Mumbai: The Telangana bench of the GST-Authority for Advance Rulings (AAR) has held that an amount paid to a sub-contractor as compensation by way of an out-of-court settlement will not be subject to goods and services tax (GST). 

Under GST provisions, “agreeing to the obligation to refrain from an act, or to tolerate an act or situation, or to do an act constitutes a taxable supply of service”. 

Varying interpretations have resulted in contrasting judgments being given by high courts on the taxability of liquidated damages. The Central Board of Indirect Taxes and Customs (CBIC) issued a clarificatory circular dated August 3, 2022 on the applicability of GST on various charges arising out of the breach of contract. However, taxability of liquidated damages, amounts received pursuant to out-of-court settlements or arbitration awards continues to be a bone of contention .

This ruling is being welcomed by tax experts. “This ruling has rightly appreciated the fact that receipt of damages does not imply that the recipient has permitted or tolerated non-fulfilment of the promise. Damages are paid only to compensate for loss of damage due to breach of the contract, and hence there is no underlying supply of service,” states Harpreet Singh, partner, KPMG India.