The question as to whether “damages” are taxable in GST is one of the great controversies of the present regime. Justice Krishna Iyer explains the legal conception of “damages” in the following terms in Organo Chemical Industries v. Union of India1:
“38. What do we mean by “damages”? The expression “damages” is neither vague nor over-wide. It has more than one signification but the precise import in a given context is not difficult to discern. A plurality of variants stemming out of a core concept is seen in such words as actual damages, civil damages, compensatory damages, consequential damages, contingent damages, continuing damages, double damages, excessive damages, exemplary damages, general damages, irreparable damages, pecuniary damages, prospective damages, special damages, speculative damages, substantial damages, unliquidated damages. But the essentials are (a) detriment to one by the wrongdoing of another, (b) reparation awarded to the injured through legal remedies, and (c) its quantum being determined by the dual components of pecuniary compensation for the loss suffered and often, not always, a punitive addition as a deterrent-cum-denunciation by the law. For instance, “exemplary damages” are damages on an increased scale, awarded to the plaintiff over and above what will barely compensate him for his property loss, where the wrong done to him was aggravated by circumstances of violence, oppression, malice, fraud, or wanton and wicked conduct on the part of the defendant, and are intended to solace the plaintiff for mental anguish, laceration of his feelings, shame, degradation, or other aggravations of the original wrong, or else to punish the defendant for his evil behavior or to make an example of him, for which reason they are also called “punitive” or “punitory” damages or “vindictive” damages, and (vulgarly) “smart-money”. [See Black’s Law Dictionary, 4th Edn., pp. 467-648]”
Taxability of damages may arise in many contexts in GST. Before I go into the question of taxability, let us first understand the scope of the charging provision in GST.
GST is a levy most concerned with contracts. Indeed, the term “supply for consideration” which is the heart and soul of the charging provision in Section 7, is a statutory formulation which is part of the charging provisions of VAT/GST laws all over the world. Courts all over the world have understood this phrase to require a reciprocal bargain between a “supply of goods or services” and “consideration”, where a supply evokes consideration and vice versa. A supply of goods and services which will take place no matter whether consideration is payable, is not a supply “for” consideration. A musician playing by the road side to entertain bystanders who are not bound to pay him is not supplying any service for consideration Tolsma v. Inspecteur der Omzetbelasting Leeuwarden2.
The question therefore should always be whether damages is consideration given for any supply of goods and services. But things are seldom so simple in taxation law. If they are so, creativity of persons entrusted with implementation of revenue statutes is apt to turn a monkey into a tiger. I say this with the utmost respect to this creativity, for the simplicity of the charging provision has been complicated by a curiosity in Schedule II of the GST Act. Schedule II is supposed to be legislative declaration of what supply should be treated as a “supply of goods” and what supply should be treated as a “supply of services”. Para 5(e) of that Schedule II reads as follows:
“5. Supply of services – The following shall be treated as supply of services, namely:—
(e) agreeing to the obligation to refrain from an act, or to tolerate an act or a situation, or to do an act;”
Are damages therefore consideration for “tolerating” an act or situation? The word “tolerate” is defined “to allow exist, or to be done or practiced, without authoritative interference or molestation” (Mills v. Silver)3 or to “put up with” (Budejovicky Budvar Narodini Podnik v. Anheuser-Busch Inc).4 One must at once note the words “agreeing to…” in the Para 5(e). Thus there must be an agreement to tolerate. We must not forget that the Para 5(e) is ultimately subject to the charging provision “supply for consideration”. Therefore, the agreement to tolerate must be “for” consideration. There must be a bargain to tolerate in exchange for consideration and the consideration must be payable to obtain the tolerance.
Let us now look at various fact situations in which damages may arise. A defames B and is sued by B for damages. Court awards such damages to B. Can it be said that there is any “agreement” by B to tolerate the defamation by A in exchange for B paying the damages? B has in fact not tolerated anything. It has dragged A to Court and made him pay. Where is the tolerance here? Furthermore, the damages are payable under Court orders and not under any agreement.
Damages arise in contractual matters in two ways: (i) Unliquidated damages and (ii) liquidated damages. The term “liquidated damages” is used when damages are stipulated in the contract itself. Where they are not so stipulated, then the damages are said to be “unliquidated”. The problem with unliquidated damages is the excess time consumed in litigation as compared to liquidated damages. In cases where the contract does not specify the exact quantum of damages payable, when there is a contractual breach, the affected party has to go to Court, prove the breach, the loss as well as the quantum necessary to compensate the loss. Per contra, when the contract specifies the event which is considered as the breach of the contract and the quantum which is payable on occurrence of such event, the affected party merely has to prove the breach. Proof of injury and quantum sufficient to compensate the injury are dispensed with, thus shortening the time of litigation. However, the quantum fixed in the contract must be a “genuine pre-estimate” of the loss caused and must be reasonable.
Again the question one must ask is whether a “genuine pre-estimate of the loss” can by any stretch of imagination be treated as “consideration” under the GST law? Assuming that this is so, simply because there is a liquidated damages clause in a contract, is there an agreement to tolerate anything in exchange for payment of liquidated damages?
Let us go back to examples, for this subject is best understood by examples than theoretical discussions. Suppose an employee leaves his employment before serving the notice period and some amount is payable by him to the employer as “notice pay recovery” due to this early abandonment. Now, a contract for employment is a contract which is not specifically enforceable in law.5 This means that Courts have never forced an employee to work somewhere against his will due to the fundamental rights protected under our Constitution and under the common law. I would ask myself, if the employee cannot be forced to work under the employer, then the employer is not tolerating anything in return for payment of the notice pay. He is bound to suffer, and he is merely receiving compensation. Whether or not the employee pays the notice pay amount, the employee cannot be stopped. When the law taxes an agreement to tolerate for consideration, what is required to be seen is whether there is any option to not tolerate. Does the employer have any option to not tolerate this act of early abandonment? If he does not, then how can the notice pay be consideration for tolerating that act? The employer has no remedy in law except damages in such a case.
A liquidated damages clause therefore ensures to the benefit of the person who demands them and to the detriment of the person who is paying them. It cannot be said that the person paying the liquidated damages has received any benefit from this arrangement. Reduction in litigation time is a boon to the person who is demanding the liquidated damages, and not to the person who is inflicted with it. In this case, the employer has reduced his litigation time. But has the employee received any benefit? It cannot be said that the employee has received any service if he has not received any benefit at the end of the day.
Now let us take the case of construction contracts where liquidated damages are payable if there is any delay in completion of work. Where time is of the essence, the aggrieved party has the right to terminate the contract if work is not completed on time. Section 55 of the Indian Contract Act states that a party can lawfully rescind a contract where time was the essence of the contract or the time element was regarded as so important by the parties as to make a breach of that element a valid ground for rescission of the contract. However, the law presumes that time is not of the essence in a contract for construction work6 or a contract for sale of immovable property7 and in fact a liquidated damages clause has been held to be an indicator that the parties did not intend to make time of essence. If the parties themselves never intended time to be of essence.
It is therefore necessary to find exactly what are the consequences in each case of a contractual breach and what is the effect of the liquidated damages clause. Principles of general law relating to damages have to be seen. Every case of liquidated damages presents different questions, but the underlying principle is that it is merely compensation and not “consideration” for anything. There is no “service” being supplied to anyone of tolerance or otherwise.
I have gone through the Advance Rulings in Maharashtra State Power Generation Company Limited 2018(13) G.S.T.L.177, the order of the Appellate Authority in that case reported in 2018 (17) G.S.T.L. 451 and another Advance Ruling in Bajaj Finance Limited 2019 (19) G.S.T.L.95. I have also gone through some other Advance Rulings. In all these rulings the law laid down by various Courts in other countries, as discussed above, has been ignored. Those are therefore not worth discussing.