GST Royalty withholding by government departments from contractors executing infrastructure projects has sparked controversy, with GST authorities raising demands under Reverse Charge Mechanism, creating confusion and financial strain. This scenario arises when contractors purchase materials from registered dealers who have already paid royalty, and the government department withholds a portion of the payment pending production of a Royalty Clearance Certificate, which is often misinterpreted as a payment for licensing services.
Key Facts
- Notification 13/2017-Central Tax (Rate) Entry 5 mandates GST payment under Reverse Charge Mechanism at 18% for licensing services for mineral rights.
- Notification 12/2017-Central Tax (Rate) Serial Number 62 exempts services provided by government authorities by way of tolerating non-performance of a contract.
- CBIC Circular 178/10/2022-GST dated August 3, 2022, clarifies that liquidated damages paid for breach of contract don’t constitute consideration for supply.
- Section 74 of the CGST Act deals with fraud or willful misstatement, requiring satisfaction that tax wasn’t paid by reason of fraud, willful misstatement, or suppression of facts to evade tax.
- Section 7 of the CGST Act defines supply, requiring a supplier, a recipient, and consideration flowing for goods or services.
Tax Analysis
The GST demands raised on royalty withholdings are legally flawed, as they misunderstand the commercial reality of the transaction. The contractor hasn’t obtained any mining lease or licensing service from the government, and the withheld amount is merely a suspense account entry pending documentary verification. The government department isn’t providing any service to the contractor, and the amount remains the contractor’s money throughout. The possibility of full release upon certificate production proves this point, demonstrating that the arrangement is a security mechanism, not payment for supply. Furthermore, even if characterized as a transaction, it’s an exempt contractual penalty under Notification 12/2017, as clarified by CBIC Circular 178/10/2022.
Client Impact
Contractors facing such demands should respond comprehensively with proper documentation and systematic legal arguments. They should establish a factual foundation, structure their written reply systematically, and request a personal hearing to present their case. The two powerful defenses – absence of taxable supply and exempt contractual penalty – must be pleaded distinctly. Additionally, contractors should challenge the invocation of Section 74, demonstrating the absence of fraud or suppression, and highlight revenue neutrality, which negates the basis for interest and penalty. By presenting their case clearly and systematically, contractors can successfully contest these misconceived demands and avoid unnecessary tax liability.
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