GST: From payment for not serving notice period to cheque dishonour, CBIC clears the air

With the completion of 5-years since the introduction of GST, the certainty of tax positions and ease of compliances for taxpayers have emerged as key drivers for a robust GST system. Recent circulars issued by CBIC are a step towards removing ambiguity and disputes on interpretational issues under the law.

One such issue is GST on payment towards breach of contractual obligation, which has attracted protracted litigation under both service tax and GST laws. Tax treatment of payment by an employee to an employer for not serving the notice period agreed in the employment contract is a classic example of this dilemma.

Whether such payment is a consideration received by the employer to tolerate the act of premature exit and hence taxable under GST or compensation for breach of the employment contract and hence not taxable has been a question for ages. While CESTAT rulings under service tax laws have primarily held that service tax is not applicable on such payments or liquidated damages towards contractual non-performance, GST authorities and advance rulings under GST have treated these payments as consideration for tolerating an act and sought GST at 18%. This led to a corresponding increase in litigation as taxpayers relied on favourable interpretation under international VAT and service tax laws to contest this view.

In this backdrop, the Circular (No.178/10/2022-GST) issued by CBIC is a much-awaited relief benefiting taxpayers at large, as it clarifies that GST is not applicable on liquidated damages, notice pay/bond amount recovered from employees, fine for cheque dishonour, compensation paid for cancellation of coal blocks, the penalty for violation of laws, etc. It is clarified that the levy of GST would arise only if there is an independent agreement between the parties for doing something against a payment. Mere flow of money from one party to another would not lead to a presumption of payment for an independent taxable activity.

The Circular also mentions non-compete fees, late payment charges by utility providers of electricity, water or cancellation charges levied by railways, airlines, hotels, tour operators as examples of payments made towards the independent activity of tolerating an act. These payments are to be taxed at the same rate as that of the principal supply e.g., cancellation charges of railway tickets would attract GST at the same rate applicable to ticket booking. Therefore, the essence of the arrangement would have to be examined to determine the applicability of tax.

This clarification would go a long way in providing certainty to businesses while entering into contractual arrangements. Taxpayers can also revisit existing tax positions to evaluate instances where GST is required to be paid/not paid and related refunds to be claimed. Early recourse in pending litigation can be explored in cases where the Circular is favourable. While the Circular is silent on immunity to taxpayers who had paid GST on liquidated damages and availed credit/refund, one hopes that an instruction will be issued to plug any potential litigation on this aspect.

Overall, the Circular is a welcome move given the prolonged litigation regarding liquidated damages, fines and penalties under GST and service tax laws. It is expected that clarifications on pending interpretational GST issues would also be issued to provide certainty of tax positions and facilitate ease of business.

(Smita Roy is Partner & Leader (North) – Indirect Tax and Vaibhav Talwar, Director – Indirect Tax, BDO India)

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