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Clarification on GST applicability on liquidated damages, compensation and penalty arising out of breach of contract or other provisions of law

The Central Board of Indirect Taxes and Customs (CBIC) has issued Circular No 178/2022 dated 3rd August 2022, clarifying the applicability of GST on certain charges/fees/penalty arising out of breach of contract and other cases.  The circular has extensively dealt with various scenarios where certain charges/fee/penalty are recovered by one party from another on account of breach of terms of contract.

The term supply includes ”Agreeing to the obligation to refrain from an act or to tolerate an act or a situation, or to do an act”. Circular has given examples of activities covered under this –

1. Agreeing to the obligation to refrain from an act – This would include non-compete agreements, where one party agrees not to compete with the other party in a
product, service or geographical area against a consideration paid by the other party. Another examples is activities would be a builder refraining from constructing more
than a certain number of floors, even though permitted to do so by the municipal authorities, against a compensation paid by the neighbouring housing project, which wants to protect its sunlight.

2. Agreeing to the obligation to tolerate an act or a situation – This would include a shopkeeper allowing a hawker to operate from the common pavement in front of his shop against a monthly payment by the hawker.

3. Agreeing to the obligation to do an act – This would include case where an industrial unit agrees to install equipment for zero emission/discharge at the behest of the RWA of a neighbouring residential complex against a consideration paid by such RWA, even though the emission/discharge from the industrial unit was within permissible limits and there was no legal obligation upon the individual unit to do so.

So the intention was to cover services as described in examples give above.

Agreement to do or refrain from an act should not be presumed to exist. There should be an express or implied promise by the recipient of money to agree to do or abstain from doing something in return for the money paid to him. Payment has to be made for an independent activity of tolerating an act under an independent arrangement entered into for such activity of tolerating an act, unless  such payments will not constitute ‘consideration’.

In light of above circular clarified that GST will not be applicable in below cases :

  • Liquidated Damages
  • Compensation for cancellation of coal blocks
  • Cheque dishonor fine/penalty
  • Penalty imposed for violation of law
  • Notice Pay recovery
  • Compensation for not collecting toll charges
  • Late payment of surcharge or fee (should be assessed at the same rate as Principal supply)
  • Fixed Capacity charges for power
  • Cancellation charges (depends upon nature of supply)

Copy of circular is attached herewith.

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April 2024