Liquidated damages received by a recipient of services from a service provider for failing to comply with the terms of the contract would trigger an 18 percent goods and services tax (GST) in certain cases, the advance ruling authority (AAR) ruled in Andhra Pradesh.
Compensation for damages is the sum that one of the parties receives when the other party does not comply with the provisions of a contract between them.
The ruling was issued at an application by the Andhra Pradesh Development Company (APPDCL), a special purpose vehicle set up to implement mega energy projects in the state.
The order came despite a circular issued by the government in 2022 that says liquidated damages are a mere flow of money from a party that causes a breach of contract to a party that suffers a loss due to such a breach. Said payments do not constitute consideration for the supply and are not subject to taxes, the circular clarifies.
However, AAR said the circular is not universal or absolute, but is only intended to clarify the position of the law and will be applied reasonably considering the facts of the case.
APPDCL entered into an agreement with Chettinad Logistics Pvt. Ltd. (CLPL) for the provision of services, including liaison with MCL ports, East Coast Railways, Paradip and Adani Krishnapatnam for coordination and supervision of coal loading, arrangement of rakes, raw coal transportation, rock crushing.
In the event of failure to perform the work assigned to the service provider, the receiver (APPDCL) will collect ‘liquidated damages’ for increased moisture in the raw coal on the loading end, for increased ash percentage, fines for transportation late coal and also a penalty for a shortage of coal supply, according to the contract signed between the two parties.
APPDCL alleged in its lawsuit that these damages arise from the mutual acceptance of both parties due to unintentional occurrence, which both parties tend to avoid. Therefore, liquidated damages cannot be a consideration in tolerating a breach or breach of contract.
The AAR, however, said that the service provider is paying such amounts only for certain advantages derived or to avoid any disadvantages incurred. Thus, “it is inconsequential whether the payment is for tolerating the error or not tolerating it,” he said.
AAR emphasized that the circular quoted above must be understood in its proper context. This meant that the payment for damages is incidental to the main supply and since the main supply is taxable, they will also be taxable.
If the primary supply is exempt, the accessory will also be exempt, AAR said.
AAR said that the liquidated damages in the present case constitute supply of service and are due at 18 per cent GST.
Amit Maheshwari, tax partner at AKM Global, said the AAR’s ruling does not appear to be well reasoned. “The ruling focuses more on the meaning of ‘consideration’ than ‘offer,’ since consideration would be subordinate to the offer,” he said.
Discover more from PressNewsAgency
Subscribe to get the latest posts sent to your email.