2019 (8) TMI 311 - HC - Income Tax

Supreme Court clarifies tax liability in arbitration awards, releases funds without withholding tax

The Supreme Court dismissed the judgment debtor's objections under Section 48 of the Arbitration Act and rejected the income tax department's claims on ... Arbitral Foreign Award - Section 48 of the Arbitration and Conciliation Act, 1996 - Right of appeal to Supreme Court - the stand of the income tax department is that compensation received by the decree holder towards breach of contract is liable for taxation in India as it is a “windfall gain” and hence is covered under Article 22(3) of the Double Taxation Avoidance Agreement (DTAA) subsisting between India and Switzerland. HELD THAT:- Even a plain reading of Article 22(3) of the DTAA shows that the amounts received by the decree holder as compensation, towards breach of contract cannot fall within its ambit. The language of Article 22(3) is unambiguous. What falls within its ambit is only income received from lotteries, crossword puzzles, races including horse races, card games and other games of any sort or gambling or betting of any nature. It is only such income which can be taxed, if at all, in India. Monies received towards arbitration costs and legal costs - HELD THAT:- The income tax department proceeded on completely erroneous view of the matter - The income tax department has treated monies received under the award towards arbitration costs and legal costs as income of the decree holder and thereby proceeded to take the stand that the same will be taxable as “fee for technical services”, both under the provisions of Income Tax Act, 1962 and the DTAA - the stand taken by the income tax department on this score would also have to be rejected. The Registry is directed to release the balance amount available with it along with accrued interest to the decree holder without deducting any sum towards withholding tax - petition disposed off. Issues:Execution of foreign awards, objections under Section 48 of the Arbitration and Conciliation Act, 1996, taxation of compensation received for breach of contract, taxation of arbitration and legal costs, taxability of interest, interpretation of Double Taxation Avoidance Agreement (DTAA) Article 22(3), withholding tax liability.Analysis:The decree holder sought execution of two foreign awards, one related to merits and the other to costs. The judgment debtor's objections under Section 48 of the Arbitration Act were dismissed by the Supreme Court. The income tax department claimed tax liability on the decree holder's compensation for breach of contract, arbitration costs, legal costs, and interest. However, the court rejected the department's interpretation of the DTAA Article 22(3) regarding taxation of compensation for breach of contract, stating it only applies to specific types of income. The court also dismissed the tax department's view on taxation of arbitration and legal costs, as they were not considered income under the law.The court addressed the taxability of interest, disagreeing with the income tax department's stance based on DTAA Article 22(3). The court emphasized that the department's assertions were only prima facie views and final decisions would be made during assessment proceedings. The court clarified that assessment proceedings would involve the judgment debtor, not the decree holder, who could raise defenses, including withholding tax obligations. The decree holder was supported by legal precedent in arguing that once a claim becomes a decree, it transforms into a judgment-debt, subject to specific adjustments permitted by law.Ultimately, the court directed the release of the balance amount to the decree holder without any withholding tax deductions. The judgment highlighted the importance of executing decrees according to their terms, unless modified by relevant statutes. The judgment provided a comprehensive analysis of the tax implications of the foreign awards, emphasizing the interpretation of relevant legal provisions and international agreements to determine tax liability accurately.