No Withholding Tax on Arbitration Award to Foreign Company

Arbitration is an alternative dispute resolution method based on the consent of the parties, which is often referred to as domestic judicial systems for the settlement of disputes arising from international and domestic commercial relationships. A dispute may be brought to arbitration where the parties have voluntarily entered into an arbitration agreement.

The arbitration award normally comprises of damages or compensation, legal cost or arbitration cost and interest amount. Treatment of taxes have been constantly considered as a pertinent factor in International arbitration awards with a significant effect on the value of award being released to foreign companies. The essay focuses on whether income tax is applicable to the arbitration award received by the foreign company from an Indian company.

Background and Facts of the Case

Glencore International AG, a company incorporated in accordance with the laws of Switzerland, initiated international arbitration proceedings against Dalmia Cement (Bharat) Limited for breach of agreement and received an award in its favour. The Award declare and adjudge damages for breach of agreement (USD 45,73,013); Legal costs (USD 80,440); Arbitration cost (USD 4,73,332) and Interest cost on all (USD 6,36,853).

Dalmia Cement (Bharat) Limited had filed objections under section 48 of the Arbitration and Conciliation Act, 1996. However, the Court dismissed the objections vide judgement dated 03.07.2017. The matter was further appealed in the Supreme Court and got rejected again.

The Court passed the decree and directed Dalmia Cement (Bharat) Limited to deposit the full amount of the award to the Registry of Court. It also instructed that a part of the award is to be released to Glencore International AG and the balance amount remains with Registry of Court till the conclusion from the Income Tax Department as to whether Dalmia Cement (Bharat) Limited required to withhold tax on the said award.  In this background, Glencore approached the Court for the release of the balance amount of the award.

Moot question

Whether Dalmia Cement (Bharat) Limited is required to withhold tax under Income Tax Act 1961 and / or Double Taxation Avoidance Agreement between India and Switzerland on the international arbitral award, comprising damages, legal cost, arbitration cost and interest thereon.

Income Tax Department Contention

The Income Tax Department provided their argument on each category of awarded amount separately in order to determine their taxability:

  1. Damages for breach of agreement: The Income Tax Department argued that in the absence of Permanent Establishment, Glencore International AG cannot be taxed as Business Profit under Double Taxation Avoidance Agreement, therefore, the nature of Income is Income from Other Sources.

    Further, the Income Tax Department argued on the Taxability of Income from Other Sources under Income Tax Act 1961 and Double Taxation Avoidance Agreement between India and Switzerland as below:

    • Income Tax Act 1961 – The Income from Other Source is Taxable under Section 56 of the Income Tax Act 1961 at the rate of 40 percent plus surcharge and cess.
    • Double Taxation Avoidance Agreement between India and Switzerland – Under the Article 22 (Other Income) is Taxable only to the country of residence of the recipient i.e., Switzerland but subject to exceptions provided under Article 22(3) like income from lottery, crossword puzzles, card games etc. are taxable in the country in which it arises i.e., India.

      The Income Tax Department argued that a windfall gain is an income received due to an unforeseen event over which the recipient had no control which is covered under Article 22(3). The income from the award is also in nature of a windfall gain. Therefore, Taxable in India at the rate of 40 percent plus surcharge and cess.

      The Assessing Officer assessed the said award under Income from Other Source and Taxable at the rate of 40 percent plus surcharge and cess.

  2. Legal Cost and Arbitration Cost: Glencore International AG incurred these expenses (mainly lawyer fees) for availing services which are prima-facie technical or consultancy services and are taxable as “Fee for Technical services” under the provisions of Income Tax Act 1961 and Double Taxation Avoidance Agreement between India and Switzerland.

    The payment appears as reimbursement of cost, but actual character of payment is fee for technical services which is sourced from India. Therefore, the reimbursement of Legal Cost and Arbitration Cost is taxable at the rate of 10% under Article 12 of the Double Taxation Avoidance Agreement between India and Switzerland.

  3. Interest Cost: The Income Tax Department argued that Interest Payment is Taxable at the rate 10% under Article 11 of the Double Taxation Avoidance Agreement between India and Switzerland.

Ruling of High Court

The Court rejected the arguments of the Income Tax Department as below

  1. Damage for breach of agreement along with interest – It is held that amount of damages for breach of agreement along with the interest would not fall under Article 22 (3) of Double Taxation Avoidance Agreement between India and Switzerland.

    The plain reading of Article 22(3) of the Double Taxation Avoidance Agreement between India and Switzerland shows that the amounts received by the decree holder as compensation, towards breach of contract cannot fall within its ambit. 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.

  2. Reimbursement of legal costs and arbitration costs – It is further held that legal costs and arbitration costs cannot be regarded as income of Glencore International AG, and therefore would not be taxable in India.

    Accordingly, the Court directed the registry to release the balance amount available with it along with accrued interest to the Glencore International AG without deducting any sum towards withholding tax.

Conclusion

The court ruling held that proceeds to foreign companies about International arbitration awards are not considered as “windfall gain” and would not be subject to withholding tax in India. provided relief to many foreign companies that are in the process of the arbitration proceeding. This has offered relief to many foreign companies that are in the process of the arbitration proceeding.

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