Important Clarification Vis A Vis GST On Payments Arising Out Of Contractual Obligations Like Non-Compete Fees, Liquidated Damages, Early Termination Penalties, Late Payment Fees Etc

Published date09 August 2022
Subject MatterEmployment and HR, Tax, Contract of Employment, Sales Taxes: VAT, GST
Law FirmKhaitan & Co LLP
AuthorSudipta Bhattacharjee, Harsh Makhija and Arjyadeep Roy

Introduction

Taxability of payments made under contractual obligations like non-compete fees, early termination charges, liquidated damages, notice pay payments by employees, cancellation charges, late payment charges etc have been a subject matter of debate under Goods and Services Tax ('GST') as well as service tax before that - a debate that has revolved around the interpretation of the words 'Agreeing to the obligation to refrain from an act or to tolerate an act or a situation, or to do an act' (which have effectively been made part of the definition of 'service'/ 'supply' under both GST and service tax laws).

Under service tax, several judgments from the indirect tax tribunal concluded favorably that such payments do not qualify as 'consideration' for any 'service' and thus would not be liable to service tax. Unfortunately, under GST, numerous advance rulings from across the country took a contrary position and held in favor of levy of 18% GST on all such payments; similar view has been taken almost across the board by GST officers.

This dichotomy led to multiple contractual disputes and significant contract negotiation time being spent on (i) whether or not GST ought to be factored vis a vis such payments; and (ii) which party will be responsible to bear the litigation risk, in case no such GST has been factored.

The Circular No. 178/10/2022-GST dated 3 August 2022 (the 'Circular') clarifies the position vis a vis many such payments and tries to lay down an intelligible distinction between payments like liquidated damages and forfeiture of salary / payment of bond amount in case of an employee leaving employment before the minimum agreed period (which have been clarified to be non-taxable) versus payments like non-compete fees paid under an independent non-compete agreement, cancellation charges by a hotel / tour operator, late payment fees, etc (which have been clarified to be liable to GST).

It is interesting to note that like in the case of GST and service tax in India, similar disputes also arose under European Union Value Added Tax ('EU VAT') - in fact, even EU VAT went through a series of changes in positions vis a vis such payments in the last few years and the dust has somewhat settled only now. While the Circular does not specifically refer to judgements / clarifications under EU VAT, the positions as clarified in the Circular are largely consistent with the corresponding positions under EU VAT laws as they stand today.

Key clarifications

Key types of payments that have been clarified to qualify as consideration for the services of 'Agreeing to the obligation to refrain from an act or to tolerate an act or a situation, or to do an act' and thus liable to GST:

Key types of payments that have been clarified not to qualify as consideration for services and thus NOT liable to GST:

1.

Non-compete fees paid under an independent non-compete agreement

1.

...

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