Amount paid for early termination of the lease constitutes consideration for the supply

[CA Bimal Jain]

The AAR, Karnataka, in the case of IN RE: M/S. ENZYME BUSINESS CENTER - 2023 (12) TMI 509 - AUTHORITY FOR ADVANCE RULINGS, KARNATAKA, held that, the damages received by the Applicant from the tenant towards the termination of the sub-lease before the agreed upon lock-in period as per the sub-lease deed agreements tantamount to supply as per Section 7 of the Central Goods and Service Tax Act, 2017 (“the CGST Act”) and the amount received towards damages as per the settlement agreement is to be construed as Consideration for the supply. The services provided by the Applicant are classifiable under Chapter heading 9972 and are liable to GST at the rate of 18%.

Facts:

M/s. Enzyme Business Centre (“the Applicant”) is engaged in the sub-letting of commercial property on a rental basis. The Applicant obtained two different premises with two different landlords. Both the premises were further sub-let. Later, the tenants declared themselves incapable of continuing the contract before the lock-in period and requested for early termination of the rent agreement subject to payment of damages by the Lessee.  Thereafter, the Applicant received the amount with respect to damages by forfeiture of interest free security deposit of INR 1,19,00,000/- and 16,00,00/-. Additionally, the tenant also paid INR 50,00,000/- from July, 2022 to January, 2023 with respect to damages in order to settle the contract.

In this regard, the Applicant filed an Advance Ruling for the above transaction and contended that the amount received, and the amount forfeited are in the nature of liquidated damages for loss of rent and are in the nature of compensation for violation of the lock in period clause in the agreement. Hence, Circular No. 178/10/2022 dated August 3, 2022,  is squarely applicable in this case as the lock-in clause arises out of the primary rental contract and is only a compensatory clause and no GST is applicable.

Issue:

Whether the amount received for the early termination of the contract before lock in period by tenant will constitute consideration for the supply. If yes, what is the SAC code and rate of GST?

Held:

The AAR, Karnataka in IN RE: M/S. ENZYME BUSINESS CENTER - 2023 (12) TMI 509 - AUTHORITY FOR ADVANCE RULINGS, KARNATAKA held as under:

• Observed that, the payment of amount is for an act of tolerance in the sense that, when there is breach of the contract, the other party is put to certain hardships, which he tolerates in return of the payment received by his client. The same can be understood as consideration received by the Applicant for “agreeing to the obligation to refrain from an act, or to tolerate an act or a situation” of their client of not completing the lock-in period, which he had agreed in terms of contractual obligations. As per the contract, the Applicant agrees to refrain or tolerate or to do an act. In case the obligation/condition of the contract is not fulfilled, then such an act is squarely covered under clause 5(e) of Schedule II of the CGST Act. Therefore, this activity constitutes supply in terms of Section 7(1) of the CGST Act.
• Relied on Circular No. 178/10/2022 dated August 3, 2022, it is mentioned that amounts paid for early termination of lease as contemplated by the contract as part of commercial terms agreed to by the parties, constitute consideration for the supply of a facility, namely, early termination of a lease agreement. Therefore, such payments, even though they may be referred to as fine or penalty, are actually payments that amount to consideration for the supply, and are subject to GST, in cases where such supply is taxable. Since these supplies are ancillary to the principal supply for which the contract is signed, they shall be eligible to be assessed as the principal supply.
• Held that, the damages received by the Applicant from the tenant towards the termination of the sub-lease before the agreed upon lock-in period as per the sub-lease deed agreements tantamount to supply as per Section 7 of the CGST Act, and the amount received towards damages as per the settlement agreement is to be construed as Consideration for the above supply. The services provided by the Applicant are classifiable under Chapter heading 9972 and are liable to GST at the rate of 18% (9% CGST and 9% SGST).

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