Damages paid for breach of contract to attract 18% GST

The Authority for Advance Rulings(AAR) has ruled that payments in respect to nonperformance of a contract would be liable to goods and services tax (GST). This has made multinational companies, especially those executing infrastructure projects, and the mining sector jittery, and it could have implications on mergers and acquisitions, franchise arrangements too.

Liquidated damages are payments in lieu of non-performance of a contract. The Contract Act envisages these damaged under a contract as genuine pre-estimate so as to avoid hassles of computation of damages and possible contractual disputes, or litigations, in case of non-performance.

The Maharashtra Authority for Advance Ruling (AAR) has stated that liquidated damages paid on operation & maintenance and erection & commissioning contracts, entered by the applicant –Maharashtra State Power Generation Company — shall be taxable under GST at 18%.

The Authority has concluded liquidated damages to be a deemed service, covered under the phrase ‘agreeing to tolerate an act or situation’, under Para 5 of Schedule II of GST Acts.