Whether GST Payable on Penalties and Liquidated Damages Levied by Govt. or Local Authorities?

Further to my Article ‘Whether GST Applicable on Liquidated Damages?‘ Published in Taxguru on 9th Jan’2020,  many readers inquired, ‘Whether GST Payable on Penalties & Liquidated Damages Levied by Govt. or Local Authorities?’ Let’s discuss on the subject in this article and clarify the issue.

Government Contract

Government Contract means any prime Contract, subcontract, purchase order, task order, delivery order, teaming agreement, joint venture agreement, strategic alliance agreement, basic ordering agreement, pricing agreement, letter contract or other similar arrangement of any kind with

(i) any Governmental Authority,

(ii) any prime contractor of a Governmental Authority in its capacity as a prime contractor, or

(iii) any subcontractor at any tier with respect to any contract of a type described in clauses (i) or (ii) above.

Government contracts are contracts undertaken by the Government for varied purposes like construction, management, maintenance and repairs, manpower supply, IT related projects etc. The involvement of Central Government or State Government or Government body or Local Authority in a contract makes it a government contract.

Contractual Terms & Conditions

Every contract must have Certain Contractual Terms & Conditions which are expressly agreed between the parties, generally made in writing.

Fines & Penalties or Liquidated Damages are some of such Terms very commonly stated in a Contract.

A penalty clause in a contract obligates the defaulting party to provide some form of compensation to the innocent party in the event of a breach of contract.

A penalty clause states that one contracting party is required to give something, usually money, to the other party if he or she breaches the contract. With such a provision in place, the breaching party is more likely to pay the penalty to the other party.

Liquidated damages clause specifies the amount of damages to be paid by the breaching party if it fails to perform specified obligations and other terms in the event of certain types of breaches under the contract.

In both the cases of Penalty and Liquidated Damages, the Breaching Party shall Pay to the other, Compensation / Penalty.

Now, let’s Discuss whether GST applicable on Fines, Penalties & Liquidated Charges Levied by Government.

A Contract may be Breached by Either Party : Govt. / Local Authority or Contractor

Breach of Contract

Case – 1 : Contractor Breached the Contract.

Compensation / Penalty Payable by him to the Govt. / Local Authority

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.

Case – 2: Govt. / Local Authority Breached the Contract.

Compensation / Penalty Payable by Govt. / Local Authority to the Contractor

Certain times Government  or Local Authority also may Breach any of the Contractual Clauses, therefore liable to pay fines or liquidated damages to the Contractor.

For Example, as per Contract, the Government or Local Authority, supposed to handover clear site to the Contractor within stipulated time and failing which it is liable to pay fines or liquidated damages to the Contractor. Say, the Government or Local Authority fail to do so as per contract, it tantamount to Breach of Contract liable to pay fines or liquidated damages to the Contractor.

In such a situation, Contractor Issues Invoice on the Government or Local Authority to Recover Penalty / Compensation.

Since No relief of Exemption is Provided, GST is Payable on the amount of Penalty or liquidated damages claimed by the Contractor on the Government or Local Authority.

Disclaimer : The views and opinions; thoughts and assumptions; analysis and conclusions expressed in this article are those of the authors and do not necessarily reflect any legal standing.

Author : SN Panigrahi, GST & Foreign Trade Consultant, Practitioner, Corporate Trainer & Author.

Available for Corporate Trainings & Consultancy

Can be reached @ snpanigrahi1963@gmail.com

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November 2020