GST ON LIQUIDATED DAMAGES AFFIRMED BY APPELLATE AUTHORITY – ADVANCE RULING

[Dr. Sanjiv Agarwal]

Generally, construction or operation and maintenance activities is any factory (in this case, power plant) involves lot of activities and is time bound wherein liquidated damages can be levied in case of delay in erection, commissioning etc or time over run or under - performance or for any other reason. The  levy of Goods and Services Tax (GST) was examined by Authority for Advance Ruling, Maharashtra (AAR)  vide Order dated 08.05.2018 in Maharashtra State Power Generation Company Ltd. 2018 (5) TMI 1332 - AUTHORITY FOR ADVANCE RULING - MAHARASHTRA

In the instant case, the appellant was engaged in generation of power with object of making power available on affordable rates. The appellant entered into contract with various contractors for the purpose of construction of new power plants or renovation of old plants or for operation of maintenance activities, etc.  As per the contract, the contractor was required to commence the trial operation of unit-1 and unit-2 within 41 and 44 months respectively from zero date i.e. the date of letter of award, in normal cases. Otherwise the contract provided for payment of Liquidated Damages (LD).

In the instant case, based on agreement entered into by applicant, Maharashtra State Power Generation Company Ltd. with BHEL for purpose of erection, testing and commissioning of main plant package, there were no such clauses in agreement as would tantamount to reducing contract price or contract value of supplies of goods or services or both as made by Contractor on account of delay in delivery of manufactured goods. In fact, levy of liquidated damages had been specifically identified as an independent levy. The contract price variation clause in impugned agreement did not provide for variation on account of  liquidated damages. The empowerment to levy liquidated damages was for reason that there had been delay and same would be tolerated, but for a price or damages. Thus, in terms of the aforesaid agreement, it has been ruled that GST would be applicable on liquidated damages. In order to see whether GST is applicable on liquidated damages in case of operation and maintenance activities and  construction of new power plants or renovation of old plants or applicable in both cases, it was observed that facts of each agreement and attending circumstances need to be seen.

The Advance Ruling Authority, vide Order No. GST-ARA-15/2017/B-30 dated 08.05.2018, held that the GST will be levied on the liquidated damages, treating it as independent supply and rejected the contentions of the appellant. Being aggrieved by the said order, the appellant has filed the appeal before AAAR filing the present appeal.

The AAAR agreed with the findings of the AAR that GST would be applicable on the Liquidated Damages. IN RE: MAHARASHTRA STATE POWER GENERATION COMPANY LIMITED   2018 (9) TMI 1185 - APPELLATE AUTHORITY FOR ADVANCE RULING MAHARASHTRA

As per the agreement between Maharashtra State Power Generation Company and the contractor, there were clauses to deduct Liquidated Damages (LD) in case of default by the company or vendor to complete the work in time. The relevant clause read as under:

“The payment by Contractor or deduction by Owner of any sums under the provision of this clause shall not relieve the Contractor from his obligations to complete the works or from his other obligations under the contract.

The liability of payment of these liquidated damages by the Contractor will be established once the delay in successful completion of trial operation is established on the part of the Contractor and the Owner shall not be required to lake any further action like arbitration or approaching the Court of Law for levying the Liquidated damages.

If the contractor fails to achieve the Trial Operation of the unit within the time period specified in the Project Completion Schedule due to reasons attributable to him then the owner shall levy Liquidated damages on the Contractor @1/2% of the contract price for erection, testing and commissioning (excluding insurance charges, taxes and duties) along with applicable price variation per week of delay or part thereof subject to the maximum 10% of the contract price for erection, testing and commissioning (excluding insurance charges, taxes and duties) along with applicable price variation."

For the purpose of deciding the amount of Liquidated Damages on the erection price, contract price along with the applicable price variation (excluding taxes, duties and insurances charges.) as per contact price adjustment shall be considered.”

These clauses leads to the conclusion that the appellant was in a contractual agreement with the contractor to impose levy of liquidated damages and to accept the amount of liquidated damages in case of the completion of the project beyond the scheduled date. Thus, the appellant had tolerated an act or a situation. The purpose of payment of liquidated damages was an act of tolerance in the sense that when there was delay in the completion of the project, the appellant was put to certain hardships which he tolerated in return of the payment of liquidated damages. What entry 5(e) provides that any supply of services of tolerating an act is a supply and therefore the impugned transaction is also a 'supply' under the provisions of the CGST Act.

Black's Law Dictionary (Tenth Edition) on page 473 defines Liquidated Damages thus:

“An amount contractually stipulated as a reasonable estimation of actual damages to be recovered by one party if the other party breaches. If the parties to a contract have agreed on liquidated damages, the sum fixed is the measure of damages for a breach, whether it exceeds or falls short of the actual damages.”

The definition clearly provides that if the parties agree for liquidated damages, the sum fixed is a measure of damages for a breach. In the impugned case, liquidated damages are contractually stipulated for delay in the completion of the project. The agreement provides that the contractor may pay a certain percentage for the delay. In other words, the appellant was well within his rights to provide for the termination of agreement in case of delay in completion of the project. But in the instant case both the parties agreed that such will not be the effect in case of delay. The appellant agreed to tolerate the delay done by the contractor in return for payment of liquidated damages. The appellant could have opted for harsh measures like termination of contract but instead it chooses to tolerate the delay in return of payment of money.

In the present case, the agreement provided that the liability of payment of these liquidated damages by the Contractor will be established once the delay in successful completion of trial operation is established on the part of the Contractor. Thus, the act of delayed supply had happened. The same was being tolerated by an additional levy in the nature of liquidated damages. The agreement also provided that the payment by Contractor or deduction by Owner of any sums under the provision of this clause shall not relieve the Contractor from his obligations to complete the works or from his other obligations under the contract. This provision just ensured that the obligations under the contract were fulfilled. The facts were much obvious that the empowerment to levy liquidated damages was for the reason that there has been a delay and the same would be tolerated, but for a price or damages. The impugned income though presented in the form of a deduction from the payments to be made to the Contractor is the income of the applicant and would be a supply of 'service' by the applicant in terms of clause (e) of para 5 of Schedule II appended to the GST Act.

A plain reading of the entry 5(e) reveals that an activity of a person can be categorized under the said entry if the following ingredients are present -

i) There should be an agreement.

ii) There should be an obligation.

iii) The obligation would be to -

a) Refrain from an act;

b) tolerate an act or a situation;

c) to do an act.

It also confirmed the finding of the AAR that the following schedule entry under the Notification No.11/2017 - Central / State Tax (Rate) [as amended] for taxable services would cover the levy of liquidated damages –

Sl. No.	Chapter, Section or Heading	Description of Service	Rate (percent) [CGST + MGST]
35	Heading  9997	Other services (washing, cleaning and dyeing services; beauty and physical well-being services; and other miscellaneous services including services nowhere else classified).	18% [9% + 9%]

AAAR also confirmed the observations of the AAR that as the Agreement expressly provides that liability of payment of these liquidated damages by the Contractor will be established once the delay in successful completion of trial operation is established on the part of the Contractor, the same would define the time of supply. Further, input tax credit would be admissible subject to the conditions and restrictions as specified in the GST Act and the Rules made thereunder. Further, the levy of liquidated damages is not when the delay is occurring but the liability of payment of these liquidated damages by the Contractor will be established once the delay in successful completion of trial operation is established on the part of the Contractor. This would define the time of supply.

In terms of the aforesaid agreement, Schedule entry no.35 of the Notification no.11/2017 - Central /State Tax (Rate) [as amended] for taxable services would cover the of liquidated damages.

Both, AAR and AAAR agreed that the contractor or vendor will be eligible to utilize the amount of GST paid on liquidated damages as input tax credit subject to the conditions and restrictions imposed in GST law.