Compensation collected for Liquidated Damages under the Agreement will be subject to GST

The Andhra Pradesh, AAR in the matter of South India Krishna Oil & Fats (P.) Ltd. [AAR No. 12/AP/GST/2023 dated December 21, 2023] held that the compensation amounts, such as liquidated damages or trade settlement, collected by the Applicant from customers for non-performance or breach of contracts constitute a supply of service and are liable to CGST at 9% and SGST at 9% each under Heading No. 9997 at Serial No. 35 of Notification No. 11/2017-Central Tax (Rate) dated June 28, 2017. Further, the Applicant is not required to reverse the Input Tax Credit of common services under Rules 42 and 43 of the Central Goods and Services Tax Rules, 2017 ("the CGST Rules")/ Andhra Pradesh Goods and Services Tax Rules, 2017 ("the APGST Rules") on such activity.

Facts

M/s. South India Krishna Oil & Fats (P.) Ltd. ("the Applicant"), is engaged in the manufacturing of edible oils. The Applicant enters into agreements with its customers for the supply of a specified quantity of edible oils at a specific rate. As per these agreements, the edible oils are required to be delivered within a particular date.

Further, in certain cases, where the customers fail to lift the agreed quantity of edible oils within the stipulated delivery date, thereby breaching or non-performing the contractual obligations. In such situations, the Applicant collects compensation amounts from the defaulting customers, termed "Liquidated Damages or Trade Settlement", for the breach or non-performance of the contract.

The Applicant sought an advance ruling from the Andhra Pradesh, AAR, on the following questions:

1.  Whether GST is leviable on the compensation amounts such as liquidated damages/trade settlement/damages collected from customers for non-performing contractual obligations or breach of contract?

2.  If GST is leviable on the said activity of collecting compensation, what is the Harmonized System of Nomenclature (HSN) Code applicable, and what is the rate of GST applicable for the said activity?

3.  If GST is not leviable on the activity of collecting compensation for liquidated damages, does the restriction of ITC of common services under Rules 42 and 43 of the CGST Rules, attract?

The Applicant sought clarity on the GST implications of the compensation amounts received from customers for non-performance or breach of contractual obligations and the related input tax credit implications.

Issue

Whether the compensation amounts collected by the Applicant from customers for non-performance of contracts are subject to GST and if yes, what will be the applicable HSN Code along with GST Rate and whether the restriction of ITC of common services under Rules 42 and 43 of the CGST Rules would apply?

Held

The Andhra Pradesh, AAR in AAR NO. 12/AP/GST/2023 held as under:

• Observed that, as per the definition of "consideration" under Section 2(31) of the CGST/APGST Acts, it includes any payment made or to be made, whether in money or otherwise, in respect of, in response to, and for the inducement of the supply of goods or services.
• Opined that, in the present case, customers are paying a certain amount to the Applicant as compensation for non-performance of the contract. The amount paid is neither ad-hoc, unconditional, nor at the whims of any customer or the Applicant.
• Further opined that, in light of Section 7 of the CGST Act read with the definition of "consideration" under Section 2(31) of the CGST Act, the compensation amounts paid by the defaulting party to the non-defaulting party for tolerating the act of non-performance or breach of contract have to be treated as consideration for tolerating an act or a situation under an agreement.
• Held that, compensation amounts such as liquidated damages collected from the customers constitute a supply of service and are eligible for tax under CGST at 9% and SGST at 9% each, under Chapter Heading No. 9997 at Serial No. 35 of Notification No. 11/2017-Central Tax (Rate) dated June 28, 2017.
• Further held that, since GST is leviable on the activity of collecting compensation for liquidated damages from customers for non-performance of the contract, the question of the restriction of ITC of common services under Rules 42 and 43 of the CGST/APGST Rules, does not arise.

Our Comments

Section 7, read with Section 2(31) of the CGST Act/APGST Acts talks about "Scope of supply". According to said section, the expression "supply" includes––

(a) all forms of supply of goods or services or both such as sale, transfer, barter, exchange, licence, rental, lease or disposal made or agreed to be made for a consideration by a person in the course or furtherance of business; 

(aa) the activities or transactions, by a person, other than an individual, to its members or constituents or vice-versa, for cash, deferred payment or other valuable consideration. 

Further, Section 2(31)(b) of the CGST Act, talks about "consideration in relation to the supply of goods or services or both includes", according to this section the monetary value of any act or forbearance, in respect of, in response to, or for the inducement of, the supply of goods or services or both, whether by the recipient or by any other person but shall not include any subsidy given by the Central Government or a State Government.
With reference to the aforementioned sections, compensation collected by the Applicant from Customers for liquidated damages due to non-performance of a contract under an agreement should be considered as consideration for tolerating an act or situation, thereby constituting a supply under Section 7 of the CGST Act/APGST Act. Consequently, GST at a rate of 9% each of CGST and SGST is applicable under HSN 9997 for such activity. Moreover, the applicant is not obligated to reverse the Input Tax Credit (ITC) of common services under Rules 42 and 43 of the CGST/APGST Rules since GST is leviable on this activity.