The recent hike in the GST rate, from 6% to 8%, raises concerns for businesses about its effect on contract prices in existing contracts. This post explores the possibility of the GST rate change leading to a variation in contract price.
Background
It is important to understand that there is no straight jacket answer to this issue as each contract is unique. To determine the impact of the GST rate change on the contract price, one must examine the details of the contract price clause and the entire contract. However, general insight can be gained by considering typical clauses found in most contracts.
Contract price clauses can be classified into two types when it comes to GST. The first type is when the contract price is stated as exclusive of GST. The second type is when the contract price is stated as inclusive of GST, which is common in government contracts and construction agreements based on FIDIC Contracts.
If the contract price as stated in the contract does not include GST, the change in GST rate will not affect it, avoiding the issue of a variation in the contract price. But, if the contract price does include GST, the change in GST rate can result in a change in the price stated in the contract. This is because the increased GST rate will require businesses to use a larger portion of the contract price to pay for GST, reducing their expected base price. Now whether this would vary the contract price depends on the contract itself.
Three scenarios may occur here.
Contracts with a “change in law” clause
In the first scenario, if the contract has a “change in law” clause, this clause takes into account the impact of new, modified or repealed laws on the contracting parties. For example, in FIDIC Contracts, a change in law clause allows the parties to make adjustments to price and time. If the contract has such a change in law clause, it is likely that the contract price could be varied in light of the GST rate increase. If the contract states a specific process for taking advantage of the change in law clause, the parties should follow that process to align the contract price with the new GST rate.
However, if a change in law clause states that the contractor should bear the responsibility for future tax law changes, then it is unlikely that the contract price can be considered as varied. This is because the contractor, according to the contract, has assumed the burden of any potential tax hikes, including the increase in the GST rate.
Contracts without a “change in law” clause
The second scenario is when the contract does not expressly state a change in law clause. Here, it might benefit the parties to determine how the law will come to their aid in this situation. According to the test in Premier Property Manager Pvt Ltd v. Mohamed Ibrahim Manik, if a bystander had asked if the contract price also includes a future GST increase while the contract was being made, it is unlikely that the contractor would have agreed. This is because the contractor would not want to receive a lower base price and reduce its profit margins. Interpreting the contract differently would also be commercially unfair, as a reduced base price undermines the agreed consideration. In this scenario, it is more likely that the law would imply a variation in the contract price to give the benefit of the resulting shortfall to the contractor.
Contracts that prohibit price revisions
The third scenario is when the wording of the contract prohibits the parties from making revisions to the contract price, even due to tax changes. In this case, it is unlikely that the change in GST rate will result in a variation of the contract price. The contract price will be interpreted as including the change in GST rate, even if it lowers the contractor’s base price. The only solution for the contractor would be to negotiate with the counterparty to amend the contract price in the price clause to reflect the change in GST rate.
A question of commercial fairness
The issue of whether the GST rate change varies the contract price which is inclusive of GST is one about fairness as well. It is in the legitimate interest of a party to receive the agreed contract price, without having to suffer a reduction on its base price. Businesses must examine the details of their contracts to determine the impact of the GST rate change on their existing agreements, and consider negotiating with their counterparties to ensure that their rights and interests are protected.
