AAR Holds Compensation Received for Losses from Transporters as Non-Taxable Liquidated Damages

M/s Pon Pure Chemical India Pvt. Ltd approached the Authority for Advance Ruling Goa and sought clarification on the applicability of GST on compensation received from transporters for losses caused during the transportation of goods. The applicant is engaged with various transporters for the movement of goods through tankers. Due to the nature of chemicals transported, certain losses such as leakage, evaporation, spillage, shortage, damage and quality issues may occur during the transportation.

The applicant recovered compensation from transporters for losses beyond permissible limits, based on actual damage suffered. The applicant contended that such recoveries were in the nature of liquidated damages and not consideration for any service. Therefore, the same would not qualify as a supply under Section 7 of the CGST Act, 2017. On the basis of which the applicant seeks an advance ruling on the following question:

“Would the amount from the transporters as a compensation for loss be considered a “Supply of services’ by the applicant as per para 5(e) of Schedule II of Section 7 of the Central Goods and Services Tax Act, 2017?”

The Authority examined the provisions of Section 7 of the CGST Act, 2017,  the definition of “consideration” under Section 2(31), Clause 5(e) of Schedule II and CBIC Circular No. 178/10/2022-GST dated 03.08.2022 relating to GST treatment of liquidated damages. The Authority observed that liquidated damages are payments made to compensate for loss or injury caused due to breach of contract and are not payments made in return for an act, refraining from an act or performing any act. Such payments are only a flow of money from the party causing the breach to the party suffering loss.

The Authority noted that the transportation agreements contained clauses relating to claims, damages, shortages, leakage, and loss in transit and liabilities of transporters. These clauses prove that the recoveries were contractual damages arising from non-performance or default. The Authority referred to CBIC Circular No. 178/10/2022-GST, which provides that where an amount is paid only to compensate for damage suffered due to a breach of contract and there is no independent agreement for any act or situation, such liquidated damages can not be covered as consideration for supply and are not taxable.

The Authority further observed that the compensation received by the applicant for damaged goods and other losses is an actual reimbursement of losses suffered and did not amount to providing any service to the transporter. Therefore, the payment could not be covered under Clause 5(e) of Schedule II of the CGST Act, 2017.

Accordingly, the Goa AAR held that the compensation received from transporters was not taxable under GST as it did not come under the definition of ‘supply’ under Section 7 of the CGST Act, 2017.