Amount recovered from the Contractors as part of breach of contract or for Non-performance of Contract within the stipulated period, is Supply of service and taxable under GST: AP AAR
In case of Transmission Corpn. of A.P. Ltd.-AAR-ANDHRA PRADESH held that, Amount recovered from the Contractors as part of breach of contract or for Non-performance of Contract within the stipulated period, is Supply of service and taxable under GST.
Facts of the case:- M/s. Transmission Corporation Of Andhra Pradesh Limited, a Licensed Distribution Company for supply of electricity. The Applicant enters into multiple contracts and agreements with Suppliers (contractors) in order to construct and maintain the Transmission Network in the State of Andhra Pradesh in line with demand growth and general expansion in an efficient manner so as to ensure highest availability of electricity at lowest operational costs.
The contracts contain a clause of penalties, which are nothing but liquidated damages, that will be deducted from the amounts due to the suppliers for compensating the loss borne by the Applicant on account of the supplier not adhering to the time limits agreed upon by the contracting parties as per the agreement.
Questions raised before the authority:
The applicant sought advance ruling on the following:
1. Whether the amount recovered by the Applicant from the Suppliers or the Contractors as part of breach of contract or for Non-performance of Contract within the stipulated period, as represented by the penalty, i.e., Liquidated Damages is leviable to GST ?
On Verification of basic information of the applicant, it is observed that the applicant is under State jurisdiction i.e ,Special circle, Vijayawada Division. Accordingly, the application has been forwarded to the jurisdictional officer and a copy marked to the Central Tax authorities to offer their remarks as per Sec. 98(1) of CGST /APGST Act 2017.
Discussion and Findings:
- LIQUIDATED DAMAGES UNDER CONTRACT LAW:- The term ‘Liquidated Damages’ is defined in Black’s Law Dictionary as “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.”
- APPLICABILITY OF GST ON LIQUIDATED DAMAGES-In the case of Maharashtra State Power Generation Company Ltd. (2018-VIL-33-AAR), wherein the Maharashtra Authority for Advance Ruling (AAR) held that Liquidated Damages are to be treated as consideration for an act of tolerance of non-performance, and thus the value of Liquidated Damages is subject to GST at the rate of 18% under the Heading 9997”.
Similar rulings have also been pronounced in the below mentioned matters:
- Fastrack Deal Comm (P.) Ltd. (GUJ/GAAR/R/58/2020 dated 30.07.2020) – Gujarat AAR held that GST is applicable on advance forfeited for breach of terms of contract.
- Amneal Pharmaceuticals (P.) Ltd. (GUJ/GAAR/R/51/2020 dated 30.07.2020) – Gujarat AAR held that GST is applicable on compensation paid by an employee to the employer for not serving the stipulated notice period.
- M/S TP Ajmer Distribution Limited [(2019) 103 taxmann.com 227 (AAAR-RAJASTHAN)] – Rajasthan Appellate AAR held that GST is applicable on fees paid in lieu of dishonoured cheque.
- M/S Bajaj Finance Limited (MAH/AAAR/SS-RJ/24/2018-19) – Maharashtra AAR held that GST is applicable on compensation paid by the owner to tenant for temporary relocation.
GST dt.03.08.2022 and case laws relied upon by the applicant is not universal and absolute. The circular is only meant to clarify the position of law and shall be applied reasonably having regard to the facts of the case. The circular had clearly mentioned, interalia, vide para 7.1.6 that “Therefore, such payments, even though they may be referred to as fine or penalty, are actually payments that amount to consideration for supply, and are subject to GST, in cases where such supply is taxable. Since these supplies are ancillary to the principal supply for which the contract is signed, they shall be eligible to be assessed as the principal supply, as discussed in detail in the later paragraphs. Naturally, such payments will not be taxable if the principal supply is exempt.
Thus the circular had said payment towards damages are incidental to the main supply and if the main supply is taxable they shall also be taxable and if the principal supply is exempt then the incidental shall also be exempt. Thus the circular shall be understood in the proper context.
Ruling :- Question: Whether the amount recovered by the Applicant from the Suppliers or the Contractors as part of breach of contract or for Non-performance of Contract within the stipulated period, as represented by the penalty, i.e., Liquidated Damages is leviable to GST ?
Answer : Yes
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