A clarificatory circular[1] dated 03 August 2022 (‘Circular’) was issued by the Indian Tax Authorities inter alia on applicability of Goods and Services Tax (‘GST’) on ‘liquidated damages’. It was expected that the Circular would put to rest the ongoing litigation and uncertainty around taxability of liquidated damages. The Circular had explicitly mentioned (along with examples) that liquidated damages received by a service receiver ought not to attract GST. However, the Indian Tax Authorities continue to spring surprises, and divergent rulings on this issue are still pronounced. To read more on the Circular please refer to our earlier article here GST Circular on taxability of Liquidated Damages – Is it really clarificatory? — Publication & News (acuitylaw.co.in).
In a recent ruling by the Andhra Pradesh Authority for Advance Ruling (‘APAAR’)[2], it has been stated that GST is applicable on liquidated damages for non-performance of a contract. The ruling was pronounced against an application by the Andhra Pradesh Development Company (‘APPDCL’), a special purpose vehicle set up to implement mega power projects. APPDCL entered into an agreement with Chettinad Logistics Pvt Ltd for supply of services, which included liasioning, coordination and supervision of coal loading, arranging rakes, transportation of raw coal, and crushing of boulders. The service agreement also stated that in the event of failure in performance of the job assigned to the service provider, the service receiver i.e. APPDCL will be entitled to liquidated damages.
The APAAR while pronouncing that GST is payable, held that:
· The Circular is not universal and absolute and should be reasonably applied to the facts of each case.
· Meaning of the word ‘consideration’ in Section 2(31) of the Central Goods and Services tax Act, 2017 is very broad.
· Conditions/ scenarios contingent upon which the amounts are payable are clearly narrated in the agreement itself.
· It is immaterial to decide whether the amount collected by the appellant is for tolerating the act or for not tolerating the act.
· The service provider is paying the said amounts only for certain advantages derived or to ward-off any disadvantage incurred. Hence, it is only in response to something done by the service receiver.
· Paragraph 7.1.6 of the Circular mentions that payment towards damages which are incidental to the main supply will be treated as ‘consideration’, liable to GST.
The aforementioned reasoning appears to be misplaced, especially the reliance on Paragraph 7.1.6 which applies (based on examples provided in the Circular) to fines and penalties collected by a service provider in course of rendition of the principal supply. For the facts relevant to APPDCL, the Circular has mentioned the following while clarifying that GST ought not to be applicable:
· A contractual relationship cannot be presumed to exist simply because there is a flow of money from one party to another.
· Liquidated damages are payments for not tolerating an act or a situation and to deter such acts leading to breach of contract.
· There cannot be any contract with an intent to allow a breach or non-performance.
· Payment towards fines or damages cannot be considered as consideration, in absence of express agreement to tolerate non-performance or breach.
Conclusion
Despite the Circular, divergent rulings are being pronounced which will continue to unsettle the taxability around liquidated damages. While this is an advance ruling and applicable only to APPDCL, the same will encourage similar views to be adopted by other state advance ruling authorities. As mentioned in our earlier article, the reasoning provided in Paragraph 7.1.6 to tax certain payments in the nature of fines/ penalties appear to be misplaced and hence leaves room for misapplication of law as evident from this advance ruling. It is expected that the tax authorities recognise this anomaly at the earliest and provide clear directions to taxpayers and adjudicating authorities on taxability of liquidated damages.
Authors: Deni Shah
The information contained in this document is not legal advice or legal opinion. The contents recorded in the said document are for informational purposes only and should not be used for commercial purposes. Acuity Law LLP disclaims all liability to any person for any loss or damage caused by errors or omissions, whether arising from negligence, accident, or any other cause.
[1] Circular No. 178/10/2022-GST dated: 03.08.2022
[2] AAR No. 04/AP/GST/2023 dated: 31.03.2023