GST Circular On Liquidated Damages - Opportunities In Contracts/Claims

Published date09 August 2022
Subject MatterFinance and Banking, Corporate/Commercial Law, Tax, Financial Services, Contracts and Commercial Law, Sales Taxes: VAT, GST, Tax Authorities
Law FirmEconomic Laws Practice
AuthorMr Naresh Thacker, Alok Jain and Tvisha Desai

SETTING THE CONTEXT...

On 3 August 2022, the Department of Revenue, Ministry of Finance issued its clarificatory Circular No. 178/10/2022-GST ("Circular") which primarily addresses the taxability of liquidated damages and penalty. The basic principle emanating from the Circular is that there must be necessary and sufficient nexus between the supply (i.e agreement to do or to abstain from doing something or to tolerate an act) and the consideration to give rise to a taxable event.

The Circular lists several examples where GST would not be applicable on the amounts which are a mere flow of money to deter a breach (which would not amount to an agreement to abstain from doing something). It also lists several examples where GST would apply on the amounts (whether such amounts are termed as fine or penalty) which would be consideration for a supply (which is ancillary to the principal supply).

Basis the principles stated in the Circular, this article discusses the scope for revisiting contractual positions and particularisation of claims arising out of commercial contracts.

CURATING CLAIMS

As the Circular is quite clear on the applicability of GST on liquidated damages, we consider aspects on which the Circular is silent, namely other claims that parties may have.

In a dispute arising from a construction contract, some of the common heads of claims include (i) claims for refund of deductions from running bills/ invoices, (ii) payment of amounts due and outstanding, (iii) change order/variation claims, (iv) delay claims (prolongation costs, disruption claims, acceleration claims, etc.), (v) claims for general damages and (vi) claims arising out of termination (While this article considers typical claims arising in a construction contract, it is relevant to note that the principles/observations below hold true for any commercial contract).

For (i) and (ii), as there is a supply element directly involved, GST would be applicable on the amounts claimed. For (iii), where the claim is for additional work performed, a similar conclusion may be reached. However, if the claim is for damages for unlawful descoping, the situation is not as straightforward. It may be arguable that since no supply was made, GST would not apply on the claimed amount (presumably the expected profits on the value of the descoped work). This would be heavily dependent on how the claim is structured and the factual matrix.

Whether GST would be applicable on delay claims is not entirely...

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