GST on Liquidated Damages, Compensation, and Penalties – Key Clarifications from CBIC Circular No. 178/10/2022

02March

GST on Liquidated Damages, Compensation, and Penalties – Key Clarifications from CBIC Circular No. 178/10/2022

The Central Board of Indirect Taxes and Customs (CBIC) has issued Circular No. 178/10/2022-GST to clarify the GST applicability on various payments, including liquidated damages, penalties, cancellation charges, late payment fees, and compensation for breach of contract. These clarifications help determine whether such payments qualify as a supply of service and are taxable under GST.<hr><h2>Understanding the Scope of GST on Contractual Obligations</h2>The CGST Act, under Schedule II (Para 5(e)), categorizes certain agreements as a supply of service if they involve:<ol><li>Agreeing to refrain from an act – e.g., a builder agreeing not to construct additional floors for compensation.</li><li>Agreeing to tolerate an act or situation – e.g., a Resident Welfare Association (RWA) allowing loudspeaker use for compensation.</li><li>Agreeing to do an act – e.g., an industrial unit installing extra emission control equipment for a fee.</li></ol><hr><h2>Key Clarifications on GST Applicability</h2><h3>1. Liquidated Damages (Not Taxable)</h3><ul><li>Definition: Compensation for breach or non-performance of a contract.</li><li>Clarification: Since liquidated damages are meant to deter breaches and compensate losses, they do not constitute consideration for any supply.</li><li>Examples:<ul><li>Penalties for delayed construction.</li><li>Forfeiture of earnest money when a bidder backs out.</li><li>Compensation for unauthorized use of trademarks.</li></ul></li></ul><h3>2. Compensation for Cancellation of Coal Blocks (Not Taxable)</h3><ul><li>Background: In 2014, coal block allocations were canceled by the Supreme Court, and prior allottees were compensated.</li><li>Clarification: The compensation was not a taxable service because:<ul><li>It was not based on an agreement between the government and the allottees.</li><li>It was a statutory payment, not a contractually agreed supply.</li></ul></li></ul><h3>3. Cheque Dishonor Fine/Penalty (Not Taxable)</h3><ul><li>Reasoning: Cheque dishonor penalties deter non-compliance and do not qualify as a supply of service.</li><li>Clarification: Such penalties are imposed for non-toleration, not for providing a service.</li></ul><h3>4. Penalties for Law Violations (Not Taxable)</h3><ul><li>Examples:<ul><li>Traffic fines.</li><li>Pollution penalties.</li><li>Mining department fines for excessive extraction.</li></ul></li><li>Clarification: These are not taxable as they are not consideration for any supply.</li></ul><h3>5. Forfeiture of Salary/Bond for Premature Job Exit (Not Taxable)</h3><ul><li>Clarification: Employers impose bond penalties to deter early resignations, not as a service for tolerating the employee’s action.</li><li>Conclusion: Not a taxable supply.</li></ul><h3>6. Compensation for Not Collecting Toll Charges (Not Taxable)</h3><ul><li>Scenario: During demonetization (2016), toll operators were compensated for free road access.</li><li>Clarification: The compensation was for an exempt supply (toll service) and not taxable.</li></ul><h3>7. Late Payment Surcharges (Taxable)</h3><ul><li>Examples: Late fees on electricity, water, telecom bills.</li><li>Clarification: Since these fees are ancillary to the main service, they are taxed at the same rate as the principal supply.</li></ul><h3>8. Fixed Capacity Charges for Power (Not Taxable)</h3><ul><li>Clarification: Even if the minimum fixed charge is paid regardless of usage, it is part of the sale of electricity, which is exempt from GST.</li></ul><h3>9. Cancellation Charges (Taxable)</h3><ul><li>Examples:<ul><li>Airline ticket cancellation fees.</li><li>Hotel booking cancellation charges.</li><li>Train ticket cancellation charges.</li></ul></li><li>Clarification: Since these fees cover the cost of arranging and canceling services, they are taxable at the same rate as the main service.<a href="https://cms.plasament.com/storage/cir-178-08-2022-cgst.pdf">cir-178-08-2022-cgst</a>  </li></ul>

GST on Liquidated Damages, Compensation, and Penalties – Key Clarifications from CBIC Circular No. 178/10/2022

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