GST Treatment of Arbitral Damages after Tata Sons Ruling
1. Background: GST’s Broad Coverage of Services and Resulting Disputes
India’s Goods and Services Tax was rolled out as a unified, destination-based indirect tax intended to streamline multiple levies and curb cascading. In achieving this integration, the GST framework adopted several concepts from the earlier service tax regime—most notably, an extremely expansive definition of “services” under Section 2(102) of the Goods and Services Act, 2017. Except for what is specifically treated as “goods”, a vast range of activities are potentially captured as “services” and therefore as “supply”.
While the objective was to draft a comprehensive law and plug loopholes, this very breadth has created fertile ground for interpretational disputes. Anything that is not “goods” risks falling within the tax net unless:
- It is expressly excluded from the scope of supply, or
- It is covered by an exemption notification.
One of the most controversial illustrations of this wide net is Entry 5(e) of Schedule II to the Goods and Services Act, 2017 (Entry 5(e)), which covers “agreeing to the obligation to refrain from an act, or to tolerate an act or a situation, or to do an act”.
The recent decision of the Hon’ble Bombay High Court in Tata Sons Pvt Ltd vs Union of India, 2026 has become a key precedent in interpreting this “toleration” clause—particularly in the context of arbitral damages and compensation for breach. This article examines how that ruling reshapes the understanding of GST on damages, liquidated damages, and similar payments.
2. Evolution from Service Tax to GST: The Roots of “Declared Services”
2.1 Shift from “Positive List” to “Negative List” in Service Tax
Under the earlier service tax regime, the law initially taxed only those services expressly listed (the “positive list” model). This changed when the legislature moved to a “negative list” approach, under which all services were taxable except those specifically excluded. This transition was accompanied by a statutory expansion of what constitutes “service”.
The old law defined “service” broadly as “any activity carried out by a person for another for consideration and includes a declared service” (Section 66E of the Finance Act, 1994). The phrase “declared services” played a crucial role in ensuring that a large array of activities became taxable, even if they did not resemble traditional commercial services.
2.2 Carry-Forward of “Declared Services” Concept into GST
GST adopted this philosophy by importing the idea of “declared services” into Schedule II. Entry 5(e) of the Goods and Services Act, 2017, specifically classifies as “supply of services” the following:
“agreeing to the obligation to refrain from an act, or to tolerate an act or a situation, or to do an act”
On paper, this allows the Revenue to bring within the tax ambit any contractual arrangement where one party is paid to:
- Not do something; or
- Put up with (i.e. tolerate) a particular act or situation; or
- Undertake an act as a contractual obligation.
This formulation has been used by the Department to argue that compensatory payments, liquidated damages, penalties, and damages for breach of contract are consideration for “tolerating” a breach or undesirable event and hence liable to GST.
2.3 Litigation Cloud around Entry 5(e)
The combination of:
- An all-encompassing definition of “service”, and
- A sweeping “toleration” clause in
Entry 5(e)
has led to extensive litigation. The key controversy: Are damages and compensation for breach of contract really consideration for a service of toleration?
Different High Courts have had to step in and clarify, on a fact-specific basis, whether particular transactions fall within this provision. The Tata Sons ruling is a significant addition to this judicial trend, bringing much-needed clarity to the GST position on arbitral damages.
3. Judicial Approach to Entry 5(e) before Tata Sons
3.1 High Court Decisions Limiting the Scope of “Toleration”
Several courts have pushed back against an overbroad reading of Entry 5(e):
- Municipal trench charges not taxable:
In **Torrent Power Ltd. v.