Key Points of Decoding GST on Liquidated Damages

1. Decoding of What Constitutes Liquidated Damages:

Liquidated damages are simply a flow of money from the party that violates the terms of the contract to the party that suffers loss or harm because of the violation. These payments are not taxed and do not count as consideration for a supply. If you look at the entry at number 5(e) of Schedule II, you will see that it includes three distinct sets of obligations:

(a) The duty to refrain from doing anything,

(a) The duty to put up with a behavior or circumstance.

(c) The duty to do an action.

All three acts must be covered by an "agreement" or "contract" (whether express or inferred). To put it another way, one of the parties to such an agreement or contract (the first party) must be bound by a legal responsibility to either (a) refrain from doing something, (b) put up with something, or (c) do something. In addition, the other party to this contract or agreement (the second party) must provide "compensation" to the first party in exchange for such (a) abstaining from, (b) tolerating, or (c) acting.

2. Payment/ Consideration of Damages:

A contract may include a provision for the payment of liquidated damages to assure performance and to thwart non-performance, subpar performance, or delayed performance. A measure of loss and damage that both parties agree would result from a violation of the contract is known as liquidated damages. They do not serve as a remedy for the contract violation. The victim is not given their money back. A contract is allegedly entered into for its execution rather than for its violation. The liquidated damages or penalties are not what the contract intended to happen.

The key point is that no one enters a contract with the purpose that it would be broken, and the second party monitors the consideration that will accrue if the contract is canceled. Simply said, the second party enters the contract to ensure that the first party delivers the necessary output and the intended outcomes within the period and at a cost that the second party is willing to pay upon delivery. Liquidated damages are the effects of failing to produce the intended results within the specified time frame and budget.

3. GST Not Leviable on Such Damages:

As an illustration:

1. Damages brought on by property damage

2. Carelessness

3. Pirates

4. Unauthorized copyright and trade name usage

5. A contract's provision for a fine if house building is delayed. It is a fine that the developer pays to the purchasers, not to obtain anything from them in return, but to make up for the loss that they incur because of the building delay.

6. For how a successful bidder for the distribution of natural resources who fails to act after winning the bid causes a breach of "an agreement to sell a movable property by the buyer or by Government or local authority, a successful bidder who fails to act after winning the bid results in the forfeiture of earnest money by the seller,

7. Salary forfeiture or payment of the sum specified in the employment bond if the employee leaves the job before the minimum stipulated period. The conflicting GST AAR judgments on this issue have been resolved by this circular. According to Bharat Oman Refineries Ltd., Madhya Pradesh AAR, "releasing an employee without notice period or by accepting a shorter notice period" is a provision of service; as a result, GST is applied to the payment of notice paid by an employee to an employer.

For the transaction to qualify as a supply, there must be a quid pro quo, according to AAAR, who overturned the decision.

GST would not be imposed on certain types of recoveries, according to an advance ruling (AAR) by Syngenta India Limited Maharashtra.

The Gujarat AAR determined that GST was enforceable in the case of M/s Amneal Pharmaceuticals Pvt Ltd, Ahmedabad, in July 2020.

8. No provider wants a check that has been handed to him to be dishonored.

9. Infractions of other laws, such as traffic regulations, environmental standards, or other laws are also not considered for any supplies received and are not taxed.

There is no contract between the government and the offender that states the violation will be authorized or will be permitted in exchange for a fine or punishment. The penalties are applied to prevent and dissuade the violator from committing the offenses again. Similar circumstances apply to liquidated damages in cases of contract violation. The first party is punished to keep from committing the same violation with any other party in the future, and the punishment acts as a form of reminder to keep it from happening again.

4. The second party is given the choice to break the agreement, with the supplier keeping the advance or charging the money

In certain cases, the service provider offers the opportunity to break the agreement in exchange for the forfeiture or retention of a certain sum. The service provider is given the choice at the beginning of the contract or during the term and is willing to accept/retain some of the money in exchange for tolerating the breach of the agreement. In this case, accepting the violation of the contract is already specified, and the consumer has already been warned of the financial consequences.

The client is aware that if he does not respond by the specified date and within the specified timeframes, the advance payment may be lost, or he may be required to pay a fine for breaching the terms of the contract.

5. GST Applicability on Breach of Contracts:

As an illustration,

1. A contract for the transportation of people may include that the ticket price may be partially or entirely lost in the event the passenger fails to appear.
2. In the case that a consumer cancels a package tour, the contract may provide that the security deposit is forfeited.
3. A lease agreement for either mobile or immovable property may also provide that the lessee may not end the lease early and that, if he does, he would be required to pay an early termination charge or penalty of a specified amount.
4. Some banks similarly impose pre-payment penalties-payment pre-payment penalties. Although they may be referred to as fines or penalties, these payments are amounts of consideration for a supply and are therefore liable to GST when the supply in question is taxable. These supplies will be qualified to be valued as the major supply since they are incidental to the primary supply for which the contract is signed.
5. Making a hotel reservation
6. Making a reservation for a show
7. Purchasing an airplane or train ticket

The crucial question in these situations is whether the contested payments represent compensation for a separate agreement that calls for tolerating an act or circumstance, abstaining from doing any act or situation, or merely performing an act. If the response is "yes," then it qualifies as a "supply" within the meaning of the Act; if not, it is not.