Telangana AAR: Liquidated Damages & Penalty for Contractual Violation Attracts GST

The Telangana State Authority for Advance Ruling (AAR) has held that the liquidated damages and penalties received due to breach of conditions of contract conditions attract tax under Central GST and State GST Acts.

M/s. The Singareni Collieries Company Limited (applicant) demanded penalties and liquidated damages from their contractors due to lapses in performance, including delays, underperformance related to targeted extraction and breach of contract terms. 

Usually, when the parties to a contract specify the time limit for its performance, it is expected that the concerned party will perform his obligation within the specified time. However, if one of them fails to do so, the question arises of the effect on the contract.

A Coram of Sri B. Raghu Kiran, IRS, Additional Commissioner (Central Tax) and Sri S.V. Kasi Visweswara Rao, Additional Commissioner (State Tax), observed that this scenario is covered under Section 55 of the Indian Contract Act, 1872.

The summary of Section 55 is as below:

The contract becomes voidable when a party in the contract promises to do a certain thing(s) at or before a specified time(s) and fails to do so. However, the time should be of the essence of the contract to make it avoidable.

AAR said that Section 55 (1) & (3) of the Indian Contract Act, 1872 states that a failure to perform the contract at the agreed time makes it avoidable at the option of the opposite party. The opposite party can recover compensation for loss caused by non-performance.

The AAR ruled that Section 2(31)(b) of the CGST Act mentions that consideration of the supply of goods or services includes the monetary value of an act of forbearance. Therefore such a situation under an agreement constitutes a service supply, and the consideration attracts tax.

For any clarifications/feedback on the topic, don’t hesitate to contact the writer at dvsr.anjaneyulu@cleartax.in.