Author: Ashwarya Sharma, Advocate, Co-Founder & Legal Head, RB Law Corp
Date: 07/05/2026
Introduction: Drawing the Line Between Compensation and Supply
One of the recurring controversies under GST has been the attempt to treat compensatory payments arising out of contractual breaches as taxable supplies. Revenue authorities have frequently invoked Entry 5(e) of Schedule II to argue that payments made pursuant to settlements, damages, or contractual defaults amount to consideration for “tolerating an act.”
The decision of the Hon’ble Bombay High Court in Tata Sons (P.) Ltd. v. Union of India decisively pushes back against this expansive interpretation. The judgment reaffirms a foundational principle of indirect taxation: every monetary flow is not a supply, and every contractual consequence is not taxable under GST.
By quashing the demand raised by the DGGI, the Court clarified the legal boundaries of “tolerating an act” and restored doctrinal discipline to the interpretation of Section 7 of the CGST Act.
Understanding “Tolerating an Act” Under Schedule II
Entry 5(e) of Schedule II treats as a supply of service an agreement to:
- refrain from an act,
- tolerate an act or situation, or
- do an act.
However, the Court emphasized that this provision cannot be interpreted mechanically or in isolation.
For a transaction to qualify as “tolerating an act,” there must exist:
- a conscious and pre-agreed contractual obligation,
- a clear intention to permit or endure a specified act, and
- identifiable consideration flowing specifically for such toleration.
The Court distinguished such arrangements from damages arising out of breach of contract. Damages are compensatory in nature. They are not consideration for any independent supply but a remedy flowing from non-performance or contractual violation.
In other words, merely accepting compensation for a breach does not mean that the aggrieved party has supplied a service by “tolerating” that breach.
Factual Background: The Tata–Docomo Dispute
The dispute arose from a Shareholders’ Agreement between Tata Sons Pvt. Ltd. and NTT Docomo Inc., under which Docomo had acquired equity in Tata Teleservices Ltd.
The agreement contained performance-linked exit obligations. Upon failure to achieve specified benchmarks, Tata was required to facilitate Docomo’s exit at a predetermined price.
Disputes eventually arose, leading to arbitration before the London Court of International Arbitration (LCIA). The arbitral tribunal passed an award directing Tata to pay substantial damages to Docomo.
Subsequently:
- enforcement proceedings were initiated before the Delhi High Court,
- the award was recognized and enforced as a decree, and
- Tata deposited approximately ₹8,450 crores pursuant to the Court’s directions.
At this stage, the DGGI initiated proceedings alleging that the payment constituted consideration for “tolerating an act,” thereby attracting GST under reverse charge as import of services.
Core Issue Before the High Court
The principal issue before the Bombay High Court was whether the settlement and satisfaction of the arbitral award could amount to a “supply” under Section 7(1) of the CGST Act.
More specifically, the Court had to determine whether:
- withdrawal of enforcement proceedings, and
- settlement of the arbitral award
could be treated as consideration for agreeing to tolerate an act under Entry 5(e) of Schedule II.
Petitioner’s Stand: Damages Are Not Consideration
Tata contended that the payment was purely compensatory and arose from enforcement of a decretal liability.
Key submissions included:
- the arbitral award represented damages for breach of contractual obligations,
- settlement of the award did not create any independent commercial arrangement,
- withdrawal of foreign enforcement proceedings was merely consequential to satisfaction of the decree, and
- damages cannot be artificially converted into taxable consideration.
Reliance was also placed upon Circular No. 178/10/2022-GST, which clarifies that liquidated damages are generally not taxable under GST.
Revenue’s Argument: Settlement as “Tolerance”
The Revenue argued that the consent terms introduced an independent obligation whereby Docomo agreed to refrain from pursuing parallel enforcement proceedings for a certain period.
According to the department:
- this amounted to an agreement to refrain from an act,
- such forbearance constituted a separate supply of service, and
- GST was therefore payable under Entry 5(e) of Schedule II.
The department sought to characterize the settlement as something beyond mere enforcement of an arbitral award.
High Court’s Findings: No Supply Exists
The Bombay High Court decisively rejected the Revenue’s interpretation and held that no taxable supply existed.
The Court emphasized several important principles:
1. Consideration Is Essential for Supply
Section 7 requires the existence of consideration for a transaction to qualify as supply.
The Court held that the settlement terms were inseparably connected with the arbitral award and did not create any independent contractual arrangement supported by separate consideration.
2. Settlement Was Part of the Enforcement Process
A significant aspect of the ruling is the Court’s recognition that enforcement proceedings, settlements, and satisfaction of decrees form part of a single legal continuum.
The withdrawal of proceedings in foreign jurisdictions was merely incidental to the satisfaction of the arbitral award and not an independent commercial activity.
3. “Tolerating an Act” Requires Prior Agreement
The Court clarified that Entry 5(e) contemplates a conscious contractual arrangement where one party agrees in advance to tolerate a specified act for consideration.
A payment arising because of breach cannot retrospectively become consideration for tolerating that breach.
4. Damages Remain Compensatory
Relying upon Sections 73 and 74 of the Indian Contract Act, the Court reiterated that damages are compensatory in character.
Whether liquidated or adjudicated, damages represent restitution for loss suffered due to breach and not consideration for any service.
5. Circular No. 178/10/2022-GST Reinforces the Position
The Court also relied upon the CBIC Circular clarifying that liquidated damages are generally not taxable because they do not involve an agreement to tolerate an act.
The Revenue’s attempt to distinguish adjudicated damages from liquidated damages was rejected.
Why the Judgment Matters
The significance of the judgment extends far beyond the facts of the Tata–Docomo dispute.
Had the Revenue’s interpretation been accepted, virtually every contractual settlement could potentially be subjected to GST. This would have had serious implications for:
- commercial litigation,
- arbitration settlements,
- contractual damages, and
- negotiated dispute resolutions.
The ruling therefore preserves an important conceptual boundary within GST jurisprudence.
A Broader Principle: Substance Over Tax Engineering
At its core, the judgment reinforces a larger legal principle: GST applies to genuine supplies and commercial transactions, not to every economic consequence arising between parties.
The Court refused to permit an artificial dissection of legal remedies into taxable components. In doing so, it protected the distinction between:
- a commercial supply supported by reciprocal obligations, and
- a compensatory remedy arising from contractual breach.
This distinction is essential to maintaining coherence between contract law and tax law.
Conclusion: Not Every Monetary Flow Is Taxable
The Bombay High Court’s decision in Tata Sons is a significant reaffirmation of first principles under GST.
The ruling restores clarity to the interpretation of “tolerating an act” and prevents an over-expansive reading that could have distorted the very concept of supply.
For businesses, practitioners, and adjudicators alike, the judgment serves as an important reminder that:
- damages remain damages,
- settlements remain remedial in character, and
- GST cannot be imposed merely because money changes hands.
Ultimately, the decision reinforces a foundational principle of tax jurisprudence: substance must prevail over form, and compensatory payments cannot be transformed into taxable supplies through interpretative overreach.
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(The author is a practicing advocate, Co-Founder and Legal Head of RB LawCorp.
He specializes in GST law. Suggestions or queries can be directed to
ashsharma@rblawcorp.in. The views expressed in this article are strictly
personal.)