TAXABILITY OF LIQUIDATED DAMAGES UNDER GST
By: – Dr. Sanjiv Agarwal
Goods and Services Tax – GST
Dated:- 21-7-2018
Scope of Liquidated Damages
'Liquidated damages' is a common prevalent business terminology comprising of two words – liquidated and damages. This can be found in business agreements or contracts to protect the interests of the principal or the other party from any specified action arising out of performance or non-performance or breach of any conditions of the contract.
Literally 'to liquidate' implies the winding up of affairs of a business by ascertaining assets and liabilities, a plan to liquidate, process of liquidation.
'Damages' refer to detrimental effects. Damages are a sum of money claimed or awarded in compensation for a loss or an enquiry.
Liquidated damages are damages or a sum of money which is agreed upon in a contact to be paid to a party by another party in the event of breach of any term or condition of the contract.
According to P
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nature of the transaction, the actual damages consequent on a breach of the contract are incapable of accurate measurement, or where the sum specified is not out of all proportion to any damages which could arise, the provision will be treated as liquidated damages. But where these facts do not exist the tendency of the Court is to treat the stipulation in the nature of a penalty.
The essence of liquidated damages is a genuine pre-estimated damage and the estimate of penalty is a payment of money stipulated as in terrorem of the offending party and the question whether the sum stipulated is penalty or liquidated damages is a question of construction to be decided upon the terms of the surrounding circumstances in the context of which the contract had been made. Prahled Bhagirath Firm v. Badrilal Bhalooram, MLJ: QD (1956-1960) Vol. II CI026: 1959 MPLJ (Notes) 171. [Contract Act (9 of 1872),
S.74].
Contracts often contain provisions for the payment of sums of money or the forfeiture
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e terms a judge will not accept the phraseology of the parties; they may call the sum specified 'liquidated damages' but if the judge finds it to be a penalty, he will treat it as such. WILLIAM R. ANSON, Principles of the Law of Contract 470 (ARTHUR L. CORBIN ed., 3d Am. ed. 1919).
The distinction between a penalty and genuine liquidated damages, as they are called, is not always easy to apply, but the Courts have made the task simpler by laying down certain guiding principles. In the first place, if the sum payable is so large as to be far in excess of the probable damage on breach, it is almost certainly a penalty. Secondly, if the same sum is expressed to be payable on anyone of a number of different breaches of varying importance, it is again probably a penalty, because it is extremely unlikely that the same damage would be caused by these varying breaches. Thirdly, where a sum is expressed to be payable on a certain date, and a further sum in the event of default being m
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ny loss or damage caused to him thereby, which naturally arose in the usual course of things from such breach, or which the parties knew, when they made the contract, to be likely to result from the breach of it.”
Section 74
“When a contract has been broken, if a sum is named in the contract as the amount to be paid in case of such breach, or if the contract contains any other stipulation by way of penalty, the party complaining of the breach is entitled, whether or not actual damage or loss is provided to have been caused thereby, to receive from the party who has broken the contract reasonable compensation not exceeding the amount so named, or as the case may be, the penalty stipulated for.”
Liquidated damages are nothing but monetary compensation for suffering arising out of breach of contract.
Taxation under Service Tax regime
In Service Tax regime, there was a declared service under section 66E(e) of the Finance Act, 1994 whereby an activity to the obligation to retrain from
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seen actions not related to the provision of service'. This covered consideration or amount arising out of two situations – there is no provision of service and there exists unforeseen actions. Liquidated damages also are the outcome of these two situations.
GST on Liquidated Damages
Under the GST law, scope of supply is defined in section 7 and charging section levy and collection) is governed by section 9 of CGST Act 2017. 'Supply' is defined as an inclusive definition which shall include:
* 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;
* import of services for a consideration whether or not in the course or furtherance of business;
* the activities specified in Schedule I, made or agreed to be made without a consideration; and
* the activities to be treated as supply of goods or supply of servic
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of payment of these liquidated damages by the contractor will be established once the delay in successful completion of trial operation is established on the part of the contractor. Thus, the act of delayed supply has happened. The same was being tolerated by an additional levy in the nature of liquidated damages. The agreement had also provided that the payment by contractor or deduction by owner of any sums under the provision of this clause shall not relieve the contractor from his obligations to complete the works or from his other obligations under the contract. This provision just ensured that the obligations under the contract are fulfilled. The facts are much obvious that the empowerment to levy liquidated damages is for the reason that there had been a delay and the same would be tolerated, but for a price or damages. The income though presented in the form of a deduction from the payments to be made to the contractor was the income of the applicant and would be a supply of '
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18% [9% + 9%]
Another important issue of levy of GST is that at what time the liability to pay GST would occur. This would be governed by time of supply provision as stipulated in section 13 and 14 the GST law. Section 13(1) provides that the liability to pay tax on services shall arise at the time of supply for which agreement and section 14 are relevant. Accordingly, liquidated damages is determined and imposed upon the contractor after in-depth study. In terms of the agreement, the clauses revealed that the levy of liquidated damages is not when the delay is occurring but the liability of payment of these liquidated damages by the Contractor will be established once the delay in successful completion of trial operation is established on the part of the Contractor. This would define the time of supply.
In terms of Section 13(1) of Central Goods and Services Tax Act, 2017, liability to pay tax on services arose at time of supply. If contractor fails to achieve trial operation of uni
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