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TMI Blog2023 (6) TMI 1229X X X X Extracts X X X X X X X X Extracts X X X X ..... This includes applicability of GST on payments in the nature of liquidated damage, compensation, penalty, cancellation charges, late payment surcharge, etc., arising out of breach of contract or otherwise and scope of entry at para-5(e) of schedule-II of Central Goods Service Tax Act, 2017. The flow of consideration in the instant case fall under para-7.1.3 and para-7.1.4 of circular No. 178/10/2022, dated: 03-08-2022, therefore such consideration as stipulated in the said circular are not taxable as there is no supply of service under entry-5(e) of Schedule-II of the CGST Act, 2017. In the instant case, as no supply has happened during the GST regime as per Section 142(10) of the act ibid no GST shall be payable. Further the additional payment received by way of compensation through award by Hon ble Tribunal for Arbitration is not falling under Section 142(2)(a) and hence not chargeable to GST. - A.R.Com/06/2023 TSAAR Order No.10/2023 [ - - - Dated:- 17-4-2023 - SRI S.V. KASI VISWESWARA RAO, AND SRI SAHIL INAMDAR IRS., MEMBER [ORDER UNDER SECTION 98(4) OF THE CENTRAL GOODS AND SERVICES TAX ACT, 2017 AND UNDER SECTION 98(4) OF THE TEALANGANA GOODS AND SERVICES ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... to various companies, who were also registered dealers in their respective states. The Applicant Company received a quotation for Sub-contract from M/S. Delta Global Allied Limited (formerly known as Delta Mechons India Limited; Hereafter referred to as DGAL) (Quotation Ref No. DGAL/TPSC/032/P.Fab.Erec/2012/REV 00) for piping and Pre-Fabrication of Non- IBR Piping of all 3 units w.r.t 3 x 800 MW NTPC Kudgi Thermal Power Project, Bijapur- Karnataka. Based on the quotation, TPSC (India) Private Ltd (Hereafter referred to as TPSC, Applicant herein) issued a purchase order PO-1 dated 27/09/2013 amounting to Rs. 11,82,85,000 and PO-2 dated 10th June 2014) for Rs. 10,25,00,000. After receiving PO, DGAL commenced work and raised several invoices till January 2017 amounting to Rs. 30,05,01,903/- and service tax of Rs. 2,94,21,453/- and TPSC (Applicant) made all payments except for the retention amount Rs.91,53,199/-. (For retention also Tax Paid by TPSCI) PO Particulars Schedule Duration in months PO1 1. Fabrication for Unit 1, 2 3 Feb 14 to Dec 1 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 4 Fabrication Unit 1,2,3 And Erection Unit-1 - Cost Impact of Price Variation(PVC) due To Extended Stay 85,51,143.00 5 Fabrication Unit 1,2,3-Cost Impact due to Increase in Inch Dia BOQ 68,19,469.00 6 Fabrication Unit 1,2,3- Cost Impact of Additional Indirect Man Months for Revision of Fabrication Spools Drawings 7,86,121.00 7 For Fabrication Unit 1,2,3 And Erection Unit-1-Towards Profit on Additional Cost incurred during Extended Stay 1,23,62,784.00 8 Fabrication Unit 1,2,3 And Erection Unit-1- Cost Impact Towards 5% Quantity Variation 17,95,227.00 9 Erection Unit-2- Additional Indirect Man Months due to Extended Stay 3,32,57,667.00 10 Erection Unit-2 - Additional Direct Man Months due to Extended Stay 1,26,52,132.00 11 Erection Unit-2- Additional Ma ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... rding of oral evidences, Arbitration Award was passed on 27th May, 2022 by quantifying the damages payable to DGAL due to delay on the part of the Applicant. The Applicant justified the delay on their part due to various unavoidable circumstances. DGAL submitted the following claims before the Arbitral Tribunal: The above claim by DGAL is totally in the nature of damages and compensation for various indirect losses claimed to have been suffered by them due to delay in the completion of the project. In none of the instances, DGAL has claimed any amount towards the supply of materials or labor and the entire claim pertains to the pre-GST period. It is to be noted that all the work allocated was completed in the Pre-GST Period and the payments were also settled to DGAL in the Pre-GST period itself. The Applicant had given a sub-contract to DGAL during the pre-GST period and the contract was also completed before the implementation of GST in India. The Applicant and the Sub-Contractor have duly remitted VAT and Service Tax on the entire contract value and therefore, the damages claimed by the sub-contractor, DGAL cannot be assessed under GST net by holding the arbitral award shall b ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ave mutually agreed to bring down/reduce the Arbitral Award to Rs. 38,56,91,204/-. The amount agreed in MOM is an arbitral award amount and cannot be distinguished and treated as a distinct amount from arbitral award. Therefore, it cannot be presumed or concluded that the settlement amount of Rs. 38,56,91,204/- is to refrain or abstain DGAL from enforcing the arbitral award. We state that the payment of liquidated damages by the applicant does not fall within the scope of Entry 5(e) of Schedule II to CGST Act, as no consideration passed on for any of the act mentioned therein. Further the liquidated damages in the case on hand are not towards agreeing to the obligations to refrain DGAL from an act, or to tolerate an act or situation of DGAL, or to do an act by DGAL, but solely in due compliance with the arbitral award. In other words, the applicant has not sought any obligation or refrained DGAL from doing any act. The Amount payable as the Arbitral Award is purely in the form of Compensation payable for the delay in the completion of the contract and does not involve any additional supply or labor. It is relevant to point out that Circular No.178/10/2022, dt-3.8.2022 conside ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... sultant attended the personal hearing held on 20.03.2023. The authorized representatives reiterated their averments in the application submitted and requested to dispose the case on merit basis. The Authorized representative contended during the hearing as follows: a. That they have issued two purchase orders to their sub-contractor M/s Delta Global Allied Ltd (DGAL) who have completed the execution beyond the time limit provided to them. b. That M/s DGAL have alleged that the delay in execution of the project due to non-finalization of its drawings or supply of raw materials by the applicant and claimed compensation regarding the same. c. That M/s DGAL applied for arbitration and received an award for Rs. 42 Crs. For the compensation. d. That in view of Circular No. 178/10/2022, dt. 03.08.2022 issued by Govt. of India, Ministry of Finance such compensation including the liquidated damages claimed for breach or non-performance of the contracts by one of the parties shall be exempted. Opinion expressed by Sri S.V. Kasi Visweswara Rao, Additional Commissioner (State Member), on the issues raised by the applicant. 7. DISCUSSION FINDINGS: The a ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... refrain from an act or to tolerate an act or a situation, or to do an act. Agreeing to the obligation to refrain from an act or to tolerate an act or a situation, or to do an act has been declared to be a supply in para 5 (e) of Schedule I of CGST Act. Various transactions have been sought to be classified by the tax authorities under the said description and in many cases this has led to disputes and litigation. The issues arising out of taxation of activities by way of agreeing to the obligation to refrain from an act or to tolerate an act or a situation, or to do an act were deliberated in detail. It was felt that the entry is being very widely and at times erroneously interpreted which is leading to a lot of disputes and litigations. It was generally felt that a circular clearly explaining the situations in which an activity shall amount to a supply of service by way of agreeing to refrain from an act or to tolerate an act or a situation etc. may be issued. After detailed deliberations over course of two meetings, the Fitment Committee recommended that the issues involved may be clarified by way of the enclosed draft circular placed at Annexure B. ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... tion to tolerate an act or a situation is illustrated in the circular in the following examples: i. A shop keeper allowing a hawker to operate from the common pavement in front of his shop against a monthly payment by the hawker. ii. An RWA tolerating the use of loud speakers for early morning prayer by a school located in the colony subject to the school paying an agreed sum to the RWA as compensation. c) The phrase Agreeing to the obligation to do an act is illustrated in the circular in the following example: An industrial unit agrees to install equipment for zero emission / discharge at the behest of the RWA of a neighboring residential complex against a consideration paid by such RWA, even though the emission/discharge from the industrial unit was within permissible limit and there was no legal obligation upon the individual unit to do so. It is observed in the circular that doubts have persisted regarding the description Agreeing to the obligation to refrain from an act or to tolerate an act or a situation, or to do an act and tax authorities have initiated investigation and advance ruling authorities have upheld taxability under GST on the follow ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... erformance is the essence of a contract. Liquidated damages cannot be said to be a consideration received for tolerating the breach or non-performance of contract. They are rather payments for not tolerating the breach of contract. Payment of liquidated damages is stipulated in a contract to ensure performance and to deter non-performance, unsatisfactory performance or delayed performance. Liquidated damages are a measure of loss and damage that the parties agree would arise due to breach of contract. They do not act as a remedy for the breach of contract. They do not restitute the aggrieved person. It is further argued that a contract is entered into for execution and not for its breach. The liquidated damages or penalty are not the desired outcome of the contract. By accepting the liquidated damages, the party aggrieved by breach of contract cannot be said to have permitted or tolerated the deviation or non-fulfillment of the promise by the other party. Para-7.1.4: In this background a reasonable view that can be taken with regard to taxability of liquidated damages is that where the amount paid as liquidated damages is an amount paid only to compensate for injury, loss or ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... in return. If the payment is merely an event in the course of the performance of the agreement and it does not represent the object , as such, of the contract then it cannot be considered consideration . For example, a contract may provide that payment by the recipient of goods or services shall be made before a certain date and failure to make payment by the due date shall attract late fee or penalty. A contract for transport of passengers may stipulate that the ticket amount shall be partly or wholly forfeited if the passenger does not show up. A contract for package tour may stipulate forfeiture of security deposit in the event of cancellation of tour by the customer. Similarly, a contract for lease of movable or immovable property may stipulate that the lessee shall not terminate the lease before a certain period and if he does so he will have to pay certain amount as early termination fee or penalty. Some banks similarly charge pre- payment penalty if the borrower wishes to repay the loan before the maturity of the loan period. Such amounts paid for acceptance of late payment, early termination of lease or for pre-payment of loan or the amounts forfeited on cancellation of s ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... such facility and are subject to GST. (Para-7.1.6) In view of the above prescriptions in the circular the nature of transaction which took place between the applicant and his sub-contractor is analyzed as follows: 1. The applicant has not fulfill his promise to award the total work to the sub-contractor as stipulated in their work order. 2. There is a breach of contract by the applicant on which he has paid liquidated damages by way of out of court settlement. 3. By accepting the liquidated damages the sub-contractor cannot be said to have permitted or tolerated the deviation on non-fulfillment of the promise. 4. Thus the liquidated damages are paid only to compensate injury or loss of damage suffered by the aggrieved party due to breach of the contract. Hence, the above conditions of flow of consideration fall under para-7.1.3 and para-7.1.4 of circular No. 178/10/2022, dated: 03-08-2022, therefore such consideration as stipulated in the said circular are not taxable as there is no supply of service under entry-5(e) of Schedule-II of the CGST Act, 2017. 8. In view of the foregoing, the ruling is given by State Member as under: In view of the a ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... tion and Conciliation Act, 1996 before the Principal Special Court of Telangana. During the pendency of this appeal the parties to the dispute entered into an amicable settlement out of court for an amount of Rs. 38.56 Cr. 9.3 The principle issue before the Authority for Advance Ruling is to determine whether a mutually agreed amount for settling a dispute arising out of breach of contract constitute a supply within the scope of Entry 5(e) of Schedule-II to the CGST Act, 2017 and hence taxable. 9.4 In this connection it is pertinent to observe that the scope of entry 5(e) of Schedule-II to the CGST Act, 2017 has been elaborately discussed in the GST Council and based on the discussion a circular has also been issued to clarify the types of transactions which fall under this entry. 9.5 In the agenda for discussion in the 47th GST Council Meeting the Fitment Committee made recommendation for issuing clarification in relation to services of liquidated damages, breach of contract, etc., at Sl.No. 20 in page No. 92 of 279 in Annexure-IV to the Agenda for GST Council Meeting (Volume-II). The same is extracted here under: Proposal Details of Req ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... enalty, cancellation charges, late payment surcharge, etc., arising out of breach of contract or otherwise and scope of entry at para-5(e) of schedule-II of Central Goods Service Tax Act, 2017. 9.7 The entry at para-5(e) of Schedule-II of the CGST Act, 2017 makes the following activity a supply which is exigible to tax under the said act. Agreeing to the obligation to refrain from an act or to tolerate an act or a situation, or to do an act . 9.8 The Circular No. 178/10/2022-GST dated 03-08-2022 has discussed at length the illustration which will be covered by the entry-5(e) of schedule-II as follows: a) The phrase Agreeing to the obligation to refrain from an act is illustrated in the circular with the following examples: i. Non-compete agreements, where one party agrees not to compete with the other party in a product, service or geographical area against a consideration paid by the other party. ii. A builder refraining from constructing more than a certain number of floors, even though permitted to do so by the municipal authorities, against a compensation paid by the neighboring housing project, which wants to protect its sun light. iii. An in ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... rformance of contract by one party results in loss and damages to the other party. Therefore, the law provides in Section 73 of the Contract Act, 1972 that when a contract has been broken, the party which suffers by such breach is entitled to receive from the other party compensation for any loss or damage caused to him by such breach. The compensation is not by way of consideration for any other independent activity; it is just an event in the course of performance of that contract. Para-7.1.1: It is common for the parties entering into a contract, to specify in the contract itself, the compensation that would be payable in the event of the breach of the contract. Such compensation specified in a written contract for breach of non-performance of the contract or parties of the Circular No. 178/10/2022-GST contract is referred to as liquidated damages. Black s Law Dictionary defines Liquidated Damages as cash compensation agreed to by a signed, written contract for breach of contract, payable to the aggrieved party. Para-7.1.2: Section 74 of the Contract Act, 1972 provides that when a contract is broken, if a sum has been named or a penalty stipulated in the contract as ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... rs. Similarly, forfeiture of earnest money by a seller in case of breach of an agreement to sell an immovable property by the buyer or by Government or local authority in the event of a successful bidder failing to act after winning the bid, for allotment of natural resources, is a mere flow of money, as the buyer or the successful bidder does not get anything in return for such forfeiture of earnest money. Forfeiture of Earnest money is stipulated in such cases not as a consideration for tolerating the breach of contract but as a compensation for the losses suffered and as a penalty for discouraging the non-serious buyers or bidders. Such payments being merely flow of money are not a consideration for any supply and are not taxable. The key in such cases is to consider whether the impugned payments constitute consideration for another independent contract envisaging tolerating an act or situation or refraining from doing any act or situation or simply doing an act. If the answer is yes, then it constitutes a supply within the meaning of the Act, otherwise it is not a supply . Para-7.1.6: If a payment constitutes a consideration for a supply, then it is taxable irrespecti ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... nalty is a facility granted by supplier naturally bundled with the main supply. It is not uncommon or unnatural for customers to sometimes miss the last date of payment of electricity, water, telecommunication services etc. Almost all service providers across the world provide the facility of accepting late payments with late fine or penalty. Even if this service is described as a service of tolerating the act of late payment, it is an ancillary supply naturally bundled and supplied in conjunction with the principal supply, and therefore should be assessed as the principal supply. Since it is ancillary to and naturally bundled with the principal supply such as of electricity, water, telecommunication, cooking gas, insurance etc. it should be assessed at the same rate as the principal supply. However, the same cannot be said of cheque dishonor fine or penalty as discussed in the preceding paragraphs. Para 11.5 However, as discussed above, forfeiture of earnest money by a seller in case of breach of an agreement to sell an immovable property by the buyer or such forfeiture by Government or local authority in the event of a successful bidder failing to act after winning the bid f ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 022, dated: 03-08-2022, therefore such consideration as stipulated in the said circular are not taxable as there is no supply of service under entry-5(e) of Schedule-II of the CGST Act, 2017. 9.10 Notwithstanding anything stated above, the authority has also observed that the applicant had issued Purchase Orders in the pre-GST period and all the work allocated was completed in the Pre-GST Period and the payments were also settled to DGAL in the Pre-GST period itself. The Applicant and the Sub-Contractor have duly remitted VAT and Service Tax on the entire contract value. Thus it is pertinent here that the supply/work was completed during Pre-GST period. However though the execution of the contract was over in Pre-GST period, the Arbitration Award was announced only in the GST period. Accordingly the award/amount received under the said arbitration is also examined in terms of transitional provisions provided under CGST Act, 2017.. 9.11 The relevant provisions are as follows:- Section 142(10): Save as otherwise provided in this Chapter, the goods or services or both supplied on or after the appointed day in pursuance of a contract entered into prior to the appointed day s ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ted day and the taxable person is entitled to take credit of taxes that were paid under the earlier regime. On a combined reading of Section 142(10), Section 142(11)(b) and Section 142(11)(c), the following scenarios are evident: If the service is already leviable under the provisions of service tax law, then there cannot be any tax under the provisions of CGST Act to such an extent, notwithstanding anything contained in Section 13, that is time of supply for services. However, if a transaction is subjected to both VAT and service tax, let us say, a works contract service, then there will be a tax to the extent of supplies made under the GST regime, though the contract is entered prior to the GST regime. If the taxpayer has paid tax on such supplies (that are yet to be provided and provided in GST regime), he can claim the credit of such taxes. As to the receipt of the award amount during GST regime, would create any issue under the provisions of CGST Act is to be now analysed. This also, in our view, should not create any issues, especially, when the provisions of Section 142(11)(b) use the expression notwithstanding anything contained in Section 13 . In other ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 2, dated 03-08-2022 and in terms of the transitional provisions discussed supra, 12. In view of the foregoing, the ruling is given by Central Member as under: Questions Ruling 1. Whether the contract completed during the Pre-GST period and the consequential demand based on the completed contract can be brought to assessment under GST Act, 2017? No. In view of the clarification issued vide CBIC circular No. 178/10/2022, dated: 03-08-2022 and in terms of the transitional provisions under CGST ACT, 2017 discussed supra. 2. Whether the liquidated damages, without any supply of materials and labor be assessed to GST under GST Act, 2017? No. In view of the clarification issued vide CBIC circular No. 178/10/2022, dated: 03-08-2022 and in terms of the transitional provisions under CGST ACT, 2017 discussed supra. 3. The mutually agreed and settled amount, based on arbitral award, in the nature of compensation, payable for delay in completion of the contract and agreed to be payable by the Applicant to DGAL without any supply of goods or services, is li ..... X X X X Extracts X X X X X X X X Extracts X X X X
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