18% GST Applies on Liquidated Damages and Delay Penalties
Tax authorities ruled that liquidated damages charged to contractors for delays attract 18% GST as toleration of delay.
- Ruling
- NO.GST-ARA- 15/2017-18/B- 30, Mumbai, dated 08/05/2018
- Dated
- 08 May 2018
- Authority
- Authority for Advance Ruling
This page was written by Patron Accounting’s AI from the official release and reviewed before publishing. It explains the document in plain language. It is not the document itself. Where this page and the original differ, the original governs.
The short version
- Liquidated damages recovered for project delays attract 18% GST.
- Delay penalties are classified as service under HSN code 9997.
- Penalties cannot be treated as a contract price reduction.
- GST liability arises when the penalty is formally established.
In short
The company asked whether GST applies when it deducts liquidated damages or delay penalties from contractors for late work. It also asked about the GST rate, when tax becomes payable, and if penalties could reduce the main contract value instead of being taxed separately.
What has changed
How it worked before
Before this ruling, many businesses assumed that delay penalties were compensation for loss or a price adjustment rather than a separate taxable supply under GST.
What has changed
The Maharashtra Authority for Advance Ruling decided that recovering liquidated damages is a separate service of tolerating a delay, taxable at 18% GST under HSN code 9997. The authority clarified that these penalties cannot be treated as a discount or contract price reduction. The tax liability arises as soon as default is determined and the right to recover the penalty crystallizes under contract terms.
Who this affects
Businesses that recover liquidated damages, late completion penalties, or delay fees from their suppliers and contractors.
An example
A construction firm contracts a builder to erect a warehouse by December, with a clause charging 1 lakh rupees per week for delay. The builder finishes four weeks late, resulting in a 4 lakh rupees penalty finalized in April. Under this ruling, the firm cannot simply reduce the builder's final contract payment by 4 lakh rupees. Instead, the firm must treat the penalty as separate income for tolerating delay and pay 18% GST on 4 lakh rupees in April.
What you should do
Review your contract terms with a professional before deducting penalties or issuing invoices for delay charges. Keep in mind that an advance ruling binds only the company that asked for it and its tax office. You cannot assume this ruling automatically applies to your business without independent advice.
If you do nothing
Assuming this ruling protects you without getting your own legal clarity carries tax risks. If a tax officer audits your business and finds unbilled delay penalties, they can demand 18% GST along with interest and late fees. You could also face disputes if contractors challenge your tax deductions on penal payments.
The terms explained
- Liquidated Damages
- A pre-agreed penalty amount fixed in a contract that one party pays to another if they breach a rule, such as failing to meet a project deadline.
- Input Tax Credit
- The GST a business pays on its purchases, which it can subtract from the GST it collects on its own sales.
- Time of Supply
- The specific legal point in time when tax liability arises under GST rules, deciding which monthly return the tax must be reported in.
The ruling in detail
Authority for Advance Ruling
M/s Maharashtra State Power Generation Company Limited
NO.GST-ARA- 15/2017-18/B- 30, Mumbai, dated 08/05/2018 · Maharashtra
Questions before the authority
- Whether GST is applicable on Liquidated Damages in case of Type 1 i.e. Operation & Maintenance activities, Type 2 i.e. Construction of new power plants or renovation of old plants, or is applicable in both cases?
- If GST is applicable, kindly clarify whether the GST on Liquidated Damages is covered under Schedule II entry No 5(2)(e) vide HSN code 9997-Other Services rate 18% is correct or any other entry is relevant?
- Liquidated Damages is determined and imposed upon the contractor after in-depth study. In such case, what will be construed as the time of supply? Will it be the period in which delay is occurring or it is the time when decision to impose Liquidated Damages is taken?
- If some part of delay has occurred before GST roll-out and some part of delay has occurred after GST roll-out, whether GST will be applicable to the Liquidated Damages imposed for entire period of delay or to the period falling after GST roll-out? In case when GST is to be imposed for period after date of GST rollout but due to maximum capping of LD, the amount of LD is calculated at given percentage instead of being period-based, then how GST needs to be levied?
- Whether the contractor / vendor will be able to utilize the amount of LD imposed over him as Input Tax Credit subject to satisfying all other conditions?
Facts
The applicant, a state power utility, enters into contracts with vendors for operation and maintenance as well as construction and renovation of power plants. The contracts contain clauses allowing the applicant to deduct or recover Liquidated Damages (LD) from contractors in case of delay in completing work or trial operations. The applicant sought an advance ruling on whether GST applies to such recovered LD and how the liability, rate, and time of supply ought to be computed.
Ruling
| Question | What the authority ruled |
|---|---|
| Applicability of GST on Liquidated Damages (O&M and Construction) | GST is applicable on Liquidated Damages. Based on the agreement between applicant and contractor. |
| Schedule entry, HSN code, and tax rate for Liquidated Damages | Covered under Schedule entry no. 35 of Notification no. 11/2017-CT(R) at 18% GST. Falls under heading 9997 for taxable services. |
| Time of supply for Liquidated Damages | When liability of payment of LD is established upon successful completion of trial operation. Not when the delay is actively occurring. |
| Applicability of GST for delay straddling pre-GST and post-GST period | Governed by Section 13(1) and Section 14 of the GST Act based on time of supply. Applicant must refer to specific facts and Section 14. |
| ITC availability to the contractor on LD paid | Not answered. The contractor/vendor is the proper person to raise this question, not the applicant. |
The Authority held that **recovery of Liquidated Damages constitutes a taxable supply of service** under GST as toleration of an act or situation. Such LD is taxable at 18% under Notification No. 11/2017-Central Tax (Rate) and cannot be treated as a reduction in the contract value of the main supply. The time of supply arises when the liability to pay LD is established under the terms of the contract.
Reasoning
The Authority reasoned that under Schedule II Para 5(e) of the CGST Act, agreeing to tolerate an act or situation constitutes a supply of service. Liquidated damages are an independent contractual liability and income for the applicant, rather than a mere reduction in the transaction value or contract price of the main project supply under Section 15(1). Thus, recovery of LD is consideration for the service of tolerating delay, classified under Heading 9997 (Sr. No. 35 of Notification No. 11/2017-CT(R)) at 18% GST. The time of supply under Section 13 is the point when the delay is established and the right to levy LD crystallizes under the agreement terms.
Provisions relied on
- Section 13(1) of the CGST Act, 2017
- Section 14 of the CGST Act, 2017
- Section 15(1) of the CGST Act, 2017
- Schedule II Para 5(e) of the CGST Act, 2017
- Notification No. 11/2017-Central Tax (Rate) dated 28.06.2017 (Sr. No. 35, Heading 9997)
- Notification No. 12/2017-Central Tax (Rate) dated 28.06.2017
For the practitioner
Confirms that **liquidated damages or delay penalties are independent taxable supplies** of service under Schedule II Para 5(e) taxable at 18% GST, rather than price adjustments to the main contract. It establishes that time of supply crystallizes when contractual default and liability are formally determined. It leaves open the question of whether the paying contractor can claim Input Tax Credit on such liquidated damages.
Source
This is a summary prepared from the published order, which is a scanned document. It is a reading aid and not the authority: where the two differ, the order governs. Verify every provision against the original before relying on it.
Original order: https://www.gstcouncil.gov.in/sites/default/files/AAR/mah_aar_15_2017-18_b-30_maha_state_power.pdf
Legibility of the scan, as read: high.
Prepared 17-10-2026.
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