Damages Have Become Less Damaging

• Published date: 09 August 2022
• Subject Matter: Corporate/Commercial Law, Tax, Corporate and Company Law, Contracts and Commercial Law, Sales Taxes: VAT, GST
• Law Firm: Economic Laws Practice
• Author: Ritesh Kanodia

The Government of India has issued the much-awaited clarification (vide Circular No. 178/10/2022- GST dated 3rd August 2022) on what could get covered as a 'supply' under the entry of "Agreeing to the obligation to refrain from an act or to tolerate an act or a situation, or to do an act". The entry has been a subject matter of deliberation and dispute since its introduction under the service tax regime, which then continued into the GST regime.

The key question for determination has been that when a Party (say 'A') recovers compensation or damages or cancellation charges from another Party (say 'B') for non-performance or any breach of contract by it, then is that non-performance or breach a separate independent supply of 'tolerating an act' by Party A, and consequently whether GST is applicable.

The Circular clarifies that the following key aspects would be determinative of whether GST applies:

• There is a contract [express or implied] between parties for a consideration - A contract to do something or to abstain from doing something cannot be said to have taken place unless there are two parties, one of which expressly or impliedly agrees to do or abstain from doing something and the other agrees to pay consideration to the first party for doing or abstaining from such an act.
• There cannot be said to be a contract where a party agrees to tolerating a breach or to an illegal act or violating the provisions of law.
• There must be a necessary and sufficient nexus between the supply (i.e., agreement to do or to abstain from doing something) and the consideration.
• An agreement to do an act or abstain from doing an act or to tolerate an act or a situation cannot be imagined or presumed to exist just because there is a flow of money from one party to another.
• The amounts are recovered as a deterrent to avoid the event - if yes, they cannot be considered as consideration.
• The recoveries arise out of mere events in the contract and are not an independent supply.
• The recoveries are to compensate for the loss / damage that has been incurred.
• There is no option but to bear / tolerate the act when it happens (such as cancellation of coal block by the Government or dishonour of cheque)
• The other party does not get anything in return.

Basis the above principles, it is clarified that that amount received towards liquidated damages, compensation for cancellation of coal blocks, cheque dishonor fine/ penalty, penalty imposed for violation of laws, forfeiture of salary or...