Whether amount forfeited on account of breach of sale of land agreement taxable under GST

In M/s. Fastrack Deal Comm Pvt. Ltd. [ADVANCE RULING NO. GUJ/GAAR/R/58/2020 dated July 30, 2020] M/s. Fastrack Deal Comm Pvt. Ltd. ("the Applicant") after entering into a sale agreement to sell a factory land to a "Mr.B" for a consideration didn't receive 80% of the value of consideration due to which has filed the current application seeking clarification of whether 20% the amount forfeited on account of breach of agreement of sale of land is liable to Goods and Services Tax ("GST") or not.

The Applicant contended that 20% of the amount forfeited is on account of sale of land which is a transaction not liable to GST as per Schedule III of the Central Goods and Services Tax Act, 2017 ("the CGST Act") which provides that sale of land is an activity or transaction, which is treated as, neither supply of goods nor service under GST.

The Hon’ble Gujarat Authority of Advance Ruling ("GAAR") noted that the Applicant has not received the said amount on account of sale of land but received the same on account of non-fulfillment of conditions of agreement of purchase of factory land by the customer. The current case is covered under Clause 5(e) of Schedule-II of the CGST Act which provides "(e) agreeing to the obligation to refrain from an act, or to tolerate an act or a situation, or to do an act" to be construed as a taxable supply under Section 7(1) of the CGST Act.

Noted that the amount, which was received from Mr. B and forfeited by the Applicant, was a part of the terms and condition of an agreement. Mr.B also accepted that in the contingency of his inability to fulfill the transaction, the Applicant can exercise the option of forfeiting the amount received as an advance amount.

Further noted that the purpose of payment of amount is an act of tolerance implying that when there is breach of the contract, the Appellant is put to certain hardships, which he tolerates in return of the payment received as advance being forfeited. Therefore, the impugned transaction is a supply which is taxable under the CGST Act,.

Our Comments

Earlier (before the Central Goods and Services (Amendment) Act, 2018) the same was dealt under Section 7(1)(d) of the CGST Act which included activities referred to in Schedule II to CGST Act, in the scope of supply. Paragraph 5 of Schedule II to the CGST Act provides a list of activities to be treated as either as ‘supply of goods’ or ‘supply of services’ wherein inter alia comprised Para 5– "(e) agreeing to the obligation to refrain from an act, or to tolerate an act or situation, or to do an act".

The Hon’ble Maharashtra AAR in the matter of Maharashtra State Power Generation Company Limited [Order No. GST-ARA- 15/2017-18/B-30, decided on May 8, 2018] held that GST at the rate of 18% would be payable on liquidated damages received by the Applicant for delayed supply under a contract and considered liquidated damages to be a consideration for agreeing to the obligation to tolerate an act or a situation, which is treated as a supply of service under Para 5(e) of Schedule II of the CGST Act.

Further, a similar view has been taken by the Hon’ble Gujarat AAR, in the matter of M/s. Dholera Industrial City Development Project Ltd. [Advance Ruling No. GUJ/GAAR/R/2019/06, decided on March 4, 2019] wherein it was held that Applicant is liable to collect GST on amount recovered from contractors on account of breach of conditions specified in the contract and the transaction shall be treated as supply of services. Moreover, as violation charges are payable by the contractors, the same are required to be treated as consideration. Therefore, the transaction is liable to GST.

However, vide Central Goods and Services (Amendment) Act, 2018, Section 7(1)(d) of the CGST Act was retrospectively omitted and a new sub-section i.e., Section 7(1A) of the CGST Act was inserted w.e.f. July 1, 2017. Consequently, all activities which were specified in Schedule II to the CGST Act would be only for determination of classification of transactions either as ‘supply of goods’ or supply of services’ but, it would be chargeable to GST only if such transaction qualify as a supply in terms of Section 7(1) of CGST Act.

In our view, the levy of GST on recovery of compensation/penalty/damages depends upon the "test of supply" i.e., one has to satisfy that recovery of compensation/penalty/damages in itself is a supply, then only GST could be levied on it in terms of the insertion of sub-clause (1A) in Section 7 of the CGST Act read with omission of sub-section (d) of Section 7(1) of the CGST Act (vide Central Goods and Services Tax (Amendment) Act, 2018 w.e.f. July 1, 2017).

The Schedule II of the CGST Act is confined to define as to what constitute supply of goods or supply of services and does not defines supply per se. Schedule II of the CGST Act has to be read along with Section 7 of the CGST Act, which means if an activity does not constitute a "supply" in itself as per Section 7(1) of the CGST Act, mere coverage of the same under the entry Schedule II ibid cannot make it liable to GST.

Further, there is no positive act of supply of services between the parties and there is no agreement between the parties to cause loss or damage by breaching terms and conditions of an agreement for a consideration. The expression ‘to tolerate an act’ relates to situations where a person commissions another person to do or commit a particular act for a consideration. The payment of damages is a condition of contract and not a consideration for any service in the nature of forbearance or tolerating an act.