When Money Moves, But Tax Does Not
In everyday thinking, we often assume a simple rule - if money is received, tax must follow. But taxation, especially under GST, does not operate on such a straightforward assumption. The law is far more precise and selective. GST is not concerned with every movement of money; it comes into play only when a specific legal condition is satisfied, what the law calls a "taxable event." At the heart of this taxable event lies one key concept: supply .
This means that even if large sums of money are paid or received, GST will not apply unless there is a supply of goods or services or both, as understood under the law. Many financial transactions, settlements, or adjustments may appear commercial in nature, but legally, they may not qualify as "supply." It is in these subtle situations that the real test arises, distinguishing between a true commercial transaction that attracts GST and a mere financial or legal adjustment that does not. In GST, therefore, it is not the presence of money but the supply of goods, services, or both that ultimately determines taxability.
From Contract to Courtroom - When Business Turns into a Legal Battle
In 2015, Aayra Limited, a company engaged in infrastructure development, entered into a high-value international contract with Anish Global Inc., USA, for the supply of specialised high-precision industrial alloy components. The contract was worth USD 10.2 million and, like most large commercial arrangements, it was backed by safeguards, most notably, a Performance Bank Guarantee equal to 10% of the contract value to ensure proper execution.
However, as the project progressed, things did not go as planned. Delays began to occur, and soon both parties started blaming each other. Aayra Limited alleged that the Contractor had failed to perform on time and, invoking the terms of the contract, encashed the Performance Bank Guarantee and made deductions under the Price Variation Clause, claiming compensation for the losses suffered due to delay. On the other hand, Anish Global Inc. strongly disputed this position, arguing that the delays were caused by factors beyond its control—such as international logistical disruptions, delays in approvals, and Aayra Limited's lack of site readiness.
With both sides holding firmly to their positions, the dispute eventually reached arbitration. After carefully examining the contract and the facts, the Arbitral Tribunal ruled largely in favour of the Contractor in 2025. It directed Aayra Limited to clear the pending dues, correctly recompute the price variation, refund the amount recovered from the encashed Performance Bank Guarantee, and also pay interest for delayed payments.
At this stage, what appears on the surface as a settlement of financial obligations gives rise to a deeper legal question are such payments, arising out of an arbitral award, merely compensatory in nature, or do they amount to a "supply of goods or services or both" under GST?
No Supply, No GST - The Law’s First Checkpoint
To determine whether GST applies at all, we must begin with the law's very foundation—Section 7 of the CGST Act, 2017. This provision defines the term "supply", which is the starting point of GST. In simple terms, GST applies only when there is a supply of goods or services or both, made for a consideration, and in the course or furtherance of business. This concept is further reinforced by Section 9, which provides that tax is levied only on such supplies. In other words, without a taxable supply, there can be no GST.
In the present case, the nature of the payments directed by the Arbitral Tribunal is very important. These payments are not arising from any new business transaction or fresh commercial activity between the parties. There is no new agreement, no new obligation, and no exchange of goods, services, or both. Instead, these payments are simply the result of a dispute being settled—essentially, a correction or adjustment of what should have happened earlier under the original contract.
This distinction is crucial. For a transaction to qualify as a "supply," certain basic elements must exist —a current transaction, a consideration directly linked to that transaction, and a clear connection with business activity. In the case of an arbitral award, these elements are missing. What we see instead is a settlement of past disputes, not a creation of new supply.
Therefore, before analysing each component of the award in detail, one fundamental question must be asked: does any "supply of goods or services or both" exist at all? If the answer is no, the matter ends there, because under GST, the entire tax structure rests on this single pillar. Remove "supply," and the levy itself cannot survive.
When the Tax Was Already Paid - A Story That Began Before GST
To truly understand the taxability of the present case, we must go back to where the story actually began—not under GST, but under the Customs law. The original transaction between the parties was not a service or a domestic supply, but an import of goods into India. Such transactions are governed by the Customs Act, 1962, which has its own well-defined tax framework.
Under Section 12 of the Customs Act, customs duty is levied on goods imported into India. Over the years, the courts have clarified when this tax applies. In the landmark judgment of Garden Silk Mills Ltd. v. Union of India (1999 (113) ELT 358 (SC), decided on 20 April 1999), the Hon’ble Supreme Court explained that the taxable event in the case of imports is completed when the goods cross the customs frontiers and are cleared for home consumption. In simple terms, once the goods enter India and are cleared through customs, the tax event is over—the liability arises, crystallises, and is discharged then and there.
Applying this understanding to the present case, it becomes clear that the import of goods had already been completed before the introduction of GST. The applicable duties under the customs law had been duly paid at that stage itself. Therefore, the original transaction had already reached its tax consequences under the law in effect at that time.
What happened later was something entirely different. The dispute between the parties did not relate to a fresh supply of goods or services, or both, but to issues such as delay, performance, and financial adjustments under the same contract. In other words, the subsequent developments were not a continuation of the original supply but merely a fallout of contractual disagreements.
This distinction is vital because GST is a forward-looking tax on supply. It does not go back in time to reopen or reclassify transactions that were already completed and taxed under the earlier regime. Therefore, the very foundation of this transaction lies outside the GST framework, and any payments arising later—whether by way of refund, compensation, or adjustment, must be examined in that light.
Seen this way, the issue is not about taxing a new transaction, but about understanding the nature of a past one that has already lived its full legal and tax life.
Old Contract, New Law - But Does GST Really Apply?
When we examine the amounts awarded for outstanding invoices and price variation, it is important to understand the role of Section 142 of the CGST Act, which addresses transitional situations—that is, cases where contracts were entered into before GST but certain events occur after GST came into force.
At first glance, Section 142(2)(a) may appear relevant. It provides that if the price of a pre-GST contract is revised after GST is introduced, the supplier may issue a supplementary invoice, an*d such a revision can be treated as a supply under GST. However, this provision is not automatic—it applies only when certain conditions are satisfied. One of the most important conditions is that the supplier must be registered under GST.
In the present case, this condition itself is not fulfilled. The supplier is located outside India and is not registered under the CGST Act. Therefore, the very foundation required to invoke this provision is missing.
Further, Section 142(10) extends GST to supplies made after the appointed day, even if they arise from pre-GST contracts. But here again, the key requirement is that there must be a supply taking place after GST. In our case, the factual position is clear—the supply of goods was fully completed before GST came into force. Nothing new was supplied thereafter.
What happened later was only the determination of amounts, whether through negotiations or through arbitration. But determining or recalculating an amount does not mean that a new supply has taken place. It is simply a financial adjustment of an already completed transaction.
This is where the law draws a clear and important boundary. GST applies only when specific statutory conditions are met. It does not extend to every financial consequence arising out of old contracts. The amounts awarded towards outstanding invoices and price variation are therefore not payments for any new supply of goods or services or both, but merely the settlement of existing contractual rights.
In essence, what we see here is not a fresh taxable event but the closing chapter of a transaction completed long before GST entered the scene.
Returning What Was Never Yours - A Refund, not a Supply
The refund of the Performance Bank Guarantee, as directed by the Arbitral Tribunal, must be understood in light of a very basic GST principle - consideration. Under Section 7 of the CGST Act, 2017, GST applies only when there is a supply of goods or services or both, and such supply is made for a consideration. In simple terms, there must be a clear exchange— something given in return for something received.
But in the present case, this essential element is missing. The refund of the bank guarantee is not a payment made in return for any goods or services or both. It arises because the earlier encashment of the guarantee was found to be incorrect and inconsistent with the contract. Therefore, the Tribunal has merely directed that the amount be returned.
What we see here is not a commercial transaction, but a case of restitution, that is, restoring the Contractor to the position it would have been in had the incorrect encashment not occurred. There is no new obligation, no new activity, and no exchange between the parties. It is simply a reversal of an earlier action.
This distinction is crucial in GST. For tax to apply, there must be a direct link between the payment and the supply. Here, the payment is not linked to any supply of goods or services; it is only correcting a past event.
Therefore, the refund of the Performance Bank Guarantee clearly falls outside the scope of GST. It is not a taxable event, but merely a financial correction—returning what, in law, was never meant to be retained.
Interest Without Supply - Compensation Cannot Become Tax
The interest awarded by the Arbitral Tribunal brings us to another important principle under GST, when does interest become taxable? The answer lies in Section 15(2)(d) of the CGST Act, which states that interest or late fee becomes part of the value of supply only when it relates to the delayed payment of any consideration for any supply. In simple terms, interest is not taxed on its own; it is taxed only when it is connected to an underlying taxable transaction.
In the present case, this connection itself is missing. The interest awarded by the Tribunal does not arise from any independent agreement or any fresh activity involving goods or services or both. It is simply compensatory in nature, granted because payments were delayed and funds were wrongfully retained. Its purpose is not to reward any service or commercial activity, but to compensate for the time value of money.
This distinction is very important. The interest here is not a separate transaction; it is only an extension of the principal amount. It follows the same character as the main payment. Therefore, if the principal amount itself is not linked to any taxable supply of goods or services or both, the interest attached to it cannot suddenly become taxable.
Courts have also consistently taken the view that compensation, when not linked to a supply, does not amount to consideration. Applying this principle, the interest awarded by the Tribunal remains a pure compensatory payment, and not a consideration for any supply.
Thus, the conclusion becomes clear—when there is no supply, even interest cannot create one. The interest awarded in this case falls outside the scope of GST, as it merely compensates for delay and does not involve any taxable event.
TDS Begins with Identity - Is Aayra Ltd. Even a Deductor?
Section 51 of the CGST Act applies only to specified deductors and only when payment is made for taxable goods or services or both. Even before examining the nature of payment, it must be established whether Aayra Limited falls within the notified categories of deductors. If it does not, the provision fails at the threshold.
Even assuming that it qualifies as a deductor, the second requirement remains unfulfilled. The payments in question arise from a pre-GST transaction, along with refund and compensatory interest, none of which constitute a supply under Section 7. In the absence of a taxable supply, the machinery provision relating to TDS cannot be invoked.
Where the Journey Ends - Settlement Without Supply, and Hence No GST
The conclusion that emerges is clear. The payments pursuant to the arbitral award do not arise from any supply of goods or services or both and therefore do not attract GST. The transitional provisions under Section 142 do not apply, and the provisions relating to TDS under Section 51 also remain inapplicable.
What we see is not a taxable transaction, but the settlement of contractual rights arising from a completed transaction. GST, as a tax on supply, does not extend to such situations.
GST is a tax on supply, not on money, not on disputes, and not on settlements. Where there is no supply, the law itself steps back and taxation has no role to play.
By: CA Raj Jaggi & Adv Kirti Jaggi
CAclubindia
