Tax-related disputes arise broadly out of three areas: 1) Tax authorities disagreeing with tax positions adopted by a company on legal grounds; 2)tax authorities disagreeing with tax positions adopted by a company on account of erroneous contract drafting that does not reflect the intended tax positions; 3) Difference in interpretation of tax clauses or tax treatment in a contract.
Goods and Services Tax (GST) completes two years on 1 July 2019. In that time, taxpayers have mostly focused on avoiding disputes arising out of the first two points. As a result, the third point has hardly received attention either from taxpayers or commentators.
However, there are a number of instances where disputes arise due to the third point.
- Impact of “change in law” benefit: In calculating the change in contract price necessitated by a “change in law”, disputes frequently arise as to whether there is actually an increase in tax burden or the other contracting party is trying to profit from a change in the tax regime. Disputes of this nature are not only leading to arbitration claims but also to scenarios where the recipient threatens the supplier with a complaint to the anti-profiteering authority as a strategy to avoid arbitration.
- Delay as an excuse to nullify a “change in law” benefit: Construction contracts provide that in the case of a delay on the part of the contractor, the employer is not liable to pay increased tax rates or new taxes. Therefore, if the employer is able to prove that the project was delayed by the contractor then the whole incremental tax cost due to GST or any change in GST rate will have to be borne by the contractor. However, establishing such a delay is a lengthy process often leading to arbitration and until then the contractor has to bear the burden of incremental taxes. This is emerging as a serious challenge in large construction contracts (especially with public sector or public sector undertakings [PSU]).
- Forcing the contractor to adopt or continue old contracting structures: Before GST, the conventional wisdom in tax structuring of contracts involved splitting a turnkey scope of work into separate supply and services contracts. However, after GST such structuring has mostly been rejected by advance ruling authorities who treat the multiple contracts together as one composite or mixed supply. Such collapsing of separate contracts leads to a higher GST liability and unless a clear indemnity is pre-negotiated, this leads to heated contractual disputes (and at times arbitration claims) in respect of such incremental GST liability.
- Forcing the contractor to pass on input credit agreed in the contract pre-GST: Often, long-term contracts entered into with PSUs pre-GST would contain a stipulation that the contractor pass on a specified quantum of input tax credit to the PSU-customer. The amount agreed would, of course, be based on the earlier pre-GST tax regime and common sense would dictate that post-GST such terms should either be specifically re-negotiated or be agreed between parties as irrelevant or unenforceable owing to a change in the law. Unfortunately, many PSU are pressing hyper-technical contractual interpretations to force the contractor to pass on the same pre-agreed quantum of input credit failing which, arbitration claims are being raised or threatened against such contractors.
- Disputes on GST on liquidated damages: It has been internationally recognized that no GST can be levied on liquidated damages as they are in the nature of compensation or damages. However, Indian tax authorities (as well as advance ruling authorities) have taken a different stance. This leads to disputes between the contracting parties as to whether GST is leviable and other related issues. If liquidated damages already imposed should be treated as GST inclusive or exclusive, it is difficult to ascertain whether the levy of GST and availability of input tax credit in respect of liquidated damages at the time of entering into the contract. Further, if disputes arise after the project is completed, the parties cannot go back and ask for additional taxes or refund, as the case may be.
Clearly, the introduction of GST and subsequent rate changes have often led to acrimonious disputes between contracting parties who frequently arrive at differing interpretations of the clauses in their contracts.
The second part of this article, to be published in the next issue of India Business Law Journal, will touch upon contractual best practices to mitigate the chances of such disputes and consequent litigation and arbitration.
Sudipta Bhattacharjee is a partner and Kanupriya Bhargava is a principal at Advaita Legal.
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