1. Background & Facts of the Case
Mr. X, a person located in India, received an export order from a foreign client situated outside India. Pursuant to the order, Mr. X commenced preparatory activities for execution of the proposed export and incurred various expenses in the ordinary course of business.
However, before completion of the transaction and prior to any actual export of goods or completion of service the foreign client unilaterally cancelled the order. Upon such cancellation, the foreign client reimbursed Mr. X for the expenses already incurred.
The amount received was specifically described as reimbursement/compensation for cancellation of the order and not as consideration for any service rendered.
2. Issues for Consideration
The following key questions arise for examination under GST law,
- Whether the reimbursement / compensation received by Mr. X constitutes a "supply" under Section 7 of the CGST Act, 2017?
- If yes, whether such receipt is liable to GST?
- Whether the amount can be treated as "export of service" under GST law?
3. Scope of Supply
As per Section 7(1)(a) of the CGST Act, 2017, "supply" includes all forms of supply of goods or services or both, made or agreed to be made for a consideration by a person in the course or furtherance of business.
For any receipt to be taxable under GST, the following two conditions must coexist:
- There must be a supply of goods or services, and
- There must be a direct and proximate nexus between the supply and the consideration received.
Key Test:
Is the reimbursement consideration for a supply?
- If YES → Taxable
- If NO → Not a supply → Not taxable
4. Reimbursement - Not Automatically a Supply
GST law does not tax reimbursements but It taxes consideration for supply.
Therefore, reimbursement may be:
- Taxable, or
- Non-taxable,
depending upon the underlying reason for which the payment is made.
5. Possible Legal Interpretations of Reimbursement
Interpretation 1: Reimbursement as Consideration for Supply (Taxable)
Where:
- Expenses are incurred in one’s own capacity, and
- The same are recovered from the client as part of the price of service,
Then:
- Reimbursement forms part of consideration
- A supply exists
- GST is payable
Key principle: What is reimbursed is irrelevant but why the amount is paid is decisive.
Interpretation 2: Reimbursement as "Pure Agent" (Rule 33 of CGST Rules, 2017)
Under Rule 33, reimbursement is excluded from the value of supply only if all prescribed conditions are satisfied, such as:
- The supplier acts as a pure agent of the recipient,
- Expenses are incurred on behalf of the recipient,
- The amount is separately indicated in the invoice, and
- The recipient is liable to pay such expenses.
In such cases:
- A supply exists, but
- Reimbursement is excluded from taxable value, and
- GST is not payable on that portion.
Rule 33 applies only when there is an underlying taxable supply, which is not the situation in the present case.
Interpretation 3: Reimbursement as Compensation / Liquidated Damages (Schedule II - Para 5(e))
Schedule II, Para 5(e) treats "agreeing to the obligation to refrain from an act, or to tolerate an act or a situation, or to do an act" as a supply of service.
In Eye of the department, liquidated damages and penalties were sought to be taxed as consideration for "tolerating an act".
Now Government has clarified by CBIC Circular No. 178/10/2022-GST dated 03.08.2022 , Liquidated damages, compensation, or penalty for breach or non-performance of contract do not constitute consideration for any supply, unless there is a specific contractual agreement to tolerate an act for consideration.
Also Clarify that to tax under "tolerating an act", there must be a clear contractual obligation to tolerate and consideration for it.
Mere acceptance of liquidated damages or compensation for breach or cancellation of contract does not amount to an agreement to tolerate an act.
6. Application to the Present Case
In the present facts:
- There is no contractual obligation on Mr. X to tolerate cancellation.
- Cancellation of the order is a unilateral breach by the foreign client.
- The amount received is compensatory and consequential, meant to reimburse costs already incurred.
Accordingly, the transaction does not fall under Schedule II, Para 5(e) and cannot be treated as a supply of service.
7. Whether the Receipt Qualifies as "Export of Service"?
As per Section 2(6) of the IGST Act, 2017, "export of services" requires fulfilment of all five conditions,
"Export of services" means the supply of any service when -
(i) the supplier of service is located in India;
(ii) the recipient of service is located outside India;
(iii) the place of supply of service is outside India;
(iv) the payment for such service has been received by the supplier of service in convertible foreign exchange or in Indian rupees wherever permitted by the Reserve Bank of India and
(v) the supplier of service and the recipient of service are not merely establishments of a distinct person.
Critical Failure in the Present Case:
- No service was completed or supplied
- The export order was cancelled mid-way
- The amount received is not consideration for any service, but mere reimbursement
Since the fundamental condition of "supply of service" itself fails, the transaction cannot qualify as an export of service.
8. Final Opinion & Conclusion
Based on the factual matrix, statutory provisions and binding CBIC clarification, it is our considered opinion that:
- The reimbursement received by Mr. X on cancellation of the export order is in the nature of compensation / liquidated damages.
- Such receipt does not constitute consideration for any supply under Section 7 of the CGST Act, 2017.
- The transaction does not qualify as supply of service, "tolerating an act", or export of service.
- Consequently, no GST (CGST/SGST/IGST) is payable on such reimbursement.
- The amount need not be included in taxable turnover or reported in GST returns, subject to proper contractual documentation and accounting treatment.
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