Liquidated Damages are being levied for Non-Performance or Breach of Contract, Late Delivery of Supplies etc. In this article let’s discuss about applicability of GST on Liquidated Damages.

Meaning of Liquidated Damages: 

Black’s Law Dictionary (Tenth Edition) on page 473 defines Liquidated Damages thus:

An amount contractually stipulated as a reasonable estimation of actual damages to be recovered by one party if the other party breaches. If the parties to a contract have properly agreed on liquidated damages, the sum fixed is the measure of damages for a breach, whether it exceeds or falls short of the actual damages.” 

Liquidated damages are a means of compensation for the breach of a contract.

Example : If a contractor failed to complete a construction project on time and LD is charged daily until the project has been finished.

A liquidated damages clause generally specifies a predetermined amount of money that must be paid as damages for failure to perform under a contract.

Word of GST on wooden alphabet blocks on calculator

Relevant Provisions of CGST Act

Section 7(1) (d) of the GST Act, 2017 includes activities referred to in Schedule II in the Scope of Supply. Paragraph 5 of Schedule II to CGST Act provides a list of activities to be treated as ‘supply of services’ which inter alia comprises – “(e) agreeing to the obligation to refrain from an act, or to tolerate an act or situation, or to do an act“.

The view supporting levy of tax on liquidated damages and forfeiture of earnest money is based on premise that the party has ‘tolerated’ the non-performance which is Supply.

GST is applicable on ‘supply’ of goods or services or both and is charged on the ‘value of supply’.

Section 15(1) of the GST Act defines ‘value of taxable supply’ as the transaction value, which is the price actually paid or payable for the said supply where the supplier and the recipient of supply are unrelated and the price is the sole consideration.

In case of Liquidated Damages, there is an act of Non-Performance / Breach and the same has been tolerated by an additional levy in the nature of liquidated damage.

There are two events, the first event calls for the payment of a contract price to the Contractor and the second event calls for the payment of liquidated damage to the owner.

The income (though presented in the form of deduction) from payments to be made to the Party that Breached (Contractor) is the income of the Party that Suffered Damage (Principal / Owner) and would be a supply of ‘service’ in terms of schedule II para 5 clause (e) of the GST Act.

Therefore, GST is applicable on Liquidated Damages.

Advance Ruling on Liquidated damages (“LD”)

In re M/s. Maharashtra State Power Generation Co. Ltd (AAR Maharashtra) No. GST-ARA- 15/2017-18/B-30; dt. 08/05/2018

The Maharashtra Authority for Advance Ruling (“AAR”) in the case of Maharashtra State Power Generation Company Limited (“Applicant”) held that Goods and Services Tax (“GST”) at the rate of 18% would be payable on liquidated damages (“LD”) received by the Applicant for delayed supply under a contract.

The AAR has considered LD to be a consideration for agreeing to the obligation to tolerate an act or a situation, which is treated as a supply of service under para 5(e) of Schedule II of the Central Goods and Services Act, 2017 (“CGST Act”) / Maharashtra Goods and Services Act, 2017 (“MGST”)

Similar Ruling are made in the following AARs

In re M/s. North American Coal Corporation India Private limited (GST AAR Maharashtra); Advance Ruling No. GST-ARA-07/2018-19/B-63; 11/07/2018

In re Rashtriya Ispat Nigam Ltd (GST AAR Andhra Pradesh);  Advance Ruling No. AAR 01/AP/GST/2019; 11/01/2019

In re M/s. Dholera Industrial City Development Project ltd. (GST AAR Gujarat);  Advance Ruling No. GUJ/GAAR/R/2019/06;  04/03/2019

In re Bajaj Finance Limited (GST AAAR Maharashtra); Order No. MAH/AAAR/SS-RJ/24/2018-19; 14/03/2019

The Rulings also impacts many other similar transactions.

For example, if a builder forfeits a buyer’s earnest money after the buyer fails to buy a flat in a contracted period, GST will be levied on that forfeited amount since the builder has ‘tolerated your act’ of not paying the full amount, therefore, it becomes a ‘deemed service’ and GST is due.

So, GST is Applicable on

> Liquidated Damages & other Penalties like milestone penalties,

> Penal / Default Interest in case of delay in repayment of EMI

> Advance Forfeited for Cancellation of Agreement,

> Forfeiture of Security for Damages Done,

> Compensation to Termination of Contract,

> Non-Compete Fee for Agreeing Not to Compete,

> Cancellation Charges for Cancelling Travel Ticket (Air, Train, Bus),

> Demurrage or Detention Charges,

etc…etc….

Who will Raise the Invoice:

The Party Collecting Liquidated Damages, Penalties, Compensation, Cancellation Charges, Demurrage or Detention Charges etc. shall raise the Invoice by Charging GST with SAC code 9997 (Other services) GST @ 18%.

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13 Comments

  1. sunil bhageria says:

    What will be the value for LD. Means total invoice value(including GST) or Supply value i.e Value before GST.. For example goods value 100 + 18 % GST. now customer deducts LD for delay say 5 % so would it be deducted as RS 5 (5 %on RS 100) or RS 5.90 (5 % of total value of RS 118)

  2. hardik dhariwal says:

    Dear Sir,
    please guide on the case where there is a performance guarantee received from Supplier (E.g. C) and the supplier is not exist as he become insolvent in that case we forfeit his amount pertaining to Performance guarantee. Whether liable to GST if yes then whom we issued an invoice as the party not exist.

  3. Subir says:

    Dear Sir,
    we supplying to gov.body as per contract customer was deducted LD on total invoice value in such case can we pass credit to our customer and take GST amount benfit..
    Please sugest

  4. Ankit Gupta says:

    Sir in case of post sale discounts or target based discounts where the OEM provides the amount to the dealer based on achieving some specified targets by dealer by way of Commercial Credit Notes (CCN).
    1.Then whether the Value +tax has to be reduced from the value of supply from OEM’s view point?
    2.Whether ITC has to be received by the Dealer i.r.o such CCN??
    3.If such amount received by dealer ,can GST be levied on such supply treating it as agreeing to the obligation to refrain from an act, or to tolerate an act or situation, or to do an act.??
    4.Cases where no GST Credit notes is being issued by the OEM then what shall be the treatment from both OEM and Dealer?
    5.Whether in case of point no 4 above Dealer will still need to be required to reverse ITC i.r.o such CCN??

  5. K PRAKASH BABU says:

    Dear Sir,
    As far as my understanding goes, by recovering Liquidated Damages or penalties from a contractor for breach or violation of agreed contract terms and this LD or Penalty clause is imbibed in the said contract, this is no service/supply rendered by the Contractee to the Contractor to attract the GST. Further it does not attract the entry no:e of Schedule II to Section 7 of CGST Act’2017. As per the provisions contained in Section 73 & 74 Of Indian Contract Act;1872, this LD or penalty is only a compensation and not consideration, This LD or Penalty can be equated to the mandatory interest levied by the Government for belated payment of Tax Liability. If GST is applicable on LD or Penalty, then on payment of interest for belated remittance, the tax payers have pay GST under RCM.
    Hence, it is felt that the recovery of LD or Penalty under a agreed contract, GST is not applicable.

  6. SHASHANK says:

    Sir, What treatment should be done in case liquidating charges are received from foreign buyer??
    Should be raise invoice assuming that the services are given in India or outside India?

  7. krishna says:

    i am not satisfied. Government of Karnataka under taking collected GST from Solar Power Generators as they have not full filled work/delayed hence LD collected whether GST is applicable pl confirm sir.

    1. snpanigrahi says:

      Pl. go Through my Article
      GST on Penalties & Liquidated Damages Levied by Govt. or Local Authorities
      Published on 15th Jan’2020

      As per Entry No: 62 of Exemption Notification No. 12/2017- Central Tax (Rate); 28th June, 2017 under Chapter Heading / SAC which describes that

      “Services provided by the Central Government, State Government, Union territory or local authority by way of tolerating non-performance of a contract for which consideration in the form of fines or liquidated damages is payable to the Central Government, State Government, Union territory or local authority under such contract”.

      Govt. / Local Authority Issues Invoice on Contractor to Recover Penalty / Compensation.

      Since such Fines / Penalties or liquidated damages payable to Government or Local Authority are Exempted, therefore, No GST is Charged or Even Payable on RCM basis.

  8. Rajesh says:

    If the Contractor providing services to the government authority, then whether the need to pay GST on liquidated damages under RCM..? please clarify the same.

    1. snpanigrahi says:

      As per Entry No: 62 of Exemption Notification No. 12/2017- Central Tax (Rate); 28th June, 2017 under Chapter Heading / SAC which describes that

      “Services provided by the Central Government, State Government, Union territory or local authority by way of tolerating non-performance of a contract for which consideration in the form of fines or liquidated damages is payable to the Central Government, State Government, Union territory or local authority under such contract”.

      Govt. / Local Authority Issues Invoice on Contractor to Recover Penalty / Compensation.

      Since such Fines / Penalties or liquidated damages payable to Government or Local Authority are Exempted, therefore, No GST is Charged or Even Payable on RCM basis.

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