Telangana AAR: Settlement out of Court Would Not be Levied to GST

The GST Authority for Advance Ruling, in a recent ruling, exempted GST on compensation that is paid to sub-contractor as an out-of-court settlement.

As per GST provisions, complying with the obligation to evade an act, abide by an act or situation, or do an act constitutes a GST-taxable supply of service.

High courts have given contrasting judgments on the taxability of liquidated damages due to varying interpretations. To clarify the applicability of GST on charges arising from contract breaches, the Central Board of Indirect Taxes and Customs (CBIC) issued a circular on August 3, 2022. However, the taxability of liquidated damages, payments from out-of-court settlements, and arbitration awards remain contentious issues between India Inc and GST officials.

Although advanced rulings do not establish judicial precedents, they do carry a potent impact during assessments. As a result, tax experts are happy with this ruling. According to Harpreet Singh, a Partner at KPMG India, this ruling is well-reasoned and rightly appreciates the fact that receipt of damages does not indicate tolerance or permission for non-fulfilment of promise. Damages are solely meant to compensate for losses incurred due to contract breaches, and there is no underlying supply of services.

In this particular case, TPSC (India), a private limited company engaged in thermal projects, sought an advance ruling. For one project, TPSC subcontracted work to Delta Global Allied (DGAL). DGAL claimed that the project’s delay was due to the contractor’s failure to finalise drawings or provide raw materials. As a result, TPSC reassigned a portion of the work to other subcontractors.

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Unsatisfied with the reduction in quantum work, DGAL resorted to arbitration proceedings and was awarded compensation of Rs. 42.5 crore by the tribunal, consisting of liquidated damages and interest. TPSC appealed the decision but eventually, two parties settled with the amount of Rs. 38.6 crore while the appeal was pending. The AAR bench ruled that this settlement amount would not be subject to GST.