{"id":30943,"date":"2020-04-17T19:15:08","date_gmt":"2020-04-17T13:45:08","guid":{"rendered":"https:\/\/enterslice.com\/learning\/?p=30943"},"modified":"2021-02-18T15:34:34","modified_gmt":"2021-02-18T10:04:34","slug":"a-complete-detail-on-gst-on-liquidated-damages","status":"publish","type":"post","link":"https:\/\/enterslice.com\/learning\/a-complete-detail-on-gst-on-liquidated-damages\/","title":{"rendered":"A Complete Detail on GST on Liquidated Damages"},"content":{"rendered":"

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<\/strong><\/em>. 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.  <\/p>\n\n\n\n

What is the Meaning of Liquidated Damages?<\/h2>\n\n\n\n

According to Black’s Law Dictionary<\/strong>\n-Liquidated damages are a fixed amount contractually specified as a reasonable\nestimate of actual damages to be recovered by one party in case the other party\nbreaches the contract. If the parties in a contract have properly settled the\namount of liquidated damages, the sum fixed is the measure of damages for\nbreach of contract, it does not matter if the actual damages is more than or\nless than the fixed damage amount. The difference between penalty and substantial\nliquidated damages is difficult to apply. <\/p>\n\n\n\n

<\/p>

 Firstly, if the sum payable is more than the\namount is far more than the probable damage on breach, it is approximately a\npenalty<\/em><\/div>\n\n\n\n

What is the Need of Liquidated Damages?<\/h2>\n\n\n\n

The\nmain essence of a contract is performance. The parties in contract generally\ninclude their expectation in terms of damage, which is caused by the failure of\neither party to perform its duty as per the terms in the agreement. The\ncontract may mention the costs for deficiency in the performance of a contract,\nwhich is known as ‘liquidated damages.’ It is to deter unsatisfactory\nperformance or non-performance of a contract. For instance, a contract mentions\nin its clauses that time is the essence in the contract, then any delay would\ninvite liquidated damages fixed in the contract.<\/p>\n\n\n\n

What is the Basic Difference Between Liquidated Damages and Unliquidated\nDamages?<\/h2>\n\n\n\n

Liquidated Damages<\/h3>\n\n\n\n

Liquidated\ndamages, which are also referred to as liquidated and ascertained damages, are\nthose damages of which the amount is fixed by the parties during the formation\nof a contract. The injured party in the contract can collect the compensation\nupon a specific breach. The clauses of liquidated damages are used in various\ntypes of contracts like Construction contracts or IT. The liquidated clause in\na contract provides certainty to the parties. It also assists in the recovery\nof the amount breached by avoiding the requirement of the proof of loss.\nLiquidated damages simplify the procedure relating to any types of disputes and\nmay persuade the performance of a contract. The liquidated damage clause\nregulates the right of the parties after the breach of contract.<\/p>\n\n\n\n

Unliquidated damages<\/h3>\n\n\n\n

Unliquidated damages\nare not a pre-fixed or determined amount. A claim for unliquidated damages is\ngenerally governed by common law. Whenever the amount of damages is not decided\nin advance, then the amount to be recovered must be agreed or determined by a\ncourt or tribunal in the event of breach. <\/p>\n\n\n\n

Why is GST on Liquidated Damages Levied?<\/h2>\n\n\n\n

The\nview which supported levy of tax on liquidated damages is based on the\nprinciple that the party has tolerated the non-performance of the contract.<\/p>\n\n\n\n

In Notification number 25\/2012, entry 573-Service Tax, 20th June, 2012<\/em><\/strong> 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.<\/p>\n\n\n\n

The\nGST Act continued with the same scheme for taxation and exemption according to\nthe Service Tax law. <\/p>\n\n\n\n

As perEntry 5(e) in Schedule II of the GST Act<\/em><\/strong> 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.<\/p>\n\n\n\n

The Notification number 12\/2017-Central Tax (Rate) dated 28th June, 2017<\/em><\/strong> provides for exemption from tax. The appropriate entry in the Notification reads as below:<\/p>\n\n\n\n

\n Serial\n No.\n  \n <\/td>\n Heading\n <\/td>\n Description\n of Services\n <\/td>\n Rate\n (Percent)\n <\/td><\/tr>
\n 77\n  \n <\/td>\n Heading\n 9991\n or\n Heading\n 9997\n <\/td>\n Services\n provided by the Central Government or State Government or Union territory or\n local authority by tolerating non-performance of a specific contract for\n which consideration in the form of fees or liquidated damages is payable to\n the Central\n  or State Government or Union territory or\n local authority under such contract\n <\/td>\n 18%\n <\/td><\/tr><\/tbody><\/table><\/figure>\n\n\n\n

Advance Ruling of Taxability of GST on Liquidated Damages<\/h2>\n\n\n\n

In a case for Advance Ruling before the Maharashtra State Power Generation\nCompany Ltd-2018<\/h3>\n\n\n\n

The matter on this case was on applicability of GST<\/em><\/strong> 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.<\/em><\/strong><\/p>\n\n\n\n

In this case, the authority held that GST on liquidated damages would be levied by observing the following facts:<\/strong><\/p>\n\n\n\n

  • The\nvalue of completed work and the amount which is to be paid is not affected by\nthe amount deducted liquidated damages. Thus the compensation for work done\nremains unchanged.<\/em><\/li>
  • The\nact of delaying the supply has occurred. This act is tolerated by charging an\nadditional amount like liquidated damages.<\/em><\/li>
  • The\ncharged income, though made in the form of a deduction from payments must be\nmade to the party and here the profit of the applicant.<\/em><\/li>
  • In yet another matter, the same\nauthority decided that the act of vacating the rented premises for\nredevelopment according to the redevelopment agreement is agreeing to the contract\nto refrain from performing an act or tolerating an act or any situation of\nrenewal in place of old premises and of not causing barrier or creating hindrance\nin the same<\/em>. <\/li><\/div>
    \n\n\n\n

    In re Bajaj Finance Limited (GST AAAR Maharashtra); Order No.\nMAH\/AAAR\/SS-RJ\/24\/2018-19; 14\/03\/2019<\/h3>\n\n\n\n

    Facts of the Case<\/h4>\n\n\n\n
    1. The\nAppellant here is a non-banking financial company (NBFC<\/a>). It provides various\ntypes of loans to the customers, such as loans against the property<\/a>, auto\nloans, personal loans, consumer durable goods loans, etc. These loans are all\ninterest-bearing loans. <\/li>
    2. The\nAppellant, among other things, makes agreements with its borrowers or customers\nfor providing loans to them. The loan agreements offers repayment of the\noutstanding dues or equated Monthly Installments or (EMI) through cheque\/ Electronic\nClearing System (`ECS’) or National Automated Clearing House (‘NACH’) or any\nother electronic or clearing mandate. The descriptive copies of the loan\nagreement between the applicant and the customers have been enclosed.  <\/li>
    3. In\ncase of dishonour of cheque or ECS or NACH or through any other electronic, the\napplicant collects penal or cheque bounce charges, which is as per the agreed\nterms and conditions between the borrower and the applicant. The bounce charges\nare primarily a fixed amount fixed as per the default of the customer. For\ninstance. Rs.350 is charged for dishonour of cheque. Only the defaulting\ncustomers need to pay the bounce charges.<\/li><\/ol>\n\n\n\n

      This\nRuling also impacts many other similar transactions.For instance, if a builder\nforfeits a buyer’s earnest money after the buyer fails to buy a flat in a\ncontracted period, GST will be levied on that forfeited amount since the\nbuilder has ‘tolerated your act’ of not paying the full amount.\nTherefore, it becomes a ‘deemed service,’ and GST is due.<\/p>\n\n\n\n

      Hence, GST applies\non<\/strong><\/p>\n\n\n\n