GST Daily

Dear Reader,

Today’s newsletter analytically summarizes the top GST stories reported at taxmann.com.

Allahabad HC imposed a cost of Rs. 50000 on State Govt. for arbitrary cancellation of GST registration and harassment

Drs Wood Products v. State of U.P - [2022] 141 taxmann.com 263 (Allahabad)

The authorities issued a Show Cause Notice (SCN) to the petitioner for cancellation of registration on the ground that the petitioner is not functioning / non-existing at the principal place of business. It passed an order of cancellation of registration after noting no reply to SCN from the petitioner. The petitioner got to know that its registration has been cancelled during the generation of the E Way Bill (i.e. no communication for cancellation of registration was received by the petitioner). The petitioner applied for the revocation of cancellation of registration along with the extension of time to submit its reply to SCN. The officer rejected the application for revocation of registration without considering the petitioner’s request. ? ? ?

On filing the petition before the Hon’ble Allahabad High Court, it was noted that authorities have not relied upon any report or any inquiry conducted to form the opinion and on what basis was the allegation levelled that the taxpayer was found non-functioning. The rejection order does not indicate when the inspection was carried out. The High Court held that a vague SCN without any allegation or proposed evidence against the petitioner clearly is violative of principles of administrative justice. The actions are not in consonance with the ease of doing business, which is being promoted at all levels. In view of the above, the High Court has quashed the order passed by authorities and it further imposed a cost of Rs.50,000/- on the State Government for harassing the petitioner.

Demystifying – Liquidated damages, penalty, notice pay recovery

Gulzar Didwania & Anubhav Jain - [2022] 141 taxmann.com 232 (Article)

The taxability of liquidated damages, penalty, and notice pay recovery has been largely debated since the inception of the negative list regime under service tax with numerous litigations around the subject in the erstwhile service tax regime and the GST regime. Recently, the Government has issued a circular (no. 178/10/2022-GST) explaining various facets to determine the taxability. In order to analyze the ramifications of the circular, let us first understand the meaning or applicability of the following terms:

• Liquidated damages (LD): Damages that an injured party is entitled to collect on account of a specific breach or non-fulfillment of conditions. These are typically ascertained at the time of forming the contract.
• Penalty: Penalty is typically imposed for breaking a law or a contract. Generally, the nomenclature "penalty" is used in relation to the violation of laws. Further, there is no agreement that the violator would be allowed or permitted to do an act against payment of penalty.
• Notice Pay recovery: Notice pay recovery is made by an employer from an employee in the case where the employee is leaving employment before the minimum agreed period, as stated in the employment contract.

Why taxability of these items is under question?

Section 7 of the CGST Act states the scope of supply. Further, Section 7(1A) of the CGST Act specifies certain activities or transactions to be treated either as the supply of goods or supply of services in Schedule II. Clause 5(e) to Schedule II mentions that "agreeing to the obligation to refrain from an act, or to tolerate an act or a situation, or to do an act shall be treated as supply of services". The same clause was identical to the declared service stated under Section 66E(e) in the erstwhile service tax regime as well. Now, with the inclusion of the above, the moot question is whether the transaction which is in the nature of liquidated damages, penalty or notice pay recovery, is subject to GST or not.

Judgements / Rulings around this issue

Various judgements/rulings around liquidated damages

• Various Advance Rulings upheld that the payment of liquidated damages for breach of contract is taxable under Clause 5(e) of Schedule II of the CGST Act

- Bajaj Finance Ltd., In re [2019] 108 taxmann.com1/[2020] 77 GST 119 (AAAR-Maharashtra)

- Maharashtra State Power Generation Co. Ltd., In re [2018] 97 taxmann.com 408/70 GST 411 (AAAR-Maharashtra)

- Rashtriya Ispat Nigam Ltd, In re [2019] 112 taxmann.com 5 (AAR-Andhra Pradesh)

• Judgments in the erstwhile Service tax regime wherein CESTAT held that Section 66E (e) of Finance Act, 1994 (identical to Clause 5(e) to Schedule II) not be applicable to cases for payment of liquidated damages for breach of contract

- Amit Metalinks Lts v. Commissioner of Central Goods & Service Tax [2011] 127 taxmann.com 248 (Kol. - CESTAT)

- Vikhroli Corporate Park v. CST [2017] 78 taxmann.com 12/59 GST 455 (mum. - CESTAT)

- KN Foods Industries (P.) Ltd. v. Commissioner of CGST & Central Excise [2020] 38 GSTL 60 (Trib. - All.)

• European Union Judgements (EU) VAT contains provisions which are identical to Clause 5(e) of Schedule II stating the provisions do not apply to liquidated damages received under the contract

- Societe Thermale d Eugine-les-Bains v. Minister de Economie, des Finance set de I' Industries [2010] BVC 367

- Lloyds Bank Plc v. Carrick & Carrick [1996] BVC 2875

Various judgements/rulings around Notice Pay recovery

• Rulings upheld the notice pay recovery is covered under Clause 5(e) to Schedule II and the applicant liable to pay GST

- Amneal Pharmaceuticals (P.) Ltd., In re [2022] 138 taxmann.com 521/92 GST 1 (AAAR-Gujarat)

• Judgments in the erstwhile Service tax regime wherein it is held that notice pay recovery is not taxable under Section 66E (e) of Finance Act, 1994

- GE T&D India Ltd. v. Dy. CCE [2020] 115 taxmann.com 213 (Mad.)

- Shriram Pistons and Rings Ltd. v. CCT [2021] 126 taxmann.com 183 (All-CESTAT)

Due to these divergent rulings, the tax position around the applicability of GST on these payments has become contentious giving rise to a plethora of litigations. To put these litigations to rest, the government issued the circular clarifying various aspects and applicability of GST on the same.

Clarification stated under Circular no. 178/10/2022-GST dated 03 August 2022

The following parameters were laid down to determine the activities or transactions to fall under clause 5 (e) to Schedule II of the CGST Act:

• Activities listed under Clause 5(e) should be covered (either explicitly or implied) by way of agreement i.e. one party to the agreement is under contractual obligation to either (a) refrain from an act; (b) tolerate an act or situation (b) to do an act
• "Consideration" should flow from another party to the contract/agreement to the first party for refraining, tolerating, or doing an act
• The contractual arrangement must be independent arrangement/activity in its own right

Applying the above parameters to determine taxability in case of liquidated damages, penalty, notice pay recovery, the following has been clarified:

(A) Liquidated damages: Liquidated damages should not be construed as consideration for tolerating breach or non-performance of the contract. The payment is rather on account of not tolerating the breach of contract. LD is stated under the contracts to ensure performance and to deter non-performance, unsatisfactory performance or delayed performance. It is a measure of loss and damage that the parties agree, would arise in case of breach of contract. It does not act as a remedy for breach of contract.

Where it would not be regarded as consideration for independent arrangements: Damages to property, Negligence, Piracy, Unauthorized use of trade name, Copyright, Penalty for delayed construction of the house, Forfeiture of earnest deposit

Where it would be regarded as 'supply' irrespective of the fact that the consideration recovered by whatever name called: Contract of transport of passenger stipulating ticket shall be partially forfeited if the passenger does not show up, Forfeiture of the security deposit in case of cancellation of tour by the customer, Pre-Payment Penalty for early closure of loan, Amount paid for early termination of lease.

It was clarified that these supplies are ancillary to principal supply under the contract and therefore they shall be assessed for taxability as principal supply. If the principal supply is exempt, the same would not be taxable.

(B)?Penalty: Penalty levied for violation of laws such as traffic violations, pollution norms or other laws, cheque dishonour, cannot be regarded as consideration for any supply received and are not taxable.

(C)?Notice pay recovery: The recovery made by the employer on account of premature leaving of employment by an employee. The premature exit from the job results in disruption of the employer's business and therefore the employer recovers a certain amount as per the employment contract, to discourage non-serious candidates from taking up employment. The same cannot be considered as consideration for tolerating an act but as penalties for dissuading non-serious employees from taking up the employment and to discourage and deter such a situation.

Way Forward

The industry has wholeheartedly welcomed the circular as it would not only help in curtailing litigation but will also help in analyzing the taxability of similar activities or transactions.

However, the following issues were still not addressed in the circular, which may give rise to different types of litigations:

• Whether the taxpayer would be eligible to claim the input tax credit in instances where he has paid tax on account of liquidated damages, penalty etc. to the supplier for the past period?
• Cases where the taxpayer is not entitled to claim the input tax credit in his business on grounds that he is engaged in the supply of exempt goods or services. Whether the taxpayer would be entitled to claim a refund of the taxes so paid, subject to satisfying the unjust enrichment conditions?
• Whether the taxpayer can claim a refund of GST paid so far on the notice pay recoveries

A clarification on the above aspects will also go a long way in settling several other disputes/ refund claims that are pending with the GST authorities.

That’s it from us for today! Stay Tuned for more updates from?Taxmann.com

#TaxmannWebinar?#EqualisationLevy

Join Taxmann’s Live Webinar | Equalisation Levy

?? 3rd September 2022 (Saturday) | ?? 05:00 PM – 06:00 PM (IST)

?? Register Now for FREE (Limited Slots Available):?https://taxmann.social/dwCZa

?? Coverage of the Webinar:

?? The genesis for the work undertaken by the OECD under Pillar 1 and Pillar 2 of the Inclusive Framework

?? Interpretational issues arising pursuant to the widening of EL

?? Classification of income – Royalty/FTS vs EL

?? EL vs DTAA – Beneficial provisions

?? What retaliatory measures USA has taken against India’s EL

?? Case Study 1 | E-Commerce Operator – Marketplace vs Inventory Model

?? Case Study 2 | Bundled Transactions – Specified Services and Others

?? What next?

?? Speaker:

? Pankaj Sancheti – Founder | Kevalin Consultants

With over 19 years of professional experience with Big 4 consulting firms in corporate taxation, transfer pricing and regulatory matters, Pankaj has served various Indian and global companies in different industry verticals.

Pankaj is extensively involved in advising foreign MNCs on Indian inbound investments, tax-efficient financing & repatriation structures and controversy management.

#TaxmannUpdates?#OECD?#DTAA?#BEPS?#Tax?#eCommerce