Liquidated Damages & GST — Karnataka HC Brings Clarity

Compensation for breach ≠ taxable supply

---

1️⃣ Case Snapshot (At a Glance)

Particular	Details
Court	Karnataka High Court
Case	Krazybee Services Pvt. Ltd. v. DGGI
Writ No.	W.P. No. 16471 of 2024
Issue	GST on liquidated damages / compensation
Outcome	GST not leviable

---

2️⃣ Facts in Simple Terms

Aspect	Position
Business	NBFC
Agreement	Framework / Master Service Agreement with LSPs
Clause	Pre-agreed liquidated damages for breach
Department’s view	“Tolerating an act” → taxable
Taxpayer’s stand	Compensation for failure, not a service

---

3️⃣ Core Legal Question

Question
Does compensation received for breach of contract (liquidated damages) amount to a taxable “supply” under GST?

---

4️⃣ GST Law Framework (Clean Test)

A. What Is a “Supply”? — Section 7, CGST Act

Mandatory Elements	Status in Liquidated Damages
Supply	❌ No
Consideration	❌ Not for a service
In course of business	Irrelevant if no supply

📌 If any element fails → GST fails.

---

B. Department’s Usual Argument — Schedule II, Para 5(e)

Provision	Text
Para 5(e), Sch. II	“Agreeing to refrain from an act, or to tolerate an act or a situation”

Revenue logic:
Money received → tolerance → taxable service.

Court’s answer: ❌ Incorrect when payment arises due to breach.

---

5️⃣ CBIC Circular No. 178/10/2022 — The Decisive Clarification

Circular Para	What It Clarifies
7.1 – 7.1.6	Distinguishes object of contract vs consequence of failure
Key principle	GST applies only if payment is for a conscious supply
Liquidated damages	Compensation, not consideration

📌 Circulars are binding on the Department.

---

6️⃣ Contract Law Backbone (Why LD Is Compensation)

Provision	Relevance
Section 73, Contract Act	Compensation for loss due to breach
Section 74, Contract Act	Pre-agreed damages (liquidated damages)
Nature	Restorative, not remunerative

📌 LD aims to make good the loss, not to reward tolerance.

---

7️⃣ High Court’s Key Findings (Issue-wise)

A. Liquidated Damages ≠ Consideration

Observation	Reason
Not object of contract	Triggered only on failure
No service intention	No buyer–seller relationship
Circular para 7.1.6	Directly applicable

---

B. No “Tolerating an Act” Arrangement

Department’s Claim	Court’s Rejection
Pre-agreed tolerance	Clause deters breach
Payment = service	Payment = failure consequence

📌 Deterrence clause ≠ service contract.

---

C. Circular Binding on Officers

Principle	Impact
CBIC clarification issued	Must be followed
Selective reliance	Not permissible

---

8️⃣ Practical GST Matrix (Very Important)

When GST Does NOT Apply

Nature of Receipt	GST
Liquidated damages	❌
Compensation for breach	❌
Penalty for non-performance	❌
Damages without service	❌

---

When GST MAY Apply

Nature of Receipt	Why
Early termination fee	Part of pricing
Cancellation charges	Linked to supply
Late payment charges	Facility consciously provided

📌 Key test: intent & object of the contract — not the label.

---

9️⃣ Simple Real-Life Illustration

Scenario	GST Result
Delay penalty in logistics contract	❌ Not taxable
Was delay “hired” as a service?	❌ No
Was contract meant to fail?	❌ No

👉 Failure ≠ Supply

---

🔟 Statutory Provisions Referenced

Provision	Why It Matters
Section 7, CGST Act	Definition of supply
Schedule II, Para 5(e)	“Tolerating an act”
Sections 73–74, Contract Act	Legal basis of LD
Rule 142, CGST Rules	Voluntary payment procedure
CBIC Circular 178/10/2022	Taxability clarification

---

🔚 Finin2min Bottom Line

Principle	Final Take
GST is a tax on supplies	✔
GST is not a tax on failures	✔
Compensation ≠ consideration	✔
Intent matters more than wording	✔

---

Final Finin2min Verdict

Liquidated damages are compensatory, not taxable.
Unless money is paid for a conscious supply, GST has no role to play.
GST taxes performance — not breach.

⚠️ Disclaimer

For information only. This summary is based on prevailing statutory provisions and judicial precedents. Applicability depends on facts, timing, and documentation. Professional advice recommended.

Article related to –
GST on compensation
Is liquidated damages taxable under GST
Schedule II Para 5(e) GST
Tolerating an act GST
CBIC Circular 178/10/2022 explained
GST on breach of contract