There is a misnomer that every compensation received towards liquidated damages by a person is chargeable to GST. There are number of queries which are raised at Unitax regarding compensation received by the client either by order of court, or by arbitration/mediation or even simple penalty for violation of contract. It is found that department tends to cover such transactions under Entry No 5(e) “agreeing to the obligation to refrain from an act, or to tolerate an act or a situation, or to do an act” of Schedule II of CGST Act 2017 to classify it as services.
Scope of agreeing to the obligation to refrain from an act, or to tolerate an act or a situation, or to do an act?
The entry intends to cover only those specific contracts by virtue of which one party agrees or refrain or tolerate a situation or an act. The examples for such contracts could be Non-Compete Agreement, Business Competition Agreement etc. This entry does not cover anything which is awarded by way of a compensation towards noncompliance of underlying service. To call any activity as a service it is necessary that both recipient and service provider should have expressly agreed to do. Where any money flows because of an event which was never agreed upon, it cannot be called a service. Recently in M/s Steel Authority of India Limited vs Commissioner GST, Salem, CESTAT Chennai has held that the view of Commissioner Appeals that since task was not completed within the time scheduled, the appellant agreed to tolerate the same for a consideration in form of liquidated damages is not sustainable. It was held that the said compensation was penal in nature which does not attract services tax. Similar view was also taken in the case of M/s NEYVELI Liginite Corporation Limited case by CESTAT Chennai.
Although there are couple of Advance rulings in GST which have held that transactions like notice pay recovery or forfeiture of advance for noncompliance shall be treated as supply covered within the scope of Entry 5(e). But going by that understanding the scope of entry 5(e) shall be extremely widened. This would then also include forfeiture of rental security, compensation towards delayed possession by builder etc. But the fact remains that these were never agreed upon services. It was a result of non-happening of an agreed event that the loss borne by the recipient is made good by the supplier. Hence Entry No 5(e) must be enforced very diligently and precisely. Further any entry in Schedule II can only be brought to tax once it is classified as supply under Section 7 of CGST Act 2017. Therefore, when liquidated damages are not covered under the ambit of supply there arises no question of levy of GST.
GST Notice Reply preparation is critical?
From above discussion it can be conclude that though the matter is clear going by the provision of law, but due to interpretational issues matter becomes ambiguous. Therefore, it becomes essential that the replies to GST Notices must be prepared with utmost care and with legal knowledge. At Unitax, our research team ensures that whenever we draft a reply, we investigate all the perspectives of law and then pen down the reply. If you are a professional, you can’t miss to join Unitax. Join us at unitax.in
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