{"id":110220,"date":"2022-09-26T10:54:18","date_gmt":"2022-09-26T05:24:18","guid":{"rendered":"https:\/\/legalwindow.in\/?p=110220"},"modified":"2022-09-26T11:47:53","modified_gmt":"2022-09-26T06:17:53","slug":"gst-on-liquidated-damages","status":"publish","type":"post","link":"https:\/\/www.legalwindow.in\/blog\/gst-on-liquidated-damages\/","title":{"rendered":"GST Applicability on Liquidated Damages, Compensation and Penalty"},"content":{"rendered":"<p><span style=\"font-weight: 400;\"><img loading=\"lazy\" decoding=\"async\" class=\"alignnone wp-image-110233 size-full\" title=\"GST on Liquidated Damages\" src=\"https:\/\/legalwindow.in\/wp-content\/uploads\/GST-Applicability-on-Liquidated-Damages-Compensation-and-Penalty-1.png\" alt=\"GST on Liquidated Damages\" width=\"1200\" height=\"630\" srcset=\"https:\/\/www.legalwindow.in\/blog\/wp-content\/uploads\/GST-Applicability-on-Liquidated-Damages-Compensation-and-Penalty-1.png 1200w, https:\/\/www.legalwindow.in\/blog\/wp-content\/uploads\/GST-Applicability-on-Liquidated-Damages-Compensation-and-Penalty-1-600x315.png 600w, https:\/\/www.legalwindow.in\/blog\/wp-content\/uploads\/GST-Applicability-on-Liquidated-Damages-Compensation-and-Penalty-1-300x158.png 300w, https:\/\/www.legalwindow.in\/blog\/wp-content\/uploads\/GST-Applicability-on-Liquidated-Damages-Compensation-and-Penalty-1-1024x538.png 1024w, https:\/\/www.legalwindow.in\/blog\/wp-content\/uploads\/GST-Applicability-on-Liquidated-Damages-Compensation-and-Penalty-1-768x403.png 768w\" sizes=\"auto, (max-width: 1200px) 100vw, 1200px\" \/>In a circular dated August 3, 2022, the <\/span><span style=\"font-weight: 400;\">Central Board of Indirect Taxes and Customs<\/span><span style=\"font-weight: 400;\"> (CBIC) clarified the application of the GST to various taxes, fines, and penalties resulting from contract violations and other situations. The circular has examined a wide range of situations when one party recovers a charge, fee, or penalty from another due to a violation of the contract in great detail.<br \/>\n<\/span><span style=\"font-weight: 400;\">In this article, we\u2019ll discuss GST On Liquidated Damages.<\/span><\/p>\n<table style=\"width: 100%;\">\n<tbody>\n<tr>\n<td style=\"border: 1px solid #555;\"><b>Table of Content<\/b><\/p>\n<ul>\n<li style=\"font-weight: 400;\" aria-level=\"1\"><a href=\"#Key\"><span style=\"font-weight: 400;\">Key Abstract<\/span><\/a><\/li>\n<li style=\"font-weight: 400;\" aria-level=\"1\"><a href=\"#of\"><span style=\"font-weight: 400;\">Meaning of Liquidated Damages<\/span><\/a><\/li>\n<li style=\"font-weight: 400;\" aria-level=\"1\"><a href=\"#on\"><span style=\"font-weight: 400;\">GST on Liquidated Damages<\/span><\/a><\/li>\n<li style=\"font-weight: 400;\" aria-level=\"1\"><a href=\"#for\"><span style=\"font-weight: 400;\">GST coverage for Liquidated Damages<\/span><\/a><\/li>\n<li style=\"font-weight: 400;\" aria-level=\"1\"><a href=\"#tax\"><span style=\"font-weight: 400;\">Input tax credit (ITC) availability and raising the GST invoice for Liquidated Damages<\/span><\/a><\/li>\n<li style=\"font-weight: 400;\" aria-level=\"1\"><a href=\"#the\"><span style=\"font-weight: 400;\">Key Clarifications regarding the notice on GST on Liquidated Damages<\/span><\/a><\/li>\n<li style=\"font-weight: 400;\" aria-level=\"1\"><a href=\"#in\"><span style=\"font-weight: 400;\">Exemption of GST on Liquidated Damages in various cases<\/span><\/a><\/li>\n<li style=\"font-weight: 400;\" aria-level=\"1\"><a href=\"#to\"><span style=\"font-weight: 400;\">Case study on the application of GST to Liquidated Damages<\/span><\/a><\/li>\n<li style=\"font-weight: 400;\" aria-level=\"1\"><a href=\"#Endnote\"><span style=\"font-weight: 400;\">Endnote<\/span><\/a><\/li>\n<\/ul>\n<\/td>\n<\/tr>\n<\/tbody>\n<\/table>\n<h2 id=\"Key\"><b>Key Abstract<\/b><\/h2>\n<p><span style=\"font-weight: 400;\">In this article, our GST specialists at <\/span><a href=\"https:\/\/legalwindow.in\/\" target=\"_blank\" rel=\"noopener\"><span style=\"font-weight: 400;\">Legal Window<\/span><\/a><span style=\"font-weight: 400;\"> provide a summary of recent Circulars from the Central Board of Indirect Taxes and Customs (CBIC) that address the taxability of various goods and services as well as the applicability of the Goods and Services Tax (GST) on liquidated damages, compensation, and penalties for violations of contractual or other legal obligations.<\/span><\/p>\n<p><span style=\"font-weight: 400;\">Liquidated damages are frequently assessed in situations of contract violation, failure to fulfill goods, etc. We will talk about the effect and rates of <\/span><span style=\"font-weight: 400;\">GST<\/span><span style=\"font-weight: 400;\"> that apply to liquidated damages in this write-up.<\/span><\/p>\n<p><span style=\"font-weight: 400;\">Let us first discuss Liquidated Damages so that we can easily understand the notification released by the Central Board of Indirect Taxes and Customs (CBIC).<\/span><\/p>\n<h2 id=\"of\"><b>Meaning of Liquidated Damages<\/b><\/h2>\n<p><span style=\"font-weight: 400;\">Liquidated damages are an amount specified in a contract to represent an estimate of the actual losses sustained by one party as a result of a particular violation by the other party. Liquidated damages are simply recompensed for contract violations, to put it simply.<\/span><\/p>\n<p><span style=\"font-weight: 400;\">Where there has been an intangible loss, liquidated damages are often determined. The amount of compensation required for breach of the contract will be outlined in a provision in the agreement.<\/span><\/p>\n<p><span style=\"font-weight: 400;\">For instance, if a seller delays supplying raw materials, causing a manufacturer to lose income, the seller is responsible for paying 0.5% of the revenue lost for each week of delay, up until delivery is made.<\/span><\/p>\n<h2 id=\"on\"><b>GST on Liquidated Damages<\/b><\/h2>\n<p><span style=\"font-weight: 400;\">The scope of the entry in paragraph 5(e) of Schedule II of the <\/span><span style=\"font-weight: 400;\">Central Goods and Services Tax Act, 2017<\/span><span style=\"font-weight: 400;\">, and the application of GST to payments made in the form of liquidated damages, compensation, penalties, cancellation fees, late payment surcharges, etc. resulting from contract violations or other circumstances.<\/span><\/p>\n<p><span style=\"font-weight: 400;\">According to the circular from August 3, 2022, &#8220;Agreeing to the obligation to refrain from an act, to tolerate an act or a situation, or to perform an act&#8221; has been specifically declared to be a supply of service in paragraph 5 (e) of Schedule II of the CGST Act if the same constitutes a &#8220;supply&#8221; within the meaning of the Act.<\/span><\/p>\n<p><span style=\"font-weight: 400;\">According to the circular, &#8220;forfeiture of earnest money by a seller in case of breach of &#8216;an agreement to sell an immovable property by the buyer, or such forfeiture by Government or local authority in the event of a successful bidder failing to act after winning the bid for allotment of natural resources, is a mere flow of money, as the buyer or successful bidder receives nothing in return for such forfeiture of earnest money.&#8221; In such circumstances, the forfeiture of earnest money is provided not as consideration for accepting the breach of contract, but as recompense for losses incurred and as a deterrent for discouraging non-serious purchasers or bids. Such payments, as a flow of money, are not a consideration for any supply and are thus not taxed.&#8221;<\/span><\/p>\n<p><span style=\"font-weight: 400;\">It went on to say that &#8220;the amount forfeited in the case of a non-refundable air travel ticket or a security deposit or earnest money forfeited in the event of the customer failing to avail the travel, tour operator, or hotel accommodation service or such other intended supplies should be assessed at the same rate as applicable to the service contract, say air transport or tour operator service, or other such services.&#8221;<\/span><\/p>\n<h2 id=\"for\"><b>GST coverage for Liquidated Damages<\/b><\/h2>\n<p><span style=\"font-weight: 400;\">According to Section 7(1) (d) of the Central Goods and Services Tax (CGST) Act, 2017,\u00a0Schedule II activities are included in the definition of the term &#8220;scope of supply.&#8221; According to Schedule II Paragraph (5) (e) above, the definition of supply of services includes &#8220;agreeing to the requirement to refrain from an act, or to tolerate an act or a condition, or to do an act.&#8221;<\/span><\/p>\n<p><span style=\"font-weight: 400;\">Given that the party that has been wronged has put up with the other party&#8217;s failure to comply with the contract, it might be assumed that liquidated damages are taxable under GST.<\/span><\/p>\n<p><span style=\"font-weight: 400;\">Liquidated damages will be subject to taxation as a service under the GST Act since GST is applicable to the sale of both commodities and services. According to the terms of the contract, the breach would occur at the moment of supply. When a contractor, for instance, fails to finish a building by a certain date and the delay is documented, that is the period of supply.<\/span><\/p>\n<table>\n<tbody>\n<tr>\n<td style=\"border: 1px solid #555;\"><strong>Chapter\u2019s<br \/>\nHeading<\/strong><\/td>\n<td style=\"border: 1px solid #555;\"><strong>Description<\/strong><\/td>\n<td style=\"border: 1px solid #555;\"><strong>Applicable Rate<\/strong><\/td>\n<\/tr>\n<tr>\n<td style=\"border: 1px solid #555;\"><b>9997<\/b><\/td>\n<td style=\"border: 1px solid #555;\"><span style=\"font-weight: 400;\">Other Services<\/span><\/td>\n<td style=\"border: 1px solid #555;\"><span style=\"font-weight: 400;\">18%<\/span><\/td>\n<\/tr>\n<tr>\n<td style=\"border: 1px solid #555;\"><b>9991 or 9997<\/b><\/td>\n<td style=\"border: 1px solid #555;\"><span style=\"font-weight: 400;\">Services supplied by the Central Government, a state government, a union territory, or local authority in exchange for the payment of penalties or liquidated damages to the Central Government, a state government, a union territory, or a local authority under a contract.<\/span><\/td>\n<td style=\"border: 1px solid #555;\"><span style=\"font-weight: 400;\">NIL<\/span><\/td>\n<\/tr>\n<\/tbody>\n<\/table>\n<h2 id=\"tax\"><b>Input tax credit (ITC) availability and raising the GST invoice for Liquidated Damages<\/b><\/h2>\n<p><span style=\"font-weight: 400;\">GST paid on liquidated damages can be used as an input tax credit to offset any future tax payment, subject to GST law&#8217;s limits and requirements.<\/span><\/p>\n<p><span style=\"font-weight: 400;\">The party receiving liquidated damages is required to generate a separate GST invoice for the same.<\/span><\/p>\n<h2 id=\"the\"><b>Key Clarifications regarding the notice on GST on Liquidated Damages<\/b><\/h2>\n<p><span style=\"font-weight: 400;\">The clarifications regarding the GST on Liquidated Damages are as follows:<\/span><\/p>\n<ul>\n<li style=\"font-weight: 400;\" aria-level=\"1\"><span style=\"font-weight: 400;\">Liquidated damages cannot be regarded as payment made in exchange for tolerating a contract&#8217;s violation or non-performance. They are more like compensation for not tolerating the contract violation. Such payments are not taxed since they do not qualify as consideration for a supply.<\/span><\/li>\n<li style=\"font-weight: 400;\" aria-level=\"1\"><span style=\"font-weight: 400;\">A fine for a dishonored check, a fine for breaking the law, the loss of pay, or the recovery of a bond&#8217;s value, are not considerations for services and are thus not taxable.<\/span><\/li>\n<li style=\"font-weight: 400;\" aria-level=\"1\"><span style=\"font-weight: 400;\">A facility offered by the supplier that comes naturally with the primary supply is the ability to accept late payments with interest or a charge, close a loan before it is due, and permit the cancellation of an anticipated supply in exchange for a fee. The same should thus be evaluated as the major supply.<\/span><\/li>\n<li style=\"font-weight: 400;\" aria-level=\"1\"><span style=\"font-weight: 400;\">There have been requests for clarity about the taxability of certain commodities and services. As a result, the GST Council&#8217;s suggested issue-by-issue explanations have also been given.<\/span><\/li>\n<\/ul>\n<p><span style=\"font-weight: 400;\">The circular no. 178\/10\/2022-GST, issued August 3, 2022, gives a comprehensive knowledge of numerous such payments. The following is a summary of the same \u2013<\/span><\/p>\n<table>\n<tbody>\n<tr>\n<td style=\"border: 1px solid #555;\"><strong>Payments<\/strong><\/td>\n<td style=\"border: 1px solid #555;\"><strong>Taxability under GST<\/strong><\/td>\n<td style=\"border: 1px solid #555;\"><strong>Reason<\/strong><\/td>\n<\/tr>\n<tr>\n<td style=\"border: 1px solid #555;\"><b>Liquidated damages<\/b><\/td>\n<td style=\"border: 1px solid #555;\"><span style=\"font-weight: 400;\">It is not taxable under GST.<\/span><\/p>\n<p><span style=\"font-weight: 400;\">\u00a0<\/span><\/td>\n<td style=\"border: 1px solid #555;\"><span style=\"font-weight: 400;\">Liquidated damages are not considered received towards tolerating the non-performance\/ breach of contract. In fact, it is a payment for not tolerating the breach of contract.<\/span><\/td>\n<\/tr>\n<tr>\n<td style=\"border: 1px solid #555;\"><b>Cheque dishonor penalty\/ fine<\/b><\/td>\n<td style=\"border: 1px solid #555;\"><span style=\"font-weight: 400;\">It is not taxable under GST.<\/span><\/p>\n<p><span style=\"font-weight: 400;\">\u00a0<\/span><\/td>\n<td style=\"border: 1px solid #555;\"><span style=\"font-weight: 400;\">Cheque dishonor penalty\/ fine is not a consideration towards any service and hence the same is not taxable.<\/span><\/td>\n<\/tr>\n<tr>\n<td style=\"border: 1px solid #555;\"><b>The penalty imposed for violation of laws<\/b><\/td>\n<td style=\"border: 1px solid #555;\"><span style=\"font-weight: 400;\">It is not taxable under GST.<\/span><\/p>\n<p><span style=\"font-weight: 400;\">\u00a0<\/span><\/td>\n<td style=\"border: 1px solid #555;\"><span style=\"font-weight: 400;\">Laws are not being framed for tolerating their violation. In service tax, it was clarified, vide circular no. 192\/02\/2016- Service Tax dated 13th\u00a0April 2016 that fines\/ penalty imposed for violation of statute\/ laws are not leviable to service tax.<\/span><\/p>\n<p><span style=\"font-weight: 400;\">The same is applicable under GST and hence the same is not taxable under GST.<\/span><\/td>\n<\/tr>\n<tr>\n<td style=\"border: 1px solid #555;\"><b>Late payment\/ surcharge\/ fee<\/b><\/td>\n<td style=\"border: 1px solid #555;\"><span style=\"font-weight: 400;\">Taxable under GST<\/span><\/td>\n<td style=\"border: 1px solid #555;\"><span style=\"font-weight: 400;\">The same is naturally bundled with the principal supply and hence should be assessed on the bases of the rates of the principal supply.<\/span><\/td>\n<\/tr>\n<tr>\n<td style=\"border: 1px solid #555;\"><b>Cancellation charges \/ late payment with interest or fee<\/b><\/td>\n<td style=\"border: 1px solid #555;\"><span style=\"font-weight: 400;\">Taxable under GST<\/span><\/td>\n<td style=\"border: 1px solid #555;\"><span style=\"font-weight: 400;\">The same is naturally bundled with the principal supply and hence should be assessed on the bases of the rates of the principal supply.<\/span><\/td>\n<\/tr>\n<tr>\n<td style=\"border: 1px solid #555;\"><b>Forfeiture of earnest money<\/b><\/td>\n<td style=\"border: 1px solid #555;\"><span style=\"font-weight: 400;\">It is not taxable under GST<\/span><\/td>\n<td style=\"border: 1px solid #555;\"><span style=\"font-weight: 400;\">Forfeiture of earnest money is not considered received towards tolerating the breach of contract. In fact, it is compensation paid towards the loss suffered.<\/span><\/td>\n<\/tr>\n<\/tbody>\n<\/table>\n<h2 id=\"in\"><b>Exemption of GST on Liquidated Damages in various cases<\/b><\/h2>\n<ul>\n<li style=\"font-weight: 400;\" aria-level=\"1\"><span style=\"font-weight: 400;\">In view of the preceding circular, it has been clarified that GST would not be imposed in the following cases:<\/span><\/li>\n<li style=\"font-weight: 400;\" aria-level=\"1\"><span style=\"font-weight: 400;\">Damages in Liquidation<\/span><\/li>\n<li style=\"font-weight: 400;\" aria-level=\"1\"><span style=\"font-weight: 400;\">Compensation for coal-block cancellation<\/span><\/li>\n<li style=\"font-weight: 400;\" aria-level=\"1\"><span style=\"font-weight: 400;\">Fine\/penalty for cheque dishonor<\/span><\/li>\n<li style=\"font-weight: 400;\" aria-level=\"1\"><span style=\"font-weight: 400;\">The penalty imposed for breaking the law<\/span><\/li>\n<li style=\"font-weight: 400;\" aria-level=\"1\"><span style=\"font-weight: 400;\">Pay recovery notice<\/span><\/li>\n<li style=\"font-weight: 400;\" aria-level=\"1\"><span style=\"font-weight: 400;\">Compensation for failure to collect tolls<\/span><\/li>\n<li style=\"font-weight: 400;\" aria-level=\"1\"><span style=\"font-weight: 400;\">Surcharge or fee not paid on time (should be assessed at the same rate as Principal supply)<\/span><\/li>\n<li style=\"font-weight: 400;\" aria-level=\"1\"><span style=\"font-weight: 400;\">Power fixed capacity charges<\/span><\/li>\n<li style=\"font-weight: 400;\" aria-level=\"1\"><span style=\"font-weight: 400;\">Cancellation fees (depends upon nature of supply)\u00a0<\/span><\/li>\n<\/ul>\n<h2 id=\"to\"><b>Case study on the application of GST to Liquidated Damages<\/b><\/h2>\n<p><span style=\"font-weight: 400;\">Mr. X is a senior partner in the Mumbai-based law firm XYZ and Co. He signed a non-compete agreement with XYZ and Co. that said that when his employment with XYZ and Co. was terminated, he would not establish his own business or join any other rival firm in Mumbai for a period of 12 months. If Mr.X violates this non-compete agreement, he must pay liquidated damages to XYZ and Co.<br \/>\n<\/span><span style=\"font-weight: 400;\">On January 12, 2021, he chose to leave XYZ and Co. Mr. X joined ABC and Associates, one of XYZ and Co.&#8217;s main competitors, on March 3, 2021. As a result, because Mr.X violated the non-compete provision, he is obligated to pay liquidated damages to XYZ and Co., as specified in the agreement.<br \/>\n<\/span><span style=\"font-weight: 400;\">The violation, which is characterized as a provision of service under Section 7(1) (d) of the CGST Act, Schedule II Para 5 has been allowed by XYZ and Co. (e). As a result, XYZ &amp; Co. must issue a GST invoice to Mr. X for the liquidated damages at the current rate.<\/span><\/p>\n<h2 id=\"Endnote\"><b><a href=\"https:\/\/legalwindow.in\/gst-registration\/\" target=\"_blank\" rel=\"noopener\"><img loading=\"lazy\" decoding=\"async\" class=\"alignnone wp-image-110231 size-full\" title=\"Quick GST Registration in Jaipur\" src=\"https:\/\/legalwindow.in\/wp-content\/uploads\/Get-your-GST-Registration-in-1000-All-Inclusive.-2.png\" alt=\"Quick GST Registration in Jaipur\" width=\"1000\" height=\"200\" srcset=\"https:\/\/www.legalwindow.in\/blog\/wp-content\/uploads\/Get-your-GST-Registration-in-1000-All-Inclusive.-2.png 1000w, https:\/\/www.legalwindow.in\/blog\/wp-content\/uploads\/Get-your-GST-Registration-in-1000-All-Inclusive.-2-600x120.png 600w, https:\/\/www.legalwindow.in\/blog\/wp-content\/uploads\/Get-your-GST-Registration-in-1000-All-Inclusive.-2-300x60.png 300w, https:\/\/www.legalwindow.in\/blog\/wp-content\/uploads\/Get-your-GST-Registration-in-1000-All-Inclusive.-2-768x154.png 768w\" sizes=\"auto, (max-width: 1000px) 100vw, 1000px\" \/><\/a>Endnote<\/b><\/h2>\n<p><span style=\"font-weight: 400;\"><a href=\"https:\/\/www.cbic.gov.in\/\" target=\"_blank\" rel=\"noopener\">CBIC<\/a> clarifications strive to resolve the ambiguity on the taxability of numerous products and services and are anticipated to eliminate needless litigation to a considerable extent. Given the department&#8217;s reliance on Circulars, the industry may need to identify concerns where procedures have been commenced by the adjudicating body or where matters are currently in appeal to appellate forums in order to determine the best course of action.<\/span><\/p>\n<p><span style=\"font-weight: 400;\">While the circular clarifies the taxability of cancellation costs, it does not appear to have addressed the conditions in which such charges might be viewed as liquidated damages\/compensation or payment for the supply of a facility. This might be crucial because of the varied tax treatment in both circumstances.<\/span><\/p>\n<p><span style=\"font-weight: 400;\">While the Circular considers early contract termination to be a facility offered and thus a service, a judgment by a larger bench of the Chennai Tribunal concluded that foreclosure charges were in the nature of liquidated damages and hence not subject to service tax.\u00a0Taxpayers may need to assess the impact of the Circular on the handling of employee recoveries for loss or physical damage to the employer&#8217;s assets.<\/span><\/p>\n<p><span style=\"font-weight: 400;\">Legal Window provides you with a high level of satisfaction and quick delivery of <\/span><a href=\"https:\/\/legalwindow.in\/gst-registration\/\" target=\"_blank\" rel=\"noopener\"><span style=\"font-weight: 400;\">GST Registration<\/span><\/a><span style=\"font-weight: 400;\"> Certificate, GST Return, and other GST-related services, as well as better dealing with government requirements, through its skilled workforce. Please contact our team at <\/span><b>072407-51000 or admin@legalwindow.in<\/b><span style=\"font-weight: 400;\"> for GST-related and GST-compliance services.<\/span><\/p>\n","protected":false},"excerpt":{"rendered":"<p>In a circular dated August 3, 2022, the Central Board of Indirect Taxes and Customs (CBIC) clarified the application of the GST to various taxes, fines, and penalties&hellip;<\/p>\n","protected":false},"author":4,"featured_media":110234,"comment_status":"closed","ping_status":"closed","sticky":false,"template":"","format":"standard","meta":{"footnotes":""},"categories":[6],"tags":[],"class_list":["post-110220","post","type-post","status-publish","format-standard","has-post-thumbnail","hentry","category-gst"],"yoast_head":"<!-- This site is optimized with the Yoast SEO plugin v28.1 - https:\/\/yoast.com\/product\/yoast-seo-wordpress\/ -->\n<title>GST on Liquidated Damages &#187; Legal Window<\/title>\n<meta name=\"description\" content=\"This article is about the GST on Liquidated Damages, &amp; 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