GST not payable on liquidated damages if principal supply is exempt

Facts and Issue of the Case

In terms of Section 102 of the Telangana Goods and Services Tax Act, 2017 (TGST Act, 2017 or the Act), this Order may be amended by the Appellate authority so as to rectify any error apparent on the face of the record, if such error is noticed by the Appellate authority on its own accord, or is brought to its notice by the concerned officer, the jurisdictional officer or the applicant within a period of six months from the date of the order. Provided that no rectification which has the effect of enhancing the tax liability or reducing the amount of admissible input tax credit shall be made, unless the applicant or the appellant has been given an opportunity of being heard.

Under Section 103 (1) of the Act, this advance ruling pronounced by the Appellate Authority under Chapter XVII of the Act shall be binding only

(a) On the applicant who had sought it in respect of any matter referred to in sub-Section (2) of Section 97 for advance ruling;

(b) On the concerned officer or the jurisdictional officer in respect of the applicant.

 Under Section 103 (2) of the Act, this advance ruling shall be binding unless the law, facts or circumstances supporting the original advance ruling have changed.

Under Section 104 (1) of the Act, where the Appellate Authority finds that advance ruling pronounced by it under sub-Section (1) of Section 101 has been obtained by the appellant by fraud or suppression of material facts or misrepresentation of facts, it may, by order, declare such ruling to be void ab-initio and thereupon all the provisions of this Act or the rules made thereunder shall apply to the appellant as if such advance ruling has never been made.

M/s. Achampet Solar Private Limited is engaged in production and distribution of electricity obtained from solar energy. They have engaged M/s. Belectric India (P) Ltd for construction of solar power project. The agreement has clauses for recovery of liquidated damages on (2) counts, one delay in delivering of the contract and the other regarding non- performance of the plant. The applicant is desirous of ascertaining exigibility of liquidated damages to GST on account of delay in commissioning and its time of supply. Hence this application.

Questions raised:

1. Whether liquidated damages recoverable by the applicant from Belectric India on account of delay in commissioning, qualify as a ‘supply’ under the GST law, thereby attracting the levy of GST?

2. If the answer to Question No. 1 is in the affirmative, what should be the time of supply when liability to pay GST is triggered?

3. Liquidated damages are demanded by the applicant from the contractor due to the delay in commissioning of the project and postponement in the taking over date beyond the milestones fixed for completion of project.

4. When the parties to a contract specify the time for its performance, it is expected that either party will perform his obligation at the stipulated time. But if one of them fails to do so, the question arises what is the effect upon the contract.

Further Section 2(31)(b) of the CGST Act mentions that consideration in relation to the supply of goods or services or both includes the monetary value of an act of forbearance. Therefore such a toleration of an act or a situation under an agreement constitutes supply of service and the consideration or monetary value of such toleration is exigible to tax.

The clause (6) of the co-ordination agreement filed by the applicant specifies different liquidated damages to be paid for different periods of delay on the commissioning. This clause also specifies that the amount shall be paid within (3) days after the actual commissioning date as per the prescribed formula. The formula consists of various periods of delay i.e., delay upto (1) month, delay between (1) month to (3) months and such periods. Therefore the contract itself prescribes the date on which the damage has to be determined and paid. The date on which the liquidated damage is determined as per the formula prescribed in the clause 6 of the contract is the time of supply of service entry in 5(e) of Schedule II by the applicant. The Consideration received for such forbearance is taxable under CGST and SGST @9% each under the chapter head 9997 at serial no. 35 of Notification No.11/2017- Central/State tax rate.

Lower authority, examined the submissions made by the Appellant and vide the impugned order, the Advance Ruling Authority had given the following Advance Rulings:

Questions	Ruling by AAR
1. Whether liquidated damages recoverable by the applicant from Belectric India on account of delay in commissioning, qualify as a ‘supply’ under the GST law, thereby attracting the levy of GST?	Yes.
2. If the answer to Question No. 1 is in the affirmative, what should be the time of supply when liability to pay GST is triggered?	The date on which the liquidated damage is determined as per the formula prescribed in the clause 6 of the contract is the time of supply of service entry in 5(e) of Schedule II by the applicant.

Aggrieved by the above ruling, the present appeal has been file by the appellant on the following grounds:

1. The impugned order is a non-speaking order and is liable to be set aside
2. Statement containing the Appellant’s interpretation of law and/or facts, as the case may be, in respect of the aforesaid question(s)

Observation by the court

The applicant contended that liquidated damages received towards breach and non compliance cannot be construed as ‘consideration’ for ‘refraining or tolerating an act’. The applicant further contends that claim of liquidated damages by them from contractor does not qualify as a supply of service under GST on following grounds:

• There is no contractual reciprocity or concurrence to assume an obligation to refrain from an act or tolerate an act between the applicant and the contractor, which are indispensible and essential for a transaction to qualify as a ‘supply of service’.
• The liquidated damages preferred by the applicant are not in lieu of any activity/obligation agreed to be performed at the behest of the service recipient, but on account of breach of contract(delay in compensation of project timelines).
• The applicant case does not get covered under clause 5(e) of schedule II of the CGST Act,2017.
• Mere inclusion of specific clause for payment of damages should not change the nature of transaction to transform a lawful right into an ‘obligation to tolerate’.
•  Recovery of liquidated damages by the recipient can be viewed as mere renegotiation of the price of the original contract and not a separate transaction.
•  There is difference between term ‘condition to a contract’ and consideration to a contract’ merely because the service recipient has to fulfill the conditions attached to the contract would not mean that the value would form part of the value of taxable services that are provided.
• The recovery of liquidated damages is in the nature of ‘actionable claim’, outside the ambit of GST.

The CBIC has issued Circular No. 178/10/2022-GSTdated:3.8.2022 related to GST applicability on liquidated damages. As per para 7.1.6 of the said circular, it was, interalia, observed that when principal supply is exempt, the ancillary activities to such principal supply would not get attracted to GST. Since in the present case, the applicant’s principal supply is production and distribution of electricity, which is exempt from payment of GST, the liquidated damages received by the applicant towards such supply need to be considered as flow of money without having implication of GST payment.

As per the circular where the amount paid as ‘liquidated damages’ is an amount paid only to compensate for injury, loss or damage suffered by the aggrieved party due to breach of the contract and there is no agreement, express or implied, by the aggrieved party receiving the liquidated damages, to do or abstain from doing anything for the party paying the liquidated damages, in such cases liquidated damages are mere a flow of money from the party who causes breach of the contract to the party who suffers loss or damage due to such breach. Such payments do not constitute consideration for a supply and are not taxable.

Conclusion

1. Whether liquidated damages recoverable by the applicant from Bi-electric India on account of delay in commissioning qualify as a supply under the GST law thereby attracting the levy of GST?	No. The amount recoverable by the applicant in the form of liquidated damages does not qualify as supply, as seen from the agreement.
2. If the answer to Question No. 1 is in the affirmative, what should be the time of supply when liability to pay GST is triggered?	Does not arise

The ruling of the lower authority is set aside and the subject appeal is disposed off accordingly.