GST Circular On Liquidated Damages - Opportunities In Contracts/Claims

SETTING THE CONTEXT...

On 3 August 2022, the Department of Revenue, Ministry of Finance issued its clarificatory Circular No. 178/10/2022-GST ("Circular") which primarily addresses the taxability of liquidated damages and penalty. The basic principle emanating from the Circular is that there must be necessary and sufficient nexus between the supply (i.e agreement to do or to abstain from doing something or to tolerate an act) and the consideration to give rise to a taxable event.

The Circular lists several examples where GST would not be applicable on the amounts which are a mere flow of money to deter a breach (which would not amount to an agreement to abstain from doing something). It also lists several examples where GST would apply on the amounts (whether such amounts are termed as fine or penalty) which would be consideration for a supply (which is ancillary to the principal supply).