Is TDS u/s 194R applicable on Liquidated Damages?

 

 

With effect from July 1, 2022, a new obligation to deduct tax has been introduced in Section 194R. This provision now requires any person providing a benefit or perquisite to deduct tax at 10% of the value or aggregate value of such benefit or perquisite. Since its introduction, the applicability of this provision has been debated and discussed in great detail in different fora. Readers of this Article would therefore be aware that the expression 'benefit or perquisite' though not defined in the Section, is not a phrase that is new to the Income Tax Act and finds place in Section 28(iv) of the IT Act.

In this Article, we  intends to examine the applicability of this Section to one of the contentious issues existing in the field of taxation – 'Liquidated damages'.

 

The concept of Liquidated damages is widely recognized commercially and has examined at length academically.

The concept of Liquidated damages have been elucidated by Pollock & Mulla in the book titled "The Indian Contract and Specific Relief Acts" (Fourteenth Edition) and the relevant portion is reproduced below: 

'Liquidated damages' means that it shall be taken as the sum which the parties have by the contract assessed as damages to be paid whatever may be the actual damage. A fixed figure of damages, which is not assessed for all circumstances, but is graduated to correspond with passage of time between the making of contract and of its breach, is a proper estimate of the damages to be anticipated from the breach and is liquidated damages."

Black's Law Dictionary defines 'Liquidated Damages' as cash compensation agreed to by a signed, written contract for breach of contract, payable to the aggrieved party.

The provisions relating to damages are usually incorporated in contracts as an agreed measure of damages which can be enforced in the event there is a breach of contract with a view to bring about certainty in contracts. Being a contractual clause, it is also relevant to touch upon the provision relating to the same under the  Indian Contract Act.

Section 73 of the Contract Act, 1972 provides that when a contract has been broken, the party which suffers by such breach is entitled to receive from the other party compensation for any loss or damage caused to him by such breach.

Section 74 of the Contract Act deals with compensation for breach of contract where penalty is stipulated in the contract.

The Section provides that if any amount or penalty is stipulated in the contract as the amount to be paid in the event of any breach, the party complaining of the breach is entitled to receive from the party who has broken the contract reasonable compensation not exceeding the amount so named. This sum is to be paid irrespective of whether the actual damage or loss is proved.

 

 

 

In day-to-day contracts, it is common for the parties entering into a contract, to specify in the contract itself, the compensation that would be payable in the event of the breach of the contract.

The moot issue which arises for consideration is whether a party who recovers from another an amount towards 'liquidated damages, can such amount tantamount to 'benefit or perquisite'. In other words, can receipt of 'Liquidated damages' be construed as a benefit is an issue which may arise for consideration.

 

In our view, it may be possible to contend that the act of recovering the agreed damages may not qualify as a benefit or a perquisite. The phrase 'perquisite' and 'benefit' have not been defined under the Income Tax Act and is subject to wide interpretations. To understand the scope of these terms, one can refer to certain judicial pronouncements.

'Perquisite' denotes meeting out of an obligation of  one  person  by directly or indirectly or provision of some facility or amenity by one person to another person  and  the  person  providing  such facility/amenity knows that whatever is being done  is  irretrievable  to him as it is granted as a privilege or right. 'Benefit' is interpreted as at the time of execution of business transaction, one party should give to

the other some irretrievable benefit or advantage¹.

It is our view that as regards liquidated damages, an argument is possible that the damages constitute an amount paid as a compensation for the loss suffered due to breach of the contract. Such payment may not be a benefit which one party gains at the expense of the other but is only an act of restitution by which the aggrieved party is put to his original position. On the other hand, the Department may contend that the receipt of liquidated damages may constitute a benefit to the receiver as these are payments over and above the consideration which are agreed upon in the contract.

At this juncture, it is apt to also refer to the recent circular of the

 

CBIC in the context of levy of GST on liquidated damages. The CBIC in its Circular held that liquidated damages cannot be construed as a consideration for any supply but will only be a compensation for loss suffered under a contract. Applying this analogy, an argument may be made that such receipt/recoveries may not be a benefit or a perquisite and is only a compensation.. Having analysed the position, considering the language of the provision, disputes may continue emanate on the interpretation of the Section and trade is advised to take suitable legal position on this subject issue.