AAR Mandates GST on Liquidated Damages Increasing Compliance and Litigation

Deependar Singh (Ex-Employee)

6 years ago

AAR or the Authority for Advance Rulings has stated that liquidated damages will attract GST. With this, the GST is now a tax for non-performance too. This has sent ripples across the infrastructure and mining sector. Reportedly, The Maharashtra Authority for Advance Ruling (AAR) has stated that an 18% GST will be levied on liquidated damages. In Financial terms, Liquidated Damages refers to payments made against non-performance of a contract. In reference to the phrase “agreeing to tolerate an act or situation” under Para 5 of Schedule II of GST Acts, liquidated services will be considered as deemed services.

The AAR feels that the practice of penalty payments were the contractors agreed upon a fixed breach amount in case of non-delivery of service or delays have to be done away with. Pre-Agreed payments on liquidated damages must be brought within GST Ambit.

However, not all agree to the AAR’s ruling. Experts believe that GST can be levied if and only if the requirement of and the consequent is met. However, non-performance do not attract tax consequences for the parties and hence cannot attract GST. A few expected consequences of the AAR ruling are highlighted below:

Infrastructure Sector is typically pegged with liquidated damages. The ruling will definitely increase litigations.
Infrastructure Sector MNCs, as well as Mining Sector companies, are the most to be affected by these. These could even have implications in mergers, acquisitions and franchise distributions.
The AAR will also have to draw a distinction between liable damages to be paid for breach of contract and delays.
A fair Computation Procedure for Non-Compete Payments must be agreed upon. (Especially for intangible assets)

In the erstwhile VAT system, no TAX was levied on liquidated damages. Under GST, The Contract Act considers the pre-estimates to be genuine. The Contract Act serves to play down any frictions or miscalculations in damage estimates post-breach of agreed terms of service leading to disputes or litigations. Currently, as per the ruling of the quasi-judicial body Non-Performance or contract breach will attract 18% GST on the pre-estimates agreed upon during the drafting of Contract. Maharashtra State Power Generation Company will charge GST on liquidated damages pertaining to maintenance and erection, commissioning contracts.