As the world shut during Covid-19, various contractual agreements were left in the limbo. There was confusion regarding performance of contracts, computation of taxes (specifically, GST) and imposition of penalties and fines. This article provides four case studies to understand how certain scenarios must be dealt with in light of the unlocking of the world after the pandemic’s initial phase.
As the unlock continues with lifting of certain restrictions at each phase to resume normalcy, serious commercial dents and consequences have already been faced by businesses with respect to the ability of honouring commitments. Several businesses are left with limited options, namely contract termination due to non-performance, delay in supplies, re- negotiation with respect to prices or redrafting contracts terms and conditions, advances forfeited or adjusted against penalty for non-performance, etc.
The article aims to encapsulate germane issues faced by businesses with respect to default in contractual obligations due to COVID-19 and the GST implication of the same.
Case 1:- In case contract cancelled due to non-performance during COVID-19, however the advances against supply received before the pandemic
As per Goods and Service Tax law in India, GST liability arises at the time of receipt of advance against supply of goods/ services based on invoice/ receipt voucher.
In case an invoice was issued at the time of receipt of advance, the supplier is eligible for credit of GST paid on such advance by issuing the credit note . The adjustment is required to be done in GSTR-1, mentioning the credit note details, and subsequently, in GSTR-3B latest by date of filling of GSTR-9, in which the invoice was issued OR 30th September of the financial year (FY) immediately succeeding the FY in which the invoice was issued, whichever is earlier.
In case a receipt voucher was issued at the time of receipt of advance, the supplier is required to file refund claim of GST paid to the Government of India. Since the contract is cancelled, the GST deposited represents Excess payment of Tax, and therefore refunded in RFD-01 to file accordingly.
Case 2:- Liquidated damages paid on cancellation of contract due to non-performance or delayed project as a result of COVID-19 impact
In case liquidated damages are paid due to non-performance of contract or delay in project, Entry 5(e) in Schedule II of the Central Goods and Service Tax Act (CGST Act) gets attracted.
Schedule II of CGST Act provides for activities to be treated as supply of goods or services which categorically includes agreeing to the obligation to tolerate an act or a situation.
Further, in this respect, the Central Board of Indirect tax And Customs (CBIC), in one of its sectorial FAQ series mentioned as under:
A non-performance of a contract or breach of contract is one of the conditions normally stipulated in the Government contracts for supply of goods or services. The agreement entered into between the parties stipulates that both the service provider and service recipient abide by the terms and conditions of the contract. In case any of the parties breach the contract for any reason including non- performance of the contract, then such person is liable to pay damages in the form of fines or penalty to the other party. Non-performance of a contract is an activity or transaction which is treated as a supply of service and the person is deemed to have received the consideration in the form of fines or penalty and is, accordingly, required to pay tax on such amount.
Thus, GST is applicable on liquidated damages or penalty or fine or accidental damages (by whatever name called) for non-performance of contract or delay in supply of goods or service. Similar position has been taken by Maharastra AAR in the case of North American Coal Corpn India (P.) Ltd. and in the case of Maharashtra State Power Generation Company Ltd.
At this point, it is pertinent to mention that there are few Advance Rulings holding split view of taxability on liquidated damages. Moreover, globally, no GST or VAT is levied on liquidated damages. Until then , Government clarification is issued in this respect, proper evaluation of contract is of supreme importance in such cases.
However, it is to be noted that consideration received by the Government from any person or supplier for non-performance of contract is exempt from tax as per GST law.
Case 3:- In case where businesses offered discounts and took the pandemic impact in order to save the contract
As per GST law in India, no tax is levied on discounts agreed at the time of contract between the supplier and buyer and said discount amount is also reflected in the tax invoice. However, post sales discounts (i.e. any discount provided after the sale has taken place), GST will not be levied on such discount only if the conditions below are met.
Further, Circular No. 92/11/2019-GST, dated 07th March, 2019, also observed that there are discounts which are not known at the time of supply or are offered after the supply is already over. Credit note will be issued with the discount amount alone without GST in such case. Nevertheless, Circular No. 105/24/2019-GST, dated 28th June ,2019, provides that it is crucial to examine the true nature of discount given by the manufacturer or wholesaler, etc. to the dealer.
Therefore, till the time representations are presented before GST councils and clarifications are passed in this respect, each and every discount offered to vendors during COVID should be evaluated vis-a-vis identification of relevant clause in the agreement/ contract to identify, such as:
Case 4:- In case interest paid on delay in payment of contract due to financial crisis owing to no/ slow turnover due to pandemic
As per GST law - Section 15(2)(d) of the CGST Act provides that value of supply includes interest or late fee or penalty for delayed payment of any consideration for any supply
Further, Central Board of Indirect Tax And Customs has clarified, in its Circular no 102/21/2019-GST, dated 28th June, 2019, that interest as well as penal interest charged in relation to the supply of goods and services shall be included in the value of goods and services and will be liable to GST. Said circular clarified with an illustration as mentioned below.
AMC Mart sells refrigerator to the customer XYZ having price INR 40,000/-. Further, AMC Mart provides an option to XYZ to pay the amount for refrigerator under an installment of INR 10000/- monthly over a period of 5 months. Further, if XYZ make default in payment of installment of loan, then in such a case, an additional amount of penal charges amounting to INR 500/- pm shall also be collected from XYZ. AMC Mart will also raise a separate invoice for recovery of interest amount as embedded in monthly installments as well as for the amount of penal interest.
As per the provisions of sub-clause (d) of sub-section (2) of section 15 of the CGST Act, the amount of penal interest is to be included in the value of supply. The transaction between AMC Mart and XYZ is for supply of taxable goods i.e. Refrigerator. Accordingly, the original amount of interest as well as penal interest would be taxable as it would be included in the value of the Refrigerator, irrespective of the manner of invoicing.
Time is crucial as the unlock continues. It is imperative for businesses to stimulate internal policy as well as strategy with third parties in executing current and future dealings by re-evaluating the terms and conditions of the contract to mitigate future litigation.Copyright 2023 – Helpline Law - HLL001