No GST on Transit Shortage Recovery as Liquidated Damages; ITC Reversal Required

Summary: Recovery of amounts from transporters for transit shortages is stated to be compensatory liquidated damages for breach of the contract of carriage and not consideration for any supply under Section 7 of the CGST Act, 2017. Circular No. 178/10/2022-GST clarifies that liquidated damages for breach are not consideration for a service of tolerating an act. In Re: Pon Pure Chemical India Pvt. Ltd., Advance Ruling No. GUJ/GAAR/R/2026/23 dated 24.06.2026, the Gujarat AAR held that recoveries from transporters for material shortage, damage, theft/pilferage and other transit defects are liquidated damages and do not constitute consideration for an independent supply or taxable service under Schedule II, para 5(e), read with Section 7. Inox Air Products Pvt. Ltd., Advance Ruling No. GUJ/GAAR/R/2025/10 dated 25.03.2025, held that no supply arises for goods lost in transit before the place and time of supply are reached, while ITC attributable to such quantity is blocked under Section 17(5)(h). The supplied material further states that the receiver must reverse proportionate ITC on shortage quantities under Sections 16(2) and 17(5)(h). Thus, no GST is payable on transporter shortage recoveries, while proportionate ITC on goods not received must be reversed.

1. Issue in hand: Treatment of recovery against transit Shortages from transporters – whether in nature of supply or Liquidated Damages under GST?

2. Background

In the course of supply chain management, “transit shortage” occurs when the quantity of goods received by the consignee is less than the quantity dispatched by the supplier. Typically, the value of this shortage is recovered from the transporter’s freight charges as compensation for the loss.

3. GST not applicable as supply:

As per section under 7 of CGST Act 2017:

1. For the purposes of this Act, the expression “supply” includes:

(a) All forms of supply of goods or services or both such as sale, transfer, barter, exchange, license, rental, lease or disposal made or agreed to be made for a consideration by a person in the course or furtherance of business.

(aa) Activities or transactions, by a person, other than an individual, to its members or constituents or vice-versa, for cash, deferred payment or other valuable consideration.

(b) Import of services for a consideration whether or not in the course or furtherance of business.

(c) Activities specified in Schedule I, made or agreed to be made without a consideration.

(1A) Where certain activities or transactions constitute a supply in accordance with the provisions of sub-section (1), they shall be treated either as supply of goods or supply of services as referred to in Schedule II.

(2) Notwithstanding anything contained in sub-section (1):

(a) Activities or transactions specified in Schedule III; or

1(b) Such activities or transactions undertaken by the Central Government, a State Government or any local authority in which they are engaged as public authorities, shall be treated neither as a supply of goods nor a supply of services.

There is no element of supply as per the above definition and the same position has been up held in the matter of Advance Ruling in the matter of Inox Air Products Pvt Ltd dated 25/03/2025.

 3. non-Taxability on transit shortage held to be as liquidated damages (LD)

The recovery of an amount from a transporter for transit shortage constitutes Liquidated Damages (LD) for a breach of the contract of carriage.

Circular No. 178/10/2022-GST: The CBIC has clarified that Liquidated Damages are not a consideration for any “supply.” A breach of contract is an event that the aggrieved party does not desire. Therefore, recovering a penalty for such a breach is not a “service” of tolerating an act.

Judicial Precedent: In the matter of South Eastern Coalfields Ltd. vs. CCE, it was held that penalty/LD is not a consideration for a service. The “literal construction” of the contract is paramount; if the deduction is specifically for a loss of goods, it cannot be categorized as a taxable supply under Schedule II of the CGST Act.

Recent Advance Ruling:

In Re: Pon Pure Chemical India Pvt. Ltd., Advance Ruling No. GUJ/GAAR/R/2026/23 dated 24.06.2026, the Gujarat Authority for Advance Ruling examined an identical issue where the applicant recovered amounts from transporters for material shortage, damage, theft/pilferage and other defects occurring in transit. The Authority held that such recoveries are in the nature of liquidated damages – a mere flow of money from the party causing the breach to the party suffering the loss – and do not constitute “consideration” for any independent supply. Relying on Circular No. 178/10/2022-GST, the AAR ruled that since there is no agreement, express or implied, by the applicant to refrain from, tolerate, or do any act in exchange for such compensation, the amount received from transporters does not fall within the scope of “supply of services” under para 5(e) of Schedule II read with Section 7 of the CGST Act, 2017, and is accordingly not taxable under GST.

In Inox Air Products Pvt. Ltd. (Gujarat AAR): In Advance Ruling No. GUJ/GAAR/R/2025/10 dated 25.03.2025, the Gujarat Authority for Advance Ruling examined the case of M/s. Inox Air Products Pvt. Ltd., a manufacturer and supplier of industrial gases such as Oxygen, Nitrogen and Argon in liquid and gaseous form, transported to customers in vacuum-insulated cryogenic tankers. Owing to the low boiling point and volatility of liquid gases, a portion evaporates in transit, and the exact quantity received by the customer can be ascertained only after decanting at the buyer’s premises – termed by the applicant as “transit loss.” Since the quantity was not known at the time of removal, goods were dispatched under a delivery challan in terms of Rule 55 of the CGST Rules, 2017, with the tax invoice raised only after actual delivery. The applicant sought a ruling, among other things, on whether GST is payable on goods lost in transit and whether ITC is required to be reversed under Section 17(5)(h) of the CGST Act, 2017.

The Authority held that the place of supply of goods, in terms of Section 10 of the IGST Act, 2017, is the location where movement terminates for delivery to the recipient, and the time of supply, in terms of Section 12 of the CGST Act, 2017, is the earlier of the date of invoice or the date of receipt of payment. Since the transit loss occurs during the course of transportation, i.e., before both the place of supply and the time of supply are reached, and the tax invoice itself is generated only after delivery, the Authority concluded that there is no “supply” within the meaning of Section 7 of the CGST Act, 2017, in respect of the gas lost in transit. Accordingly, it was ruled that no GST is payable on goods lost in transit. However, on the connected question of input tax credit, the Authority held that since there is no taxable outward supply qua the quantity lost in transit, the credit availed on inputs relatable to that quantity fails the vesting condition of end-use in furtherance of a taxable supply under Section 16(1) of the CGST Act, 2017, and is accordingly blocked credit requiring reversal under Section 17(5)(h) of the CGST Act, 2017, read with Section 16 thereof. This ruling is a valuable precedent for the present issue, as it independently affirms – on facts involving loss during transportation rather than a transporter-caused shortage – that no supply, and hence no GST liability, arises on goods lost before the place and time of supply are reached, while the corresponding ITC nonetheless remains liable to reversal.

Conclusion on LD: No GST is payable on the amount recovered or deducted from the transporter.

4. Specific provision of reversal of input tax credit (ITC) by the receiver:

While the recovery from the transporter is not taxable, the receiver must address the ITC originally claimed on the invoice issued by the supplier.

Section 16(2) of the CGST Act: One of the fundamental conditions for availing ITC is the actual receipt of goods. In the case of a transit shortage, the “short” quantity is never received by the registered person.

Section 17(5)(h) of the CGST Act: This section explicitly blocks ITC on goods that are “lost, stolen, destroyed, written off…” Since transit shortage represents goods “lost” before reaching the destination, the proportionate ITC attributed to the shortage quantity must be reversed by the receiver.

5. Summary of legal position

6. Conclusion

Based on the literal construction of the CGST Act and the clarifications issued by the CBIC, the recovery of transit shortages from a transporter is compensatory in nature and falls outside the ambit of “supply.” Consequently, no GST is applicable on such recoveries. However, the receiver is legally obligated to reverse the proportionate Input Tax Credit under Section 17(5)(h), as the goods were never received for use in the course or furtherance of business.