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TMI BlogGST applicability on liquidated damages, compensation and penalty arising out of breach of contract or other provisions of lawX X X X Extracts X X X X X X X X Extracts X X X X ..... or a situation, or to do an act has been specifically declared to be a supply of service in para 5 (e) of Schedule II of the UPSGST Act if the same constitutes a supply within the meaning of the Act. The said expression has following three limbs : (a) Agreeing to the obligation to refrain from an act Example of activities that would be covered by this part of the expression would include 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. Another example of such activities would be 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 neighbouring housing project, which wants to protect its sunlight, or an industrial unit refraining from manufacturing activity during certain hours against an agreed compensation paid by a neighbouring school, which wants to avoid noise during those hours. (b) Agreeing to the obligation to tolerate an act or a situation This would include activities such a shopkeeper allowing a hawker to operate from the common ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... thout such a relationship, i. e., without the express or implied contractual reciprocity of a consideration would not be an activity for consideration . The element of contractual relationship, where one supplies goods or services at the desire or another, is an essential element of supply. 5. The description of the declared service in question, namely, agreeing to the obligation to refrain from an act or to tolerate an act or a situation, or to do an act in para 5(e) of Schedule II of the UPSGST Act is strikingly similar to the definition of contract in the Contract Act, 1872. The Contract Act defines Contract as a set of promises, forming consideration for each other. Promise has been defined as willingness of the promisor to do or to abstain from doing anything. Consideration has been defined in the Contract Act as what the promisee does or abstains from doing for the promises made to him. 6. This goes to show that the service of agreeing to the obligation to refrain from an act or to tolerate an act or a situation, or to do an act is nothing but a contractual agreement. A contract to do something or to abstain from doing something cannot be said to have taken place unless there ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... uation. Payments such as liquidated damages for breach of contract, penalties under the mining act for excess stock found with the mining company, forfeiture of salary or payment of amount as per the employment bond for leaving the employment before the minimum agreed period, penalty for cheque dishonour, etc., are not a consideration for tolerating an act or situation. They are rather amounts recovered for not tolerating an act or situation and to deter such acts ; such amounts are for preventing breach of contract or non-performance and are thus mere events in a contract. Further, such amounts do not constitute payment (or consideration) for tolerating an act, because there cannot be any contract : (a) for breach thereof, or (b) for holding more stock than permitted under the mining contract, or (c) for leaving the employment before the agreed minimum period or (d) for doing something leading to the dishonour of a cheque. As has already been stated, unless payment has been made for an independent activity of tolerating an act under an independent arrangement entered into for such activity of tolerating an act, such payments will not constitute consideration and hence such activit ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... of contract cannot be said to have permitted or tolerated the deviation or non-fulfilment of the promise by the other party. 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 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 refrain from or tolerate an act or to do 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. 7.1.5 Examples of such cases are damages resulting from damage to property, negligence, piracy, unauthorized use of trade name, copyright, etc. Other examples that may be covered here are the penalty stipulated in a contract for delayed construction of houses. It is a penalty paid by the builder to the buyers to compensate them for the l ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... rly 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 service by the customer as contemplated by the contract as part of commercial terms agreed to by the parties, constitute consideration for the supply of a facility, namely, of acceptance of late payment, early termination of a lease agreement, of pre-payment of loan and of making arrangements for the intended supply by the tour operator respectively. Therefore, such payments, even though they may be referred to as fine or penalty, are actually payments that amount to consideration for 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, as discussed in detail in the later paragraphs. Naturally, such payments will not be taxable if the principal supply is exempt. Compensation for cancellation of coal blocks 7 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... tion in the form of cheque dishonour fine or penalty. The fine or penalty that the supplier or a banker imposes, for dishonour of a cheque, is a penalty imposed not for tolerating the act or situation but a fine, or penalty imposed for not tolerating, penalizing and thereby deterring and discouraging such an act or situation. Therefore, cheque dishonour fine or penalty is not a consideration for any service and not taxable. Penalty imposed for violation of laws 7.4 Penalty imposed for violation of laws such as traffic violations, or for violation of pollution norms or other laws are also not consideration for any supply received and are not taxable, which are also not taxable. Same is the case with fines, penalties imposed by the mining Department of a Central or State Government or a local authority on discovering mining of excess mineral beyond the permissible limit or of mining activities in violation of the mining permit. Such penalties imposed for violation of laws cannot be regarded as consideration charged by Government or a local authority for tolerating violation of laws. Laws are not framed for tolerating their violation. They stipulate penalty not for tolerating violatio ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... er 8, 2016 to December 1, 2016 for which the loss of toll charge was paid as compensation by NHAI as per the instructions of Ministry of Road Transportation and Highways. The toll reimbursements were calculated based on the average monthly collection of toll. A question arose whether the compensation paid to the concessionaire by project authorities (NHAI) in lieu of suspension of toll collection during the demonetization period (from November 8., 2016 to December 1, 2016) was taxable as a service by way of agreeing to refrain from collection of toll from users. 8.1 It has been clarified vide Circular No. 212/2/2019-ST, dated May 21, 2019 that the service that is provided by toll operators is that of access to a road or bridge, toll charges being merely a consideration for that service. During the period from November 8, 2016 to December 1, 2016, the service of access to a road or bridge continued to be provided without collection of toll from users. Consideration came from the project authority. The fact that for this period, for the same service, consideration came from a person other than the actual user of service does not mean that the service has changed. Late payment surchar ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... electricity to a third party without approval of buyer. Such agreements which ensure assured supply of power to State Electricity Boards/DISCOMS are ancillary arrangements ; the contract is essentially for supply of electricity. Cancellation charges 11. A supply contracted for, such as booking of hotel accommodation, an entertainment event or a journey, may be cancelled by a customer or may not proceed as intended due to his failure to show up for availing the same at the designated place and time. The supplier may allow cancellation of supply by the customer within a certain specified time period on payment of cancellation fee as per commercial terms of the contract. In case the customer does not show up for availing the service, the supplier may retain or forfeit part of the consideration or security deposit or earnest money paid by the customer for the intended supply. 11.1 It is a common business practice for suppliers of services such as hotel accommodation, tour and travel, transportation, etc., to provide the facility of cancellation of the intended supplies within a certain time period on payment of cancellation fee. Cancellation fee can be considered as the charges for the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 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 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. 12. Field formations are advised that while the taxability in each case shall depend on facts of that case, the above guidelines may be followed in determining whether tax on an activity or transaction needs to be paid treating the same as service 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. 13. Any difficulty in implementation of the circular may be brou ..... X X X X Extracts X X X X X X X X Extracts X X X X
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