GST on Cancellation charges I GST on Train Ticket Cancellation Charges I Liquidated Damages I Penalties I Electricity Charges I TaxAddicters I 2022

 

GST applicability on liquidated damages, compensation and penalty arising out of breach of contract or other provisions of law – reg.

    In certain cases/instances, questions have been raised regarding taxability of an activity or transaction as the supply of service of agreeing to the obligation to refrain from an act or to tolerate an act or a situation, or to do an act. Applicability of GST on payments in the nature of liquidated damage, compensation, penalty, cancellation charges, late payment surcharge etc. arising out of breach of contract or otherwise and scope of the entry at para 5 (e) of Schedule II of Central Goods and Services Tax Act, 2017 (hereinafter referred to as, “CGST Act”) in this context has been examined in the following paragraphs.

Table of Content:

1.Liquidated Damages 

2.Cheque dishonor fine/ penalty

3.Penalty imposed for violation of laws

4.Forfeiture of salary or payment of bond amount in the event of the employee leaving the employment before the minimum agreed period

5.Compensation for not collecting toll charges

6.Late payment surcharge or fee

7.Fixed Capacity charges for Power

8.Cancellation charges

➽Arjuna(Fictional Character): Krishna, whether Liquidated damages (compensation) paid for breach of a contract can be liable for tax under GST?

➽Krishna(Fictional Character): Arjuna,

• Breach or non-performance of contract by one party results in loss and damages to the other party. 
• It is common for the parties entering into a contract, to specify in the contract itself, the compensation that would be payable in the event of the breach of the contract. Such compensation specified in a written contract for breach of non-performance of the contract or parties of the contract is referred to as liquidated damages.  
• The aggrieved party shall be entitled to receive reasonable compensation not exceeding the amount so named or the penalty so stipulated.  
• A reasonable view that can be taken with regard to taxability of liquidated damages is that where the amount paid as ‘liquidated damages’ is an amount paid only to compensate for injury, loss or damage suffered by the aggrieved party due to breach of the contract and there is no agreement, express or implied, by the aggrieved party receiving the liquidated damages, to refrain from or tolerate an act or to do anything for the party paying the liquidated damages, in such cases liquidated damages are mere a flow of money from the party who causes breach of the contract to the party who suffers loss or damage due to such breach. 
• Such payments do not constitute consideration for a supply and are not taxable.
• If a payment constitutes a consideration for a supply, then it is taxable irrespective of by what name it is called.
• If the payment is merely an event in the course of the performance of the agreement and it does not represent the ‘object’, as such, of the contract then it cannot be considered ‘consideration’.
• Some banks similarly charge pre- payment penalty if the borrower wishes to repay the loan before the maturity of the loan period. Such amounts paid for acceptance of late payment, early termination of lease or for pre-payment of loan or the amounts forfeited on cancellation of service by the customer as contemplated by the contract as part of commercial terms agreed to by the parties, constitute consideration for the supply of a facility, namely, of acceptance of late payment, early termination of a lease agreement, of prepayment of loan and of making arrangements for the intended supply by the tour Operator respectually. 
• Therefore, such payments, even though they may be referred to as fine or penalty, are actually payments that amount to consideration for supply, and are subject to GST, in cases where such supply is taxable. 
• Since these supplies are ancillary to the principal supply for which the contract is signed, they shall be eligible to be assessed as the principal supply. Naturally, such payments will not be taxable if the principal supply is exempt. 

➽Arjuna(Fictional Character): Krishna, tell me whther GST applicable on Cheque dishonour fine/penalty charged by Supplier or Banker from the customers?

➽Krishna(Fictional Character): Arjuna, 

• No supplier wants a cheque given to him to be dishonoured. It entails extra administrative cost to him. The promise made by any supplier of goods or services is to make supply against payment within an agreed time (including the agreed permissible time with late payment) through a valid instrument. 
• There is never an implied or express offer or willingness on part of the supplier that he would tolerate deposit of an invalid, fake or unworthy instrument of payment against consideration in the form of cheque dishonour fine or penalty. 
• The fine or penalty that the supplier or a banker imposes, for dishonour of a cheque, is a penalty imposed not for tolerating the act or situation but a fine, or penalty imposed for not tolerating, penalizing and thereby deterring and discouraging such an act or situation.
• Therefore, cheque dishonor fine or penalty is not a consideration for any service and not taxable. 

Read: How to fill nil GSTR 1 in a single Click?

➽Arjuna(Fictional Character): Krishna, Penalty paid by a mining company to State Government for unaccounted stock of river bed material is considered as taxable supply under GST?

➽Krishna(Fictional Character): Arjuna, 

• Penalty imposed for violation of laws such as traffic violations, or for violation of pollution norms or other laws are also not consideration for any supply received and are not taxable, which are also not taxable. 
• Same is the case with fines, penalties imposed by the mining Department of a Central or State Government or a local authority on discovering mining of excess mineral beyond the permissible limit or of mining activities in violation of the mining permit. 
• Such penalties imposed for violation of laws cannot be regarded as consideration charged by Government or a Local Authority for tolerating violation of laws. 

➽Arjuna(Fictional Character): Krishna, whether Forfeiture of salary or payment of bond amount in the event of the employee leaving the employment before the minimum agreed period can be considered as Compensation liable for GST?

➽Krishna(Fictional Character): Arjuna, 

• The provisions for forfeiture of salary or recovery of bond amount in the event of the employee leaving the employment before the minimum agreed period are incorporated in the employment contract to discourage non-serious candidates from taking up employment. The said amounts are recovered by the employer not as a consideration for tolerating the act of such premature quitting of employment.
• Further, the employee does not get anything in return from the employer against payment of such amounts. Therefore, such amounts recovered by the employer are not taxable as consideration for the service of agreeing to tolerate an act or a situation. 

➽Arjuna(Fictional Character): Krishna, whether Compensation paid for not collecting toll charges considered as taxable supply under GST?

➽Krishna(Fictional Character): Arjuna, 

• In the wake of demonetization, NHAI directed the concessionaires (toll operators) to allow free access of toll roads to the users from 8.11.2016 to 1.12.2016 for which the loss of toll charge was paid as compensation by NHAI as per the instructions of Ministry of Road Transportation and Highways. 

• The toll reimbursements were calculated based on the average monthly collection of toll. A question arose whether the compensation paid to the concessionaire by project authorities (NHAI) in lieu of suspension of toll collection during the demonetization period (from 8.11.2016 to 1.12.2016) was taxable as a service by way of agreeing to refrain from collection of toll from users.

• It has been clarified vide Circular No. 212/2/2019-ST dated 21.05.2019 that the consideration came from the project authority. The fact that for this period, for the same service, consideration came from a person other than the actual user of service does not mean that the service has changed.

Read: What is Rule 86B under GST: restriction on ITC utilization?

 

➽Arjuna(Fictional Character): Krishna, whether late payment charges collected by any service provider for late payment of bills can be considered as Taxable Supply under GST?

➽Krishna(Fictional Character): Arjuna, 

• The facility of accepting late payments with interest or late payment fee, fine or penalty is a facility granted by supplier naturally bundled with the main supply. 
• Almost all service providers across the world provide the facility of accepting late payments with late fine or penalty. 
• Even if this service is described as a service of tolerating the act of late payment, it is an ancillary supply naturally bundled and supplied in conjunction with the principal supply, and therefore should be assessed as the principal supply. 
• Since it is ancillary to and naturally bundled with the principal supply such as of electricity, water, telecommunication, cooking gas, insurance etc. it should be assessed at the same rate as the principal supply. 
• However, the same cannot be said of cheque dishonor fine or penalty as discussed in the preceding paragraphs.                                           

➽Arjuna(Fictional Character): Krishna, what about Fixed charges collected by a power generating company from State Electricity Boards (SEBs) or by SEBs/DISCOMs from individual customer for supply of electricity under GST?

➽Krishna(Fictional Character): Arjuna, 

• The price charged for electricity by the power generating companies from the State Electricity Boards (SEBs)/DISCOMS or by SEBs/DISCOMs from individual customers has two components, namely, a minimum fixed charge (or capacity charge) and variable per unit charge.
• The minimum fixed charges have to be paid by the SEBs/DISCOMS/individual customers irrespective of the quantity of electricity scheduled or purchased by them during a month. They take care of the fixed cost of generating/ supplying electricity. 
• The variable charges are charged per unit of electricity purchased and increase or decrease every month depending on the quantity of electricity consumed.
• Both the components of the price, the minimum fixed charges/capacity charges and the variable/energy charges are charged for sale of electricity and are thus not taxable as electricity is exempt from GST.                          

➽Arjuna(Fictional Character): Krishna, last but not least, clarify whether, cancellation charges recovered by Railways  for cancellation of tickets etc are chargeable under GST? 

➽Krishna(Fictional Character): Arjuna, 

• It is a common business practice for suppliers of services such as hotel accommodation, tour and travel, transportation etc. to provide the facility of cancellation of the intended supplies within a certain time period on payment of cancellation fee. Cancellation fee can be considered as the charges for the costs involved in making arrangements for the intended supply and the costs involved in cancellation of the supply.
• Services such as transportation travel and tour constitute a bundle of services. The transportation service, for instance, starts with booking of the ticket for travel and lasts at least till exit of the passenger from the destination terminal.
• The facilitation service of allowing cancellation against payment of cancellation charges is also a natural part of this bundle. It is invariably supplied by all suppliers of passenger transportation service as naturally bundled and in conjunction with the principal supply of transportation in the ordinary course of business.
• Therefore, facilitation supply of allowing cancellation of an intended supply against payment of cancellation fee or retention or forfeiture of a part or whole of the consideration or security deposit in such cases should be assessed as the principal supply.                                                  

Read: Which supplies are covered under Section 9(5) and what is the reporting requirement of those?
  

• For example, cancellation charges of railway tickets for a class would attract GST at the same rate as applicable to the class of travel (i.e., 5% GST on first class or air-conditioned coach ticket and nil for other classes such as second sleeper class). Same is the case for air travel.                     

• However, as discussed above, forfeiture of earnest money by a seller in case of breach of ‘an agreement to sell’ an immovable property by the buyer or such forfeiture by Government or local authority in the event of a successful bidder failing to act after winning the bid for allotment of natural resources, is a mere flow of money, as the buyer or the successful bidder does not get anything in return for such forfeiture of earnest money. 

• Forfeiture of earnest money is stipulated in such cases not as a consideration for tolerating the breach of contract but as a compensation for the losses suffered and as a penalty for discouraging the non-serious buyers or bidders. Such payments being merely flow of money are not a consideration for any supply and are not taxable.

With this see you in the next post.

Ta da !!!

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