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Liquidated damages are a common term used by the parties under a contract. Concerning the implication of indirect taxes, both in the previous law and also the present GST law, there has always been an issue on the taxability of the liquidated damages, and the Government has never clarified this issue. Liquidated Damages are charged for Non-Performance or Breach of Contract or Late Delivery of Supplies etc. According to S 7(1) (d) of the GST Act consists of activities which are referred to in Schedule II within the scope of supply. Entry 5(e) declares that amount of service will be treated as agreeing to accountability to exempt from an act, or to tolerate an act or a situation, or to do an act.
According to Black’s Law Dictionary
-Liquidated damages are a fixed amount contractually specified as a reasonable
estimate of actual damages to be recovered by one party in case the other party
breaches the contract. If the parties in a contract have properly settled the
amount of liquidated damages, the sum fixed is the measure of damages for
breach of contract, it does not matter if the actual damages is more than or
less than the fixed damage amount. The difference between penalty and substantial
liquidated damages is difficult to apply.
main essence of a contract is performance. The parties in contract generally
include their expectation in terms of damage, which is caused by the failure of
either party to perform its duty as per the terms in the agreement. The
contract may mention the costs for deficiency in the performance of a contract,
which is known as ‘liquidated damages.’ It is to deter unsatisfactory
performance or non-performance of a contract. For instance, a contract mentions
in its clauses that time is the essence in the contract, then any delay would
invite liquidated damages fixed in the contract.
damages, which are also referred to as liquidated and ascertained damages, are
those damages of which the amount is fixed by the parties during the formation
of a contract. The injured party in the contract can collect the compensation
upon a specific breach. The clauses of liquidated damages are used in various
types of contracts like Construction contracts or IT. The liquidated clause in
a contract provides certainty to the parties. It also assists in the recovery
of the amount breached by avoiding the requirement of the proof of loss.
Liquidated damages simplify the procedure relating to any types of disputes and
may persuade the performance of a contract. The liquidated damage clause
regulates the right of the parties after the breach of contract.
are not a pre-fixed or determined amount. A claim for unliquidated damages is
generally governed by common law. Whenever the amount of damages is not decided
in advance, then the amount to be recovered must be agreed or determined by a
court or tribunal in the event of breach.
view which supported levy of tax on liquidated damages is based on the
principle that the party has tolerated the non-performance of the contract.
In Notification number 25/2012, entry 573-Service Tax, 20th June, 2012 offered for exemption with respect to the Services given by the Government or a local authority for non-performance of a contract for which compensation in the form of fines or liquidated damages is payable to the Government or local authority as per the agreement.
GST Act continued with the same scheme for taxation and exemption according to
the Service Tax law.
As perEntry 5(e) in Schedule II of the GST Act is similarly worded and declares that “agreeing to the obligation or to refrain from an act, or to tolerate an act or a circumstance, will be treated as supply of service.
The Notification number 12/2017-Central Tax (Rate) dated 28th June, 2017 provides for exemption from tax. The appropriate entry in the Notification reads as below:
The matter on this case was on applicability of GST on Liquidated damages the on the outline, “agreeing to the obligation to refrain from an act, or to tolerate an act or a situation, or to do an act,” mentioned in schedule II, para 5 in clause (e) of the GST Act.
In this case, the authority held that GST on liquidated damages would be levied by observing the following facts:
Ruling also impacts many other similar transactions.For instance, if a builder
forfeits a buyer’s earnest money after the buyer fails to buy a flat in a
contracted period, GST will be levied on that forfeited amount since the
builder has ‘tolerated your act’ of not paying the full amount.
Therefore, it becomes a ‘deemed service,’ and GST is due.
Hence, GST applies
By way of exception clause, the presence of levy of GST on Liquidated damages cannot be denied:
The taxpayer, in this case, made certain payments to SEBI as per a scheme framed by SEBI to regularise default of certain disclosures as prescribed in SEBI Substantial Acquisition of Shares and Takeovers) Regulations, 1997. The tribunal here held that such payments could not be said to be a penalty as per section 15A of the SEBI Act; hence it is not hit by explanation to section 37(1) of the Income-tax Act, 1961.
The taxpayer here made a short payment of margin money to the stock exchange. The assessee paid the penalty charged by the stock exchange during the period under consideration. Here It was held tribunal held that the payment had been made in the stock exchange on account of short payment of money. Payment made here is only a compensatory payment as per the rules of the stock exchange which is permittable as revenue expenditure as the same is not for infraction of the law.
this case, the Government of Gujrat had introduced a Gold Card scheme according
to which carrying of excess load in the vehicle was permitted on payment of
some additional fees fixed in the given gold card. The assessee here was
charged for overloading regularly. The tribunal here held that such fees were
compensatory in nature and not a
penalty. Payment of these fees empowered the transporters to carry
overloaded trucks to the final destination without stopping them from unloading
the excess weightage from the vehicles. The fact that excess weight was not
needed to be unloaded shows that payment made under the scheme was not penal as
no Government machinery encourages violation or infringement of legal
provisions. Expenditure incurred was allowed as deduction.
II of the GST Act was expected to be a mere authoritative declaration as to the
nature of the activity, whether it involves the supply of goods or services.
The Lok Sabha on 9th August, 2018 had passed four amendment bills relating to
GST. Section 7 of the CGST Act defines ‘supply’ which was amended on 1st July,
2017 itself. Sub-section (1A) was inserted in section 7(d) .Hence the role of
Schedule II is limited to classification of supply as goods or services. For
charging tax on liquidated damage, the transaction must first pass the test of
supply, which appears to be a difficult job. Previous service tax law, on the
introduction of a negative list on taxation, declared activity of agreeing to
an obligation to refrain from doing an act/to tolerate an act or a situation/
to do an act’, to perform as a service. The present GST law does not make any
such declaration. It merely divides supply as ‘goods’ or ‘services.’ Though the
levy of tax on these activities was not free from doubt in service tax law,
under GST, it is more doubtful as there is no such statutory declaration.
Liquidated damages may hardly satisfy the essentials of supply of service.
Also, Read: The Process of Claiming Damages for Illegal Termination of Work Contract.
Deepti is a Law graduate with an avid interest in reading and very proficient in summarizing legal cases. She has enough experience in handling legal affairs of the company. In the initial days of her career, she has worked as a legal researcher and has 3+ years of experience.
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