Goods and Services Tax GST applicability on compensation, liquidated damages, & penalties for contract violations etc

GST applicability on compensation, liquidated damages, & penalties for contract violations etc

GST applicability on compensation, liquidated damages, & penalties for contract violations etc

GST applicability on compensation, liquidated damages, & penalties for contract violations, among other things.

The taxability of liquidity damages, cancellation fees, late payment fees, etc. arising from contract breaches is a very frequent query under GST. The issue is raised by Central Goods and Service Tax Act, 2017, Schedule II, Paragraph No. 5(e), which says that "Agreeing to the obligation to refrain from an act, to tolerate an act or a circumstance, or to do an act" is a supply of service if the same qualifies as a "supply" under the Act.

So, in order to avoid confusion, the department released Circular No. 178/10/2022-GST on August 3, 2022, which clearly explains how GST is applied to such charges.

  • Loss and damages are suffered by the other party when one party breaches or fails to perform the contract. The payment is simply an occurrence during the performance of that contract; it is not a consideration for any other independent activity.
  • A contract's essential element is performance. Liquidated damages cannot be construed as payment made in consideration for accepting the contract's breach or non-performance.

Applicability of Goods & Services Tax on liquidated damages

  • According to the CGST Act, Section 7(1)(d), the Scope of Supply definition includes activities referred to in Schedule II of the Act. Schedule II Para (5)(e) thereon specifies that “agreeing to the obligation to refrain from an act, or to tolerate an act or a situation, or to do an act” comes under the definition of supply of services.
  • So, liquidated damages are taxable under Goods and Services Tax, based on the premise that the aggrieved party has tolerated the non-performance of the other party under the contract.
  • As Goods and Services Tax applies to the supply of goods and services, liquidated damages will be taxable as a service under the Goods and Services Tax Law. The time of supply would be the point in time when the breach happens, as defined in the contract.

GST rate on liquidated damages

Following GST rate applicable on Liquidated damages

Chapter Heading

Description

Rate

9997

Other services

18%

9991 or 9997

Services provided by the Central Govt, Union Territory or local authority, state govt  by way of tolerating the non-performance of a contract, for which consideration in the form of fines or liquidated damages is to be paid to the Central Govt, state government, Union Territory or local authority under such contract

   

Availability of ITC on liquidated damages

  • Subject to the limitations & conditions needed by Goods and Services Tax law, Goods and Services Tax paid on liquidated damages may be used as an ITC to offset any future tax due.

Who will issue Goods and Services Tax invoice on liquidated damages?

  • A separate GST invoice must be issued for the liquidated damages by the party collecting these.

Details about the Circular No. 178/10/2022-GST   

The field formations have already been advised that while the taxability in each case will depend on the facts of that case, it is possible to use the guidelines provided to ascertain whether tax on an activity or transaction needs to be paid by treating it as a service by agreeing to the obligation to refrain from performing an act, accepting an act or circumstance, or going to perform an act.

Disclaimer: The content of this post isn't considered to be professional or legal advice, We aren't responsible for any damages arising from your access to the location content & must not be relied on or used as a substitute for legal advice from a lawyer professional in your jurisdiction. CARajput is among India's big digital compliance services platform which committed to helping people have started & developed their businesses. We had started with the goal of creating it easier for start-ups to start out their business. Our main aim is to assist the businessman with applicable laws & regulations compliance and providing support at each & every level to make sure the business stays compliant and growing continuously. For any query, help or feedback you may in touch on singh@carajput.com or Call or what’s-up on 9-555-555-480

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