Sanchayita Lahkar

The High Court of Karnataka Single Bench of Justice S.R. Krishna Kumar held that amounts recovered as liquidated damages for breach or delay in contractual obligations are compensatory and do not, by themselves, amount to consideration for any supply under GST. The court was hearing a writ petition by a non-banking financial company against a tax show-cause notice that sought to levy GST on sums received from its lending service provider, which the department characterised as a “deficiency service fee” for tolerating deficient performance. Examining whether the payment was in substance liquidated damages and therefore outside GST, the court quashed the notice and directed a refund of ₹5 crore paid under protest, along with applicable interest, within eight weeks.

The writ petition was filed by a non-banking financial company challenging a show cause notice issued by the Directorate General of GST Intelligence seeking to levy Goods and Services Tax on amounts received from lending service providers. The petitioner contended that the amounts were received pursuant to breach of contractual obligations under a framework agreement and were in the nature of liquidated damages. It was asserted that such compensation was not consideration for any supply and therefore not taxable under the Central Goods and Services Tax Act, 2017, in view of the binding circular dated 03 August 2022.

Also Read: Supreme Court Denies Bail To Umar Khalid, Sharjeel Imam; Grants Bail To Five Others In Delhi Riots “Larger Conspiracy” Case

The revenue authorities maintained that the receipts were recorded as deficiency service fees and constituted consideration for tolerating an act or situation, classifiable as a taxable service under Schedule II of the CGST Act. The petitioner had paid ₹5 crore under protest during the proceedings and sought refund along with interest, contending that the payment was involuntary. Reliance was placed on the relevant contractual clauses, the GST circular, and earlier decisions of the High Court addressing involuntary tax collections during search and investigation proceedings.

The Court examined the framework agreement and recorded that “any breach of contract committed by the aforesaid LSPs would entitle the petitioner to claim liquidated damages”. Referring to the GST circular dated 03.08.2022, the Court observed that “the law provides in Section 73 of the Contract Act that when a contract has been broken, the party which suffers by such breach is entitled to receive compensation” and that such compensation “is not by way of consideration for any other independent activity”.

The Court reproduced paragraphs 7.1 to 7.1.6 of the circular and noted that “if the payment is merely an event in the course of the performance of the agreement and it does not represent the object of the contract, it cannot be considered consideration”. On examining the show cause notice, the Court stated that “the 1st respondent has imposed GST on the petitioner in relation to the liquidated damages received” and held that such amounts “are clearly covered by paragraphs 7.1 and 7.1.6 of the circular”.

Addressing the revenue’s contention regarding similar transactions with other entities, the Court observed that “merely because there are other transactions between the petitioner and LSPs, the said circumstance cannot be made the basis to fasten liability”. With respect to the amount paid under protest, the Court relied on an earlier decision and recorded that “the payment made during search, inspection and seizure proceedings cannot be construed as voluntary or by way of self-ascertainment”. The Court further noted that “collection of such amounts during investigation is contrary to the provisions of the CGST Act and the binding instructions issued by the authorities themselves”.

Also Read: Non-Signatory Developer Can Be Impleaded In Arbitration Where Conduct Shows Intent To Be Bound; Karnataka High Court Dismisses Writ Against Tribunal Order In JDA Real-Estate Dispute

The Court ordered that “the petition is hereby allowed: and “the impugned show cause notice dated 25.04.2024 issued by the 1st respondent is hereby quashed”. “The concerned respondents or any other appropriate authority are directed to refund the entire amount of ₹5 crores together with applicable interest back to the petitioner within a period of eight weeks from the date of receipt of a copy of this order”.

Advocates Representing the Parties

For the Petitioner: Sri G. Shivadass, Senior Counsel, along with Sri Prashanth S., Sri Rishab J., Sri Nitin Aditya and Smt. Shraddha Rajgiri, Advocates
For the Respondents: Sri Jeevan J. Neeralgi, Advocate

Case Title: M/s Krazybee Services Private Limited v. Additional Director, DGGI & Anr.
Neutral Citation: NC: 2025: KHC:51726
Case Number: Writ Petition No. 16471 of 2024
Bench: Justice S.R. Krishna Kumar