AP AAR: 18% GST Levy in Certain Cases Under Liquidated Damages

The Authority for Advance Ruling (AAR) in Andhra Pradesh has held that 18% of GST would be levied on goods and services tax if a service beneficiary faced liquidated damages from the service provider.

Liquidated damages happen when the party fails to meet the provisions of a contract with the beneficiary party. The Andhra Pradesh Development Company (APPDCL) gave the decision in a file for the separate purpose of setting up vehicles to enhance the state’s mega power project.

The judgement was made even after a government instruction from 2022 that considered the liquidated damages merely a transfer of funds from the party who was not in accordance with the contract to the party that faced the loss as a result of the difference. According to the circular, such payments do not qualify as consideration for a supply and are not taxable.

The circular, according to AAR, is not universal and absolute, but rather intended to clarify the legal situation and should be applied judiciously in light of the circumstances of each case.

APPDCL and Chettinad Logistics Pvt. Ltd. (CLPL) entered into a contract for the supply of services, which included coordination and supervision of coal loading, setting up rakes, transporting raw coal, and crushing boulders with MCL, East Coast Railways, Paradip, and Adani Krishnapatnam ports.

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As per the agreement reached between the two parties, in the event that the service provider fails to complete the task assigned to them, the receiver (APPDCL) shall be entitled to “liquidated damages” for any increase in the moisture content of raw coal over the loading end, any increase in the ash percentage, any penalties for late transportation of coal, and any penalties for a shortage of coal.

In their application, APPDCL claimed that these liquidated damages have been caused by accidental occurrences, which both parties generally try to avoid. Therefore, liquidated damages cannot be considered when deciding whether to overlook a contract breach or non-performance.

The AAR, however, stated that the service provider is just paying the aforementioned sums in order to avoid any disadvantages that might arise or to obtain specific benefits. Therefore, it was said that “it is irrelevant whether the payment is for tolerating the mistake or not.

The above-mentioned circular must be viewed from its appropriate perspective, according to AAR. This indicated that since the primary supply was incidental to the payments for damages, they must likewise be taxable because the main supply is. The incidental supply must also be exempted from the principal supply and cleared the AAR.

AAR concluded, the liquidated damages, in this case, constituted a supply of services and are therefore taxable under the GST at a rate of 18%.

Further AAR orders, according to Amit Maheshwari, tax partner at AKM Global, do not appear to be adequately supported. The decision focuses more on the term “consideration” rather than on “supply” because consideration would be submissive to supply, he added.