North American Coal GST Case: AAR Maharashtra on Taxability of Liquidated Damages (2018)

North American Coal GST Case: One of the most debated issues under GST has been the taxability of liquidated damages, penalties, and compensation received due to breach of contract. The main question is whether such amounts qualify as a supply of service (tolerating an act) under Schedule II, Entry 5(e) of the CGST Act, 2017, or whether they are compensatory payments outside the scope of GST.

In In Re: M/s North American Coal Corporation India Pvt. Ltd. [2018 (10) TMI 1339 – AAR, Maharashtra], the applicant sought clarity on whether liquidated damages awarded under arbitration would qualify as a taxable supply under GST.

Facts of the North American Coal GST Case

• Assessee: M/s North American Coal Corporation India Pvt. Ltd. (“NACC India”), engaged in technical consultancy for coal mining.
• Agreement:
  • Association Agreement with Sasan Power Ltd. (SPL) for providing technical know-how in mine development and operations.
  • NACC raised invoices with Service Tax (pre-GST era), even on unpaid invoices.
• Dispute:
  • SPL curtailed NACC’s role and hired its own consultants.
  • NACC terminated the agreement and raised claims for:
    • Past dues of development fees
    • Reimbursement of expenses
    • Liquidated damages for termination
  • Matter referred to ICC (International Chamber of Commerce) arbitration.

Point of Dispute

Whether liquidated damages awarded by ICC arbitration to NACC India qualify as a supply under GST, thereby attracting tax.

Submissions by the Assessee

• No service element:
  • Liquidated damages are compensatory, not consideration for any service.
  • Lack of reciprocity, which is essential for service under GST.
• Not in the course of business:
  • Termination of the agreement ended the business relationship.
  • Damages are not “in the course or furtherance of business.”
• No continuity:
  • “In course” implies ongoing activity.
  • Termination ends business activity, hence outside GST.

Findings of the AAR (Maharashtra)

The Authority for Advance Ruling (AAR) disagreed with the assessee and held:

1. Agreement included tolerance obligations:
   • The contract required compensation in case of breach.
   • By signing, parties agreed to tolerate default in return for compensation.
2. Compensation = consideration:
   • Liquidated damages are consideration for tolerating an act under Entry 5(e), Schedule II.
3. GST applicable:
   • Any damages awarded after arbitration are taxable as a supply of service.

Held:
Liquidated damages awarded under arbitration qualify as supply under GST (tolerating an act) and are subject to tax.

Practical Impact on Businesses

• GST on breach of contracts: Payments like liquidated damages, penalties for delay, and cancellation charges may attract GST.
• Contract drafting crucial: Businesses must clearly specify whether such payments are compensatory or penal.
• Increased cost burden: Taxation of damages adds financial strain.
• Arbitration awards taxable: Even arbitral claims for damages may fall under GST scope.

Related Rulings and Clarifications

• Achampet Solar Pvt. Ltd. [2022 (2) TMI 715, Telangana AAR] – Liquidated damages held taxable.
• Continental Engineering Corporation [2021 (10) TMI 635] – Similar view.
• Singareni Collieries Company Ltd. [2022 (6) TMI 419] – Damages for breach held taxable.
• Bajaj Finance Ltd. [2018 (11) TMI 884, Maharashtra AAR] – Cheque bounce charges taxable; however, penal interest exempt per CBIC Circular No. 102/21/2019-GST.
• CBIC Circular No. 178/10/2022-GST (03.08.2022): Clarified that liquidated damages, penalties, forfeiture amounts, etc. are generally taxable unless exempt.

Key Takeaways

1. Liquidated damages = taxable supply under GST if linked to tolerating an act under contract.
2. Termination damages not exempt – even if the business ends, compensation may be taxed.
3. Industry-wide risk: Construction, infrastructure, and power contracts commonly face this issue.
4. CBIC Circular 178/10/2022 provides clarity but disputes may still arise depending on contract wording.

Why This Case Matters

The North American Coal case was among the first rulings on GST applicability on liquidated damages. It set a precedent for later rulings that held damages and penalties as taxable supplies under GST.

This decision widens the GST scope to include contractual remedies, creating additional tax liability for businesses. It emphasizes the importance of careful contract drafting, classification of damages, and evaluation of tax costs in case of contractual breaches.