Probable GST implications arising from disputes during COVID-19 crisis

With over 3.5 lakh Coronavirus cases in the country, India is definitely struggling at all economic fronts. This pandemic and subsequent lockdown has created challenges at domestic as well as international levels and a major pain point during this outbreak is the impact on businesses who are currently unable to honour their commitments. Businesses will obviously shield themselves behind legal norms like force majeure clauses, termination of contracts, forfeiture of advances, re-negotiation of contracts etc. But that does not mean they will be able to shield themselves from the GST implications while dealing with such disputes.

This article outlines possible dispute scenarios and their corresponding implications under the Goods and Services Tax.

Force majeure
The force majeure clause frees both parties from liability or obligation when an extraordinary event or circumstance that is beyond the control of either party occurs, in this case, the Coronavirus pandemic and subsequent lockdown. Neither party can be held responsible for such an event. In such situations, contracts are settled by temporarily suspending certain obligations like delayed payments. While this can be easily settled, the provisions under GST law require vendors to be paid within 180 days or six months from the date of the invoice in order to claim input tax credit. If taxpayers default in payments to vendors, they will have to reverse the input tax credit along with interest.

Termination of contract
If business operations are disrupted to an extent that requires forcible termination of contract (possibly due to lack of raw materials, manpower etc), contracts usually have a penalty clause under which the defaulting party will be required to pay a previously agreed upon sum due to termination of contract. As per the provisions under GST law, penalties paid due to breach of contract might come under the consideration of supply and hence could stand the chance of attracting GST. While this situation still requires clarifications as opinions stand divided on whether penalties due to breach of contract are taxable under GST, they could very well be a possibility.

Forfeiture of advances and deposits
Similar to the above-mentioned possible implication, if a contract between two parties is terminated then any advance payments will have to be forfeited. These amounts could be considered as supply under the provisions of GST law. In an advance ruling by the AAR of Uttarakhand, the bench observed that advance amounts should be taxable under GST as consideration for tolerating an act. While the AAR ruling is for an isolated case, this implication should also be clarified by the Centre.

Encashment if bank guarantee
Business contracts can have an indemnity clause which refers to the contractual transfer of risk between two contractual parties generally to prevent loss or compensate for a loss which may occur as a result of a specified event. As per the norms of this clause, the principal indemnifies the surety upon encashment of the bank guarantee by the creditor. At present, the amount paid by the principal to the surety is not taxable under GST but there is a possibility that it is brought under the GST ambit in a bid to increase revenue collections.

If there is a takeaway from the disruption caused by the Coronavirus pandemic, it is that businesses will have to take tax laws into consideration for even unprecedented scenarios so as to easily mitigate risks in the future. 

Recent posts
Avalara TaxQuest Question: Do I need to collect sales tax for online sales to the U.S.?
Tax planning for business expansion in the U.S.: Best practices for Indian startups in 2024
U.S. sales and use tax guide for SaaS businesses in India

Prepare your business for e-invoicing under GST

Discover how to meet all compliance requirements while integrating e-invoicing into your tax function.

Prepare your business for e-invoicing under GST

Stay up to date

Sign up for our free newsletter and stay up to date with the latest tax news.