15 thousand contractors designated for services.
  • Keeping in mind these sectors, during the COVID 19 pandemic, the Government out of courtesy and to lessen the burden on the contractors have extended the time up to six months for completion assigned projects.

Conclusion

As the Country still awaits and look forward for a positive ruling on damages, the current judgments and rulings are considered on the other way of the road. In the light of the same context, we firmly believes that Government should come with more clear picture as Country is going through pandemic that has caused a desolation to human lives and economy at large.

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