GST UPDATE No 253 ON CLARIFICATION ON LEVY OF GST ON LIQUIDATED DAMAGES

The levy of GST on liquidated damage, compensation, penalty, cancellation charges, late payment surcharge etc. arising out of breach of contract and the scope of entry at para 5(e) of Schedule II of the CGST Act, 2017 has been examined in the circular. There are many instances where a doubt arises as to levy of GST on charges such as compensation awarded against cancellation of license, bond amount recovered from an employee not serving the notice period, cancellation charges recovered for cancellation of railway tickets etc. The present update seeks to highlight the key takeaways of the said clarification issued vide Circular no. 178/10/2022-GST dated 03.08.2022 regarding the circumstances in which tax would be leviable on such charges.

It is stated that the service of agreeing to the obligation to refrain from an act or to tolerate an act or a situation, or to do an act is nothing but a contractual agreement. A contract to do something or to abstain from doing something cannot be said to have taken place unless there are two parties, one of which expressly or impliedly agrees to do or abstain from doing something and other agrees to pay consideration to the first party for doing or abstaining from such an act.

Agreement to do or refrain from an act should not be presumed to exist:- There has to be an express or implied agreement; oral or written, to do or abstain from doing something against payment of consideration for doing or abstaining from such act, for a taxable supply to exist. For instance, liquidated damages for breach of contract, forfeiture of salary for not serving notice period, penalty for cheque dishonour are not consideration for tolerating an act or situation as nobody enters into contract for leaving employment before the agreed notice period or for breach of contract. Hence, such payments are mere events in contract and will not constitute consideration or supply.

Similarly, examples of liquidated damages can be penalty for delayed construction of houses, forfeiture of earnest money by a seller for breach of contract etc. which are not liable to tax as such payments are merely flow of money and not a consideration for any supply.

On the contrary, pre-payment penalty on early repayment of loan , amount forfeited on cancellation of service by customer as contemplated by the contract as part of commercial terms agreed to by the parties constitute consideration for supply of a facility and so even if such payments are referred as fine or penalty, such payments are subject to GST.

As far as compensation ordered by the Supreme Court for cancellation of coal blocks allotted to successful bidders, it was clarified that no tax is required to be paid pursuant to the Apex Court order as no such promise or offer was made by the prior allottees to the government and that the allottees had no option but to accept the cancellation.

Likewise, cheque dishonour fine/penalty is not a consideration for any service as no supplier wants a cheque given to him to be dishonoured. Moreover, it entails extra administrative cost to him and disruption of his routine activities and cash flow.

As regards imposition of tax on penalty imposed for violation of laws is concerned, no GST is leviable as laws are not framed for tolerating their violation. Reference was also made to the Service Tax Education Guide issued in 2012 that fines and penalties for violation of the provisions of law are not considerations as no service is received in lieu of payment of such fines and penalties.

Forfeiture of salary or payment of bond amount in the event of the employee leaving the employment before the minimum agreed period:-Premature leaving of the employment results in disruption of work and an undesirable situation. The provisions for forfeiture of salary or recovery of bond amount in the event of the employee leaving the employment before the minimum agreed period are incorporated in the employment contract to discourage non-serious candidates from taking up employment. The said amounts are recovered by the employer not as a consideration for tolerating the act of such premature quitting of employment. Further, the employee does not get anything in return from the employer against payment of such amounts. Therefore, such amounts recovered by the employer are not taxable as consideration for the service of agreeing to tolerate an act or a situation.

Late payment surcharge or fee:-The facility of accepting late payments with interest or late payment fee, fine or penalty is a facility granted by supplier naturally bundled with the main supply. Almost all service providers across the world provide the facility of accepting late payments with late fine or penalty. Even if this service is described as a service of tolerating the act of late payment, it is an ancillary supply naturally bundled and supplied in conjunction with the principal supply, and therefore should be assessed as the principal supply.

Fixed Capacity charges for Power:-The fact that the minimum fixed charges remain the same whether electricity is consumed or not or it is scheduled/consumed below the contracted or available capacity or a minimum threshold, does not mean that minimum fixed charge or part of it is a charge for tolerating the act of not scheduling or consuming the minimum the contracted or available capacity or a minimum threshold. Both the components of the price, the minimum fixed charges/capacity charges and the variable/energy charges are charged for sale of electricity and are thus not taxable as electricity is exempt from GST.

Cancellation charges:-A supply contracted for such as booking of hotel accommodation, an entertainment event or a journey, may be cancelled by a customer or may not proceed as intended due to his failure to show up for availing the same at the designated place and time. The supplier may allow cancellation of supply by the customer within a certain specified time period on payment of cancellation fee as per commercial terms of the contract. It is stated that the facility of allowing cancellation against payment of cancellation charges is also a natural part of this bundle as it is invariably provided by all the suppliers as naturally bundled and in conjunction with the principal supply of transportation in the ordinary course of business. Hence, cancellation charges are to be assessed to tax as principal supply.

The above detailed circular seeks to discuss every possible nature of charges that can be treated in the entry “tolerate to do an act or refrain from doing an act” and its taxability in GST Law. It is submitted that we have already mentioned in our earlier GST update that every kind of liquidated damages or compensation is not to be treated as supply leviable to service tax unless there is express agreement to recover such compensation/damages in lieu of provision of the said service. The concept of substance over form in the agreements is the key deciding factor of whether the charges are liable to GST or not. Nonetheless, the above clarification will serve as a guiding tool to the assessees to determine their tax liability.

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GST UPDATE No 253 ON CLARIFICATION ON LEVY OF GST ON LIQUIDATED DAMAGES

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