AAR (Telangana): No GST on Compensation for Contractual Delays Without Supply

AAR (Telangana): No GST on Compensation for Contractual Delays Without Supply

The Telangana Authority for Advance Rulings has determined that the amount agreed upon and settled by M/s. TPSC (India) Private Limited (applicant) to M/s. Delta Global Allied Limited (DGAL), based on an arbitral award, which served as compensation for contract delays and did not involve the supply of goods or services, is not subject to taxes under GST.

In a case involving the applicant, engaged in thermal projects, they had undertaken a contract for erection and pre-commissioning works from the National Thermal Power Corporation (NTPC). A portion of the work was subcontracted to M/s. Delta Global Allied Limited (DGAL). Following disputes, arbitration resulted in a compensation award of ₹42.45 crore. However, during the appeal process, the parties reached an out-of-court settlement, agreeing on a reduced amount of ₹38.56 crore. The central question revolved around whether this settlement amount fell under the taxable supply category as per Entry 5(e) of Schedule-II to the Central Goods and Services Tax Act (CGST Act).

The Bench comprising S.V. Kasi Visweswara Rao and Sahil Inamdar referred to Circular No.178/10/2022-GST dated August 3, 2022. They noted that compensation received for breach of contract should not be considered as an independent activity but rather as an event that occurs during the course of contract performance. The Bench further observed that liquidated damages cannot be regarded as consideration received for tolerating the breach or non-performance of the contract.

The Bench noted that in the present case, the applicant had failed to fulfil their commitment to award the entire work to the subcontractor as outlined in the work order. This failure constituted a breach of contract by the applicant, leading to the payment of liquidated damages through an out-of-court settlement. The Bench emphasised that accepting the liquidated damages does not imply that the subcontractor permitted or tolerated the deviation or non-fulfilment of the applicant's promise. If the liquidated damages were solely intended to compensate for the harm or loss suffered by the aggrieved party due to the breach of contract, they would not be taxable under GST.

Based on their assessment, the Bench concluded in the present case. They determined that since there was no supply of goods or services during the GST regime, under Section 142(10) of the Act, no GST was liable to be paid. Additionally, the additional payment received as compensation through the arbitration award did not fall within the scope of Section 142(2)(a) and thus was not subject to GST.