Under Indian GST, a payment called liquidated damages, a penalty or a forfeiture is not automatically consideration for a service of tolerating a breach. The key question is whether the recipient agreed—expressly or by implication—to do, refrain from doing, or tolerate something in return for the payment. If the amount is simply payable because a contract was breached, to compensate for loss or deter non-performance, CBIC says it is generally an event under the contract rather than payment for an independent supply. The label on the clause or invoice cannot answer the question by itself.
What is the GST test for a payment following a breach?
CBIC Circular No. 178/10/2022-GST, issued on 3 August 2022, says that the movement of money alone does not establish a taxable service. There must be a reciprocal arrangement: the recipient of the money must have agreed to do something, abstain from doing something, or tolerate an act in exchange for consideration.
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In paragraph 7, 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.” The circular’s point is that a contractual remedy for a breach does not, without more, show that the injured party sold the breaching party permission to breach.
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Outbyte PC Repair FREERepair Windows errors before they cause bigger problemsFix Now →Outbyte Driver Updater FREEFix the driver behind crashes, sound loss and screen glitchesFind Drivers →Apply the test to the arrangement as it actually operates. Identify why the payment became due, what the recipient gives in return, and whether the amount is instead part of a separate facility or the principal supply. A payment’s name—“damages,” “penalty,” “cancellation fee” or “forfeiture”—is evidence of the parties’ drafting, not a conclusion about GST.
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Is GST payable on liquidated damages for delay or breach of contract?
CBIC describes liquidated damages as amounts a contract may set in advance to compensate for injury, loss or damage caused by breach or non-performance. In the circular’s analysis, a clause designed to secure performance and provide compensation or deterrence does not by itself amount to an agreement by the injured party to tolerate a breach as a service. Such damages are treated as an event under the contract, not consideration for an independent activity.
This is not a blanket rule that every sum described as liquidated damages is outside GST. The reasoning depends on the substance of the bargain: whether the sum is genuinely compensatory and whether the recipient undertook a separate obligation in return. A clause that offers a paid option, right or facility may need a different analysis from a clause that imposes compensation when the other party fails to perform.
How does the treatment differ by type of payment?
| Payment type | What triggers payment | CBIC’s stated approach and key question |
|---|---|---|
| Liquidated damages for breach or delay | Contractual non-performance and resulting injury, loss or damage | Generally compensatory, not payment for tolerating breach, if there is no separate undertaking in return. Examine the clause and its operation. (Circular No. 178/10/2022-GST, 3 August 2022.) |
| Statutory penalties, cheque-dishonour penalties and employment-bond amounts | Conduct or breach, such as a statutory violation, dishonoured cheque, or an employee leaving before an agreed minimum period | The circular gives these as examples of amounts intended to impose consequences or deter conduct, rather than consideration for a separately promised tolerance service. The facts and legal basis still matter. (Circular No. 178/10/2022-GST, 3 August 2022.) |
| Forfeited earnest money | For example, a buyer does not proceed under an agreement to sell immovable property, or a successful bidder does not proceed after bidding for natural resources | The circular characterizes the examples as compensation for loss or deterrence against non-serious bidding, not payment to receive a service. Consider the wider commercial arrangement before applying that reasoning. (Circular No. 178/10/2022-GST, 3 August 2022.) |
| Cancellation charge or late-payment amount | A customer cancels, pays late, or invokes a contractual option or facility | Do not assume it is compensatory damages. Ask whether the charge buys a commercial facility or forms consideration, including an ancillary part, of the principal supply. Its treatment may follow that supply. (Circular No. 178/10/2022-GST.) |
| Payment for a separate promise or facility | The recipient agrees to tolerate, refrain from an act, or do something in exchange for payment | There may be consideration for a taxable supply. Identify the actual promise and its connection to the payment rather than relying on a breach-related label. (Circular No. 178/10/2022-GST.) |
Are cancellation charges and late-payment amounts taxable?
They require their own analysis. A cancellation charge may be a fee for a commercial option the supplier agreed to provide, rather than compensation imposed after an unexpected breach. A late-payment amount may be connected to the principal supply or another paid-for facility. In those situations, CBIC’s circular says the relationship to the principal supply and the actual arrangement matter; the amount may be consideration or an ancillary component taxable at the rate applicable to that supply.
By contrast, a sum that is only compensation for loss or deterrence following non-performance is assessed under the breach-and-consideration test. Do not treat every cancellation or late-payment amount as taxable—or every one as outside GST—without examining what the customer obtained and what the contract required.
How to assess a contract clause in practice
- Find the trigger. Determine whether payment follows a breach or loss, a statutory violation, a customer’s cancellation choice, late payment, or use of a facility. Read the operative clause alongside the relevant correspondence and invoice description.
- Identify what the recipient promised. Ask whether the party receiving the money agreed to tolerate the act, refrain from acting, perform an additional service, or grant a right. If there is no reciprocal undertaking, payment alone does not establish the service described in the circular.
- Separate damages from the commercial bargain. Establish whether the amount responds to injury or deters non-performance, or instead represents the price of an option, facility, or other part of the transaction.
- Trace the connection to the principal supply. If the charge is ancillary to, or consideration for, the principal supply, analyze it in that context instead of applying the treatment for compensatory damages automatically.
- Document the conclusion. Keep the contract clause, payment trigger, invoice, relevant correspondence, and evidence of how the parties performed. The conclusion should follow the arrangement’s substance, not just the account heading or tax label.
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 distinguishes a payment made only to compensate for injury or loss from consideration for an agreement to tolerate or do something. It provides later judicial context for the circular’s reasoning, but the cited record alone does not establish the complete appellate history.
A Delhi High Court decision record dated 5 December 2024 concerning Delhi Airport Metro Express discusses Circular No. 178/10/2022-GST and distinguishes the GST issue addressed by the circular from service-tax questions concerning analogous transactions. A conclusion about pre-GST service tax should not be presented as a ruling on GST, or vice versa. These decision records do not, by themselves, establish a final Supreme Court ruling on the precise GST question.
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What to take from the circular
- A payment following a breach is not automatically consideration for a service of tolerating it.
- Compensatory damages and the deterrent penalties identified by CBIC are generally treated differently from payment for a separate promise or commercial facility.
- Cancellation and late-payment charges depend on their function and connection to the principal supply.
- The contract’s trigger, reciprocal obligations and actual operation matter more than the label used for the amount.
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