Liquidated Damages for Breach of Concession Contract Are Not Taxable Consideration; GST Not Applicable

Liquidated Damages for Breach of Concession Contract Are Not Taxable Consideration; GST Not Applicable

Issue

Whether liquidated damages imposed for material default, breach, or non-performance under a Concession Agreement constitute consideration for a taxable “supply” (such as “agreeing to tolerate an act” under Schedule II of the CGST Act), or are merely non-taxable compensation for loss.

Facts

• JBM Ecolife Mobility Surat Pvt. Ltd. (the Applicant) bid for a project, which was initially accepted by CESL on behalf of the Surat Municipal Corporation (SMC).

• Subsequently, a Concession Agreement was executed with SMC, and the project was later transferred to Surat Sitilink Ltd. (SSL).

• The agreement contained specific clauses imposing liquidated damages on the Applicant in the event of material default, breach, or non-performance of contractual obligations.

• The Applicant sought an advance ruling on whether GST is applicable to the compensation (liquidated damages) paid to SSL due to such breaches.

Decision

The Gujarat Authority for Advance Ruling (AAR) ruled in favor of the Applicant, holding that liquidated damages are not liable to GST.

• Nature of Payment: The AAR held that liquidated damages represent “pre-agreed cash compensation” for genuine pre-estimated loss and damage suffered by the other party (SMC/SSL) due to a breach.

• Not Consideration: Relying on CBIC Circular No. 178/10/2022-GST, the Authority clarified that such damages are merely a “flow of money” to compensate for injury or loss. They do not constitute “consideration” for any underlying supply of goods or services.

• No “Agreeing to Tolerate”: The imposition of damages acts as a deterrent against breach; it does not imply that the aggrieved party has “agreed to tolerate” the breach in exchange for a fee.

• Precedents & Circulars: The ruling affirmed the principles laid down in CBIC Circular No. 178 and the recent Circular No. 245/02/2025-GST (regarding penal charges on loans). It also aligned with earlier rulings in GSPC, Achampet Solar, and South Eastern Coalfields.

Key Takeaways

• Damages vs. Consideration: Money paid as compensation for a breach of contract is fundamentally different from consideration paid for a service. GST applies only to the latter.

• Role of Circular 178: This ruling reinforces the binding nature of CBIC Circular No. 178, which clarified that “tolerating an act” cannot be presumed solely because money flows between parties.

• “Genuine Pre-estimated Loss”: If the contract terms indicate that the payment is a genuine estimate of loss due to default, it retains the character of compensation and remains outside the GST net.