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Repair Windows errors before they cause bigger problemsFix Now →Fix the driver behind crashes, sound loss and screen glitchesFind Drivers →Clear out junk files and repair common Windows errorsFree Scan →Under Indian GST, a payment for breach of contract is not automatically consideration for a taxable service. CBIC Circular No. 178/10/2022-GST, issued on 3 August 2022, says the key question is whether the recipient agreed to do, refrain from doing, or tolerate something in exchange for the payment. Compensation for loss or a deterrent imposed because a contract was broken is generally different from a payment for a separate promise, right, or commercial facility. The wording of a clause or invoice does not decide the issue by itself.
What is the GST test for a payment connected with breach?
A payment from one party to another does not, by itself, prove that a service was supplied. The arrangement must include a reciprocal promise: the recipient of the payment must have agreed, expressly or by implication, to do something, abstain from doing something, or tolerate an act in return.
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In paragraph 7 of Circular No. 178/10/2022-GST, the Central Board of Indirect Taxes and Customs (CBIC), Government of India, states: “There has to be an express or implied agreement; oral or written, to do or abstain from doing something against payment of consideration for doing or abstaining from such act, for a taxable supply to exist.”
A contract’s breach clause ordinarily protects performance and sets out a remedy if a party fails to perform. CBIC says that, without a separate promise to tolerate the breach or provide something in return, the resulting payment is an event under the contract—not consideration for an independent service. That distinction is why the actual bargain and payment trigger matter more than labels such as “damages,” “penalty,” or “forfeiture.”
Is GST payable on liquidated damages for delay or breach of contract?
Not automatically. CBIC describes liquidated damages as compensation for injury, loss, or damage caused by breach or non-performance. Where the amount is paid because a party failed to meet its contractual obligation, and the other party has not separately agreed to tolerate that failure for payment, the circular treats the damages as a contractual event rather than consideration for a service.
This is not a blanket rule that every sum called liquidated damages falls outside GST. A clause may form part of a wider arrangement in which one party pays for a distinct facility, right, or undertaking. The contract’s operation, the reason the amount became payable, and what the recipient agreed to provide all need to be considered before reaching a tax conclusion.
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Are penalties and forfeited earnest money taxable under GST?
The circular gives examples of amounts it does not treat as consideration for tolerating an act or situation. The common feature is that the payment is imposed to address or deter conduct, rather than paid for a separately promised service.
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1Repair Windows errors before they cause bigger problems2Fix the driver behind crashes, sound loss and screen glitches3Clear out junk files and repair common Windows errors| Payment type | Trigger and CBIC’s stated treatment | What to check |
|---|---|---|
| Liquidated damages | Contractual breach or non-performance; generally characterized as compensation for injury, loss, or damage. | Whether the payment only compensates for breach or also buys a distinct promise, right, or facility. |
| Statutory penalty for excess mining stock | A penalty imposed for conduct under mining law; CBIC gives it as an example that is not consideration for tolerating an act. | The statutory basis and the conduct that triggered the amount. |
| Employment-bond amount or forfeited salary | An employee leaves before the agreed minimum period; the circular treats the amount as a deterrent or consequence of breach, not payment for a tolerance service. | The employment terms and whether the amount is genuinely tied to breach rather than a separate service. |
| Cheque-dishonour penalty | A penalty arising from a dishonoured cheque; cited as an amount not paid for a separately promised tolerance. | The legal or contractual basis for the charge and what, if anything, is supplied in return. |
| Forfeited earnest money | Examples include forfeiture in an agreement to sell immovable property and a successful bidder’s failure to proceed after a bid for natural resources; CBIC describes the amount as compensation or a deterrent against non-serious bidding. | The terms of the larger transaction and whether forfeiture is only a remedy or part of a separate commercial arrangement. |
These are examples of CBIC’s reasoning, not a substitute for examining the particular contract or statutory provision. A payment’s name does not settle its GST treatment.
Does GST apply to a late-payment charge or cancellation fee?
These charges need their own analysis; they should not all be grouped with compensatory damages. Under the circular, a late-payment amount or cancellation charge may be taxable where it is consideration, is ancillary to the principal supply, or is paid for a commercial facility offered to the customer. In such a case, its treatment may follow the principal supply. A charge that merely compensates for loss is analyzed differently.
For example, ask whether a customer paid to obtain an option or facility under the commercial arrangement, or whether the amount became due only because a party failed to perform and it compensates the other party for resulting loss. The labels “cancellation fee” and “late fee” cannot answer that question without the surrounding terms and conduct.
How to assess a contract clause or payment
- Identify the trigger. Establish whether the amount became payable because of breach or loss, a statutory violation, a customer’s cancellation choice, late payment, or use of a commercial facility.
- Identify what the recipient promised. Look for an express or implied undertaking to tolerate, refrain from acting, perform an act, or provide a right or facility in exchange for the amount.
- Separate remedy from bargain. Determine whether the payment compensates for loss or deters non-performance, or instead pays for a distinct benefit. A breach clause alone does not establish an agreement to tolerate breach.
- Check the principal supply. If the amount is tied to an existing supply or a commercially chosen option, analyze that connection rather than assuming it is independent damages.
- Read the documents together. Review the contract clause, invoice description, correspondence, and actual course of performance. The payment’s label is evidence of wording, not a final answer about the substance of the arrangement.
What do later court records establish?
A Patna High Court decision record dated 9 May 2025 in Bihar Rajya Pul Nirman Nigam Limited v Union of India discusses the CBIC circular and the distinction between compensation for injury or loss and consideration for an agreement to tolerate or do something. A Delhi High Court decision record dated 5 December 2024 concerning Delhi Airport Metro Express also discusses the circular, while distinguishing the GST issue from whether analogous transactions attract pre-GST service tax.
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Those records should not be treated as proof that a service-tax decision independently determines GST treatment. Nor do the cited records establish that a final Supreme Court GST-specific ruling has settled this precise question. The relevant analysis here is the GST test in the circular, applied to the particular payment and arrangement.
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