The Hon’ble AAR, Andhra Pradesh in the matter of M/s Rashtriya Ispat Nigam Ltd. [Advance Ruling No. AAR 01/AP/GST/2019 decided on January 11, 2019] held Liquidated Damages (“LD”) levied for delay in execution of contract within time will be covered under Schedule Entry No. 35 of Notification no. 11/2017- Central/State Tax (Rate) dated June 28, 2017 (“Service Rate Notification”) as amended from time to time and therefore, liable to 18% GST
M/s Rashtriya Ispat Nigam Ltd. (“the Applicant”) is a Central Public Sector Undertaking under the Ministry of Steel with Navaratna Status. They have an integrated steel plant at Visakhapatnam, Andhra Pradesh, and are in the business of manufacture and selling of steel products. The steel plant consists of many sub plants, like Coke Oven battery, Raw material Handling Plant, Sinter Plant, etc. and the final steel products undergoes all the process through various sub plants. Apart from procuring raw materials, it also procures spare parts and machinery parts in huge quantities for maintenance of its plant(s).
In various contracts entered into by the Applicant, there is a clause to deduct liquidated damages (“LD”) in case of default by the contractor/ vendor to complete the work/supply in time. The LD is deducted in two types of cases:
- Type 1: Operation & maintenance activities: The Applicant enters into various contracts with vendors for providing materials and services for operational activities. In this case, if there is any delay on the part of the supplier/contractor to provide materials/ services, LD are deducted from the amount payable to such vendor. The LD so deducted is treated as other miscellaneous income.
- Type 2: Construction of new plant in expansion project or renovation of old plant: In this type of contracts, normally the contract is awarded to vendors to build the sub plant or a part of it on Turnkey basis. Normally the contracts are awarded in two parts- One for designing, manufacture and supply of machinery and another for storage, erection & commissioning. As per the terms and conditions, the period of completing the contract is fixed. When plant construction is completed, the actual time taken for completion of contract would be calculated. If the delay is on account of the contractor, then LD would be calculated as per the contractual terms and same will be charged from the contractor.
- Whether LD and other penalties like milestone penalties levied on suppliers/ contractors in the nature of making good the damages for any delays in supply of service or goods in the following cases are exigible to GST or not?
- If GST is applicable:
- Whether the GST on LD, and other penalties is covered under Schedule II Entry No. 5(e) vide HSN code 9997 – Other Services of the Central Goods and Services Tax Act, 2017 (“CGST Act”), for which the rate at 18% is relevant or any other entry is applicable?
- LD are determined and imposed upon the contractor after in-depth study. In such case, what would be the time of supply? Will it be the period in which delay has occurred or it is the time when decision is taken or at the time when accounting entry for recovery is passed?
- When some part of the delay in supply has occurred before the implementation of the GST and some part of delay in supply has occurred after GST came into force, whether GST will be applicable to the LD imposed for entire period of delay or it would be applicable only to the period falling after introduction of GST?
The Hon’ble AAR, Andhra Pradesh in Advance Ruling No. AAR 01/AP/GST/2019 decided on January 11, 2019 held as under:
- In Accounting, LD / milestone penalties imposed are treated as other miscellaneous income. This would be taking place after completion of delay analysis. In the present case, agreement provided that the liability of payment of these LD by the contractor will be established, once the delay in successful execution of work is established on the part of the contractor. Thus, the act of delayed supply has happened. The same was being tolerated by an additional levy in the nature of LD. Therefore, the levy of LD is for the reason that there had been a delay and the same would be tolerated, but for a price or damages. The income though presented in the form of a deduction from the payments to be made to the contractor was the income of the Applicant and would be a supply of ‘service’ by the Applicant in terms of Para 5(e) of Schedule II appended to the CGST Act.
- LD would be covered under Heading 9997- Other Services of the Service Rate Notification and therefore be taxable 18%.
- Another important issue of levy of GST is that at what time the liability to pay GST would occur. This would be governed by time of supply provision as stipulated in Section 13 and 14 the CGST Act. Section 13(1) of the CGST Act provides that the liability to pay tax on services shall arise at the time of supply for which agreement and Section 14 of the CGST Act are relevant. Accordingly, LD are determined and imposed upon the contractor after in-depth study. In terms of the agreement, the clauses revealed that the levy of LD is not when the delay is occurring but the liability of payment of these LD by the Contractor will be established once the delay in successful execution of work is established on the part of the Contractor. This would define the time of supply. In terms of Section 13(1) of CGST Act, liability to pay tax on services arose at time of supply. If contractor fails to achieve execution of work within specified time period which falls under GST regime, then levy of LD would be attracted and this levy would attract GST levy. Section 14 of CGST Act should be referred to by the Applicant
- LD if any collected/received under previously applicable Service Tax regime before coming into effect of GST, would be dealt with in accordance with the then existent provisions under applicable laws.
Para 5(e) of Schedule II appended to the CGST Act
“5. Supply of services
(e) agreeing to the obligation to refrain from an act, or to tolerate an act or a situation, or to do an act; and”
Heading 9997 of Service Rate Notification
Description of Service
Rate [CGST + SGST]
Other services (washing, cleaning and dyeing services; beauty and physical well-being services; and other miscellaneous services including services nowhere else classified)
18% [9% + 9%]
Section 13(1) of CGST Act
“13. Time of supply of services.
(1) The liability to pay tax on services shall arise at the time of supply, as determined in accordance with the provisions of this section.”