GST UPDATE ON LIABILITY ON RETENTION AMOUNT -LIQUIDATED DAMAGES

GST UPDATE ON LIABILITY ON RETENTION AMOUNT -LIQUIDATED DAMAGES - 014/2020-21

GST UPDATE ON GST LIABILITY ON RETENTION AMOUNT/LIQUIDATED DAMAGES:-
The litigation as regards taxability of liquidated damages stems from the introduction of negative list regime in Service Tax Laws since 2012 when the service of “Tolerate to do an act or situation” was introduced as declared service and liable to service tax. The legacy of the dispute was carried forward in the GST regime too as entry no. 5(e) of the Schedule II to the CGST Act, 2017 states that the activity of agreeing to the obligation to refrain from an act, or to tolerate an act or a situation, or to do an act as supply of service. This entry is being made applicable in many cases by the revenue authorities even to levy GST on compensation received for breach of contractual obligations. The present update seeks to discuss the applicability of GST on liquidated damages received on account of breach of contractual obligations.
In order to dwell upon this issue, it is better to consider an example of the present pandemic situation. Suppose, Mr. X has booked a room in hotel and has paid advance of Rs. 5,000/- but due to pandemic, the said hotel has been converted into wellness centre on account of compulsory orders by the government. Even otherwise, on account of lockdown, Mr. X will not be able to avail the services of hotel. In such a situation, there may be following situations:-

Hotel may decide to forfeit the entire advance amount of Rs. 5,000/- as per agreed policy and conditions.
Hotel may refund the entire amount of advance of Rs. 5,000/- due to unforeseen circumstances in provision of service to Mr. X
Hotel may retain 50% amount as per agreed policy and offer Mr. X compensation of Rs. 1,000/- which was not pre-decided at the time of booking but is given due to exceptional circumstances of their hotel being converted into wellness centre by mandatory directions of the government.

The moot question arises in that whether the amount of advance retained or compensation paid by hotel to Mr. X can be considered as service in terms of entry 5(e) of Schedule II to the CGST Act, 2017 to attract GST? Whether revenue authorities can claim that the advance amount forfeited has converted into service of “tolerating an act” and attracts GST at the rate of 18% rather than the GST rate of 12% as prescribed for accommodation services below Rs. 7,500/-? Whether change in circumstances can lead to change in classification of service altogether and the hotel is required to pay additional GST of 6% is the moot question that requires to be answered.
We hereby discuss the liability of GST under each of the situations mentioned above:-

In case the hotel decides to retain the entire amount of advance received by it, then it is required to raise invoice of the advance amount under accommodation services. The GST already paid at the time of advance will be adjusted on raising the invoice as nothing is being refunded to Mr. X and the GST already paid to the government cannot be reduced from the output liability of hotel. One may object that when hotel has not provided any service, invoice cannot be raised by it under accommodation service. However, the receipt voucher issued at the time of advance receipt is required to be settled either by issuing refund voucher or invoice. As in the present case, since there is no refund, issuance of invoice is the only option left with the hotel. The department will ask for GST @ 18% but the taxpayer has already paid the tax under accommodation service. In service tax regime also, the same issue was settled in favour of hotel.
In case where the hotel refunds the entire advance amount to Mr. X, hotel is suppose to raise credit note under section 34(1) of the CGST Act, 2017 in terms of situation that services have been returned by the recipient/not availed by the recipient. The hotel will be entitled to reduce its output liability in the month in which such credit note has been issued. This is in line with the recent clarification issued vide Circular No. 137/07/2020 dated 13^th April, 2020. Assuming that the hotel raised invoice along with receipt voucher at the time of receiving advance from Mr. X. If no invoice was issued earlier by the hotel, the hotel is entitled to claim refund of excess tax paid because credit note can be issued only if invoice has been issued earlier.
This is the situation where clarity is required by the government. In case the hotel refunds 50% of the advance amount and gives compensation of Rs. 1000/- for inability to provide accommodation service due to mandatory orders of the government. The question which arises is whether the amount of Rs. 1000/- given as compensation to Mr. X for inability to provide service as per contract would amount to provision of service mentioned at serial no. 5(e) of Schedule II to the CGST Act, 2017 and liable to GST at the rate of 18%? The revenue authorities would definitely consider the compensation as provision of service under serial no. 5(e) of Schedule II but in our opinion, the amount received cannot be treated as consideration received by Mr. X for tolerating act of the hotel of not providing the accommodation service because this provision of service was never intended either by Mr. X or by the hotel. The triggering point for payment of compensation by the hotel to Mr. X has occurred on account of unforeseen circumstances and was not at all intended by either of the parties. Moreover, the compensation for breach of the contractual obligation is merely an uncertain event which may or may not happen and so it cannot be stated that this transaction is a supply covered under serial no. 5(e) of the Schedule II to the CGST Act, 2017 so as to attract GST. Moreover, after amendment in the section 7 pertaining to scope of supply under CGST Act, 2017, any activity listed in Schedule II to the CGST Act, 2017 is not a supply of service per se and rather should be considered as supply only if it fulfils the criteria of being considered as supply under GST and is being done in course of furtherance of business.

Therefore, levying GST on compensations/liquidated damages/demurrage charges in shipping contracts/foreclosure charges in loan contracts/notice pay should be re-visited as it is not liable to taxed as service in each and every case. In this context, reference may be made to decision given by Hon’ble Allahabad Tribunal in the case of K N FOOD INDUSTRIES PVT. LTD. VS COMMISSIONER OF CGST [2019-TIOL-3651-CESTAT-ALL] wherein it was held that compensation payable on account of unintended events cannot be considered as payment for any services and cannot be liable to service tax. Although the decision pertains to negative list regime, but as there were similar provisions, the decision has precedential value and a clarification should be issued by the government so that unwarranted litigation may be avoided.

This is solely for educational purpose.
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GST UPDATE ON LIABILITY ON RETENTION AMOUNT -LIQUIDATED DAMAGES - 014/2020-21

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