“Agreeing To The Obligation To Refrain From An Act Or To Tolerate An Act Or A Situation, Or To Do An Act” – GST Implication
The description “Agreeing to the obligation to refrain from an act or to tolerate an act or a situation, or to do an act” has been included within the ambit of supply as per entry no 5(e) of Schedule II of the CGST Act, 2017.
Over the years, doubts regarding the taxability of various payments having a connection with the above description has been growing in number. In order to address some of the doubts raised by the tax payers, the government has come up with clarifications by way of circular no 178/10/2022-GST dated 3rd August, 2022.
- At the outset, we have to understand that the above mentioned description comprises of three different sets of activities viz.
a)The obligation to refrain from an act
b)The obligation to tolerate an act or a situation
c)The obligation to do an act - All the three activities must be under an agreement or a contract to fall within the ambit of the said entry.
- Further, some consideration must flow in return from the other party to the first party of this contract/agreement for such (a) refraining or (b) tolerating or (c) doing.
Following are some of the payments/transactions for which the government has issued clarification:
| S. No | Type of Transaction | GST Applicability | Essence of the Clarification given in the Circular | Additional remarks | Key Takeaway |
|---|---|---|---|---|---|
| 1 | Liquidated Damages – Breach of contract | Not applicable | 1. The compensation received for breach of contract does not represent a consideration for any independent activity, it is just an event in the course of performance of contract.
2. Liquidated damages cannot be considered as consideration received for tolerating an act. Rather, liquidated damages should be considered as payments made for NOT tolerating an act (i.e. not tolerating the breach of contract) 3. Where the amount paid as liquidated damages is an amount paid only to compensate for injury, loss or damage suffered by the aggrieved party due to breach of contract and there is no agreement, express or implied with the aggrieved party to refrain from or tolerate an act or to do anything, such damages do not constitute consideration for a supply and hence are not taxable. | Other examples that may be covered here are,
1. penalty stipulated in a contract for delayed construction of houses – it is a mere compensation for the loss suffered by the buyers and not for getting anything in return – NON TAXABLE 2. Forfeiture of earnest money in the event of a successful bidder failing to act after winning the bid– it is a mere flow of money. The bidder does not get anything in return – NOT TAXABLE | The key takeaway here is to consider whether the impugned payments constitutes consideration for another independent contract to refrain or to tolerate or to do any act. If the answer is “yes”, then it constitutes a supply and is taxable. |
| 2 | a) a contract may provide that payment by the recipient of goods or services shall be made before a certain date and failure to make payment by the due date shall attract late fee or penalty.
b) A contract for transport of passengers may stipulate that the ticket amount shall be partly or wholly forfeited if the passenger does not show up c) contract for a tour package may stipulate forfeiture of security deposit in the event of cancellation of tour by the customer. d) contract for lease of movable or immovable property may stipulate that the lessee shall not terminate the lease before a certain period and if he does so he will have to pay certain amount as early termination fee or penalty e) Pre-payment charges levied by banks for repayment of loan before maturity of the loan period as agreed by the customer via a signed contract (loan agreement) | Applicable | 1. Consideration cannot be considered to be outside the scope of the contract/agreement between two persons wherein one person does something for another and the other pays the first in return
2. If the payment is merely an event in the course of the performance of the contract, it does not represent the object of the contract and hence cannot be considered as consideration. 3. The payments listed here, even though referred to as fines or penalties, are actually payments that amount to consideration for supply and hence are subject to GST. | 1. Since these supplies are ancillary to the principal supply for which the contract is signed, they shall be eligible to be assessed in a similar manner to that of the principal supply.
2. Naturally, such payments will not be taxable if the principal supply is exempt. | 1. The difference between such payments and the liquidated damages for breach of a contract is that these payments are not mere events in the course of performance of a contract.
2. These payments signify a consideration for which both the parties to the contract agree to beforehand. |
| 3 | Cheque dishonor fine/penalty | Not taxable | 1. When a cheque is issued, there is never an implied or express offer or willingness on part of the supplier that he would tolerate deposit of an invalid, fake or unworthy instrument.
2. Like liquidated damages, the fine or penalty that the supplier or a banker imposes, for dishonour of a cheque, is a penalty imposed for NOT tolerating an act. 3. Cheque dishonor fine or penalty is not a consideration for any service and hence is not taxable. | A cheque is never given with the purpose that it will be dishonored and hence there exists no contract between the parties for tolerating a dishonor and hence any charges levied cannot be considered as consideration for tolerating an act. | |
| 4 | Penalty imposed for violation of statutory laws | Not taxable | 1. There is no agreement between the Government and the violator specifying that violation would be allowed or permitted against payment of fine or penalty.
2. Hence the amount received by the government as fine/penalty cannot be considered as consideration received by the government for tolerating an act. | A law is never intended to be violated and hence there exists no agreement with the government for tolerating violation and hence any amount paid does not represent consideration for tolerating. | |
| 5 | Forfeiture of salary or payment of bond amount in the event of the employee leaving the employment before the minimum agreed period | Not taxable | 1. The provisions for forfeiture of salary or recovery of bond amount in the event of the employee leaving the employment before the minimum agreed period are incorporated in the employment contract to discourage non-serious candidates from taking up employment
2. The said amounts are recovered by the employer not as a consideration for tolerating the act of such premature quitting of employment but as penalties for discouraging the non-serious employees from taking up employment and deter such situations. | The amount collected by the employers for premature resignation is only to discourage non serious people from taking employment. It is not a specific clause for tolerating premature resignation and hence the charges collected cannot be considered as consideration for tolerating the event of the employee leaving the employment before the minimum agreed period | |
| 6 | Late payment surcharge or fee | Taxable | 1. The facility of accepting late payments with interest or late payment fee, fine or penalty is a facility granted by supplier naturally bundled with the main supply.
2. Even if this service is described as a service of tolerating the act of late payment, it is an ancillary supply naturally bundled and supplied in conjunction with the principal supply, and therefore should be assessed as the principal supply. | 1. Late payment charges are a common item bundled with a contract/arrangement.
2. Such amounts should be considered as consideration for tolerating the act of late payment and hence taxable. | |
| 7 | Cancellation Charges | Taxable | 1. It is a common business practice for suppliers of services such as hotel accommodation, tour and travel, transportation etc. to provide the facility of cancellation of the intended supplies within a certain time period on payment of cancellation fee.
2. Services such as travel and tour constitute a bundle of services which starts with booking of the ticket for travel and lasts at least till exit of the passenger from the destination terminal. The facilitation service of allowing cancellation against payment of cancellation charges is also a natural part of this bundle. 3. Therefore, these ancillary supplies shall be eligible to be assessed in a similar manner to that of the principal supply. | 1. Cancellation charges of railway tickets for a class would attract GST at the same rate as applicable to the class of travel
2. i.e., if GST is levied at 5% for first class or air-conditioned coach ticket and nil for other classes such as second sleeper class, GST for cancellation will also attract the same GST rate. 5% for first class and NIL for second sleeper. 3. Same is the case for air travel | 1. Cancellation charges are a common item bundled with a contract/arrangement.
2. Such amounts should be considered as consideration for tolerating the act of late payment and hence taxable.
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