AAR – ANDHRA PRADESH :
Date of Order – 09-05-2024
Background: The case involved Transmission Corporation of Andhra Pradesh Ltd. (the applicant-assessee), which operates as a Licensed Distribution Company for supplying electricity. The company enters into various contracts with suppliers (contractors) to construct and maintain its transmission network in the state. These contracts often include specific time limits for supplies to be completed. In case suppliers fail to adhere to these time limits, the contracts stipulate penalties or liquidated damages that will be deducted from the amounts due to compensate the company for losses incurred due to delays.
Key Points of the Ruling:
- Nature of Liquidated Damages: The ruling clarified that liquidated damages are predetermined compensation amounts agreed upon in a contract to estimate the actual loss or injury suffered by one party (in this case, the company) due to the other party’s breach of contract obligations (delay in supplies).
- GST Implication: According to Paragraph 5(e) of Schedule II of the Central Goods and Services Tax (CGST) Act, 2017, any activity where a defaulting party “tolerates” non-performance by the other party in exchange for compensation (like liquidated damages) is considered a supply of service. Therefore, the amount received as liquidated damages is treated as consideration for tolerating the non-performance.
- Classification for GST: The ruling classified the imposition of penalties or liquidated damages by the company on its suppliers under Heading No. 9997 of the GST Tariff. This heading pertains to “Other services,” which includes services not elsewhere classified. Specifically, the liquidated damages were categorized as consideration for an act of tolerance of non-performance under a contract, making them subject to GST at the rate of 18%.
- Legal Basis: The ruling cited Section 9 and Section 7 of the CGST Act, which define taxable supply and consideration for supply respectively. It also referred to provisions under the Indian Contract Act, 1872, particularly Sections 73 and 74, which deal with the consequences of breach of contract and recovery of damages.
Elaboration: Transmission Corporation of Andhra Pradesh Ltd. sought an advance ruling to clarify the GST treatment of penalties or liquidated damages deducted from amounts due to suppliers for delays in supplying goods under their contracts. The Authority for Advance Rulings (AAR), Andhra Pradesh examined the nature of liquidated damages, which are predetermined amounts agreed upon in contracts to compensate one party for losses incurred due to the other party’s breach of contractual obligations.
The AAR concluded that under GST laws, the act of tolerating non-performance by a defaulting party in exchange for receiving liquidated damages constitutes a supply of service as per Paragraph 5(e) of Schedule II of the CGST Act. This means the amount received as liquidated damages is considered consideration for this supply of service and is therefore subject to GST.
To determine the appropriate GST rate and classification, the AAR classified these transactions under Heading No. 9997 of the GST Tariff, which covers “Other services.” This heading is a residual category for services not specifically classified elsewhere. The ruling specified that liquidated damages are subject to GST at the rate of 18% under this classification.
In essence, the ruling underscores the principle that any consideration received for tolerating non-performance under a contract, such as liquidated damages, falls within the ambit of GST. It highlights the importance of understanding contractual obligations and the GST implications thereof, ensuring clarity for both taxpayers and authorities regarding the tax treatment of such contractual remedies.
Relevant Sections : 7 & 9 of CGST Act.
