Inclusion of Liquidated Damages under GST

Source: Karnataka High Court 

Why in News? 

Justice S.R. Krishna Kumar in the case of M/s Krazybee Services Pvt. Ltd. v. Additional Director, DGGI, BZU (2025) examined whether liquidated damages paid as compensation for contractual breach constituted taxable consideration under the Central Goods and Services Tax Act, 2017 (CGST Act), ultimately holding such payments to be outside the purview of GST. 

What was the Background of M/s Krazybee Services Pvt. Ltd. v. Additional Director, DGGI, BZU (2025) Case? 

• The assessee/petitioner, M/s Krazybee Services Pvt. Ltd., was a non-banking financial company (NBFC) that entered into a Master Service Agreement with Finnovation Tech Solutions Private Limited, a Lending Service Provider (LSP). 
• The agreement contained provisions under Paragraph No.7 that entitled the assessee to claim liquidated damages in case of any breach of contract committed by the LSP. 
• The contractual provisions were in alignment with Circular No.178/10/2022 dated 03.08.2022, which recognized compensation claims for breach under Sections 73 and 74 of the Indian Contract Act, 1872. 
• The Circular dated 03.08.2022 mandated that a party suffering breach would be entitled to claim compensation from the defaulting party towards loss or damage caused by such breach or non-performance. 
• A show cause notice was issued to the assessee by the GST authorities, demanding payment of GST on the liquidated damages received from LSPs. 
• The department alleged that the assessee had supplied similar services to other entities including M/s. IIFL, M/s. PayU Finance India Pvt. Ltd., and M/s. MAS Financial Services Pvt. Ltd., which charged GST under different nomenclature. 
• The authorities contended that the assessee was not entitled to adopt two different methodologies for the same or similar transactions to evade tax liability. 
• The assessee argued that liquidated damages received from LSPs were compensatory in nature and not amenable to GST as per Paragraph Nos. 7.1 and 7.1.6 of the Circular dated 03.08.2022. 

What were the Court's Observations? 

• The Court noted that the department had imposed GST on liquidated damages received by the assessee, which was clearly covered by Paragraph Nos. 7.1 and 7.1.6 of the Circular dated 03.08.2022, making such payments non-taxable. 
• The bench agreed with the assessee's contention that while Paragraphs Nos. 6 and 7 of the Circular were generic in nature, Paragraphs Nos. 7.1 to 7.1.6 were specific and directly applicable to the assessee's case. 
• The Court observed that Paragraphs Nos. 7.1 to 7.1.6 specifically dealt with receipt of compensation by way of liquidated damages arising from contracts between the petitioner and LSPs. 
• The bench held that amounts received by the petitioner from LSPs as liquidated damages fell outside the purview of GST in terms of the said Circular and could not be made amenable to GST liability. 
• The Court stated that the impugned show cause notice wrongly demanded GST on liquidated damages and deserved to be quashed. 
• The bench opined that merely because other transactions existed between the assessee and LSPs, this circumstance could not be made the basis to fasten GST liability on the assessee, especially when liquidated damages were expressly and specifically excluded under Paragraph Nos. 7 to 7.1.6 of the Circular. 
• The Court emphasized that the compensatory nature of liquidated damages distinguished them from consideration for supply of services under the GST framework. 
• In view of the above observations, the bench allowed the petition and quashed the show cause notice demanding GST on liquidated damages. 

What is the Goods and Services Tax (GST)? 

About:  

• Introduced by the 101st Constitutional Amendment Act, 2017, is a comprehensive indirect tax levied on the supply of goods and services in India. 
• It is a value-added tax (VAT) that replaced multiple indirect taxes previously levied by the Centre and States. 

Key Features: 

• Dual GST Structure: Includes Central GST (CGST) and State GST (SGST); Integrated GST (IGST) is applicable for inter-state transactions. 
• GST Council: It is the primary body for GST policymaking and rate decisions. 
• The GST Council is a joint forum of the Centre and the states. 
• It was set up by the President as per Article 279A (1) of the amended Constitution. 

Members: 

• The members of the Council include the Union Finance Minister (chairperson), the Union Minister of State (Finance) from the Centre. 
• Each state can nominate a minister in-charge of finance or taxation or any other minister as a member. 

Functions: 

• The Council, according to Article 279, is meant to “make recommendations to the Union and the states on important issues related to GST, like the goods and services that may be subjected or exempted from GST, model GST Laws” 
• Goods and Services Tax Network (GSTN): help taxpayers in India to prepare, file returns, make payments of indirect tax liabilities and do other compliances. 
• Threshold Exemption: Small businesses with turnover below a certain limit are exempt from GST. This makes compliance easier and protects micro enterprises from excessive paperwork.