TAXABILITY OF FOREIGN AWARDS IN INDIA: IS INDIA TRULY PRO-ARBITRATION?
- By Raka Chatterjee
Keywords: taxability, tax deduction, taxation, arbitral awards, windfall gain, interest, monetary damages
In the world of international commercial arbitration, certain areas suddenly attain importance and can almost seem to be the flavor of the season. One such area is the taxability of decretal amount under an arbitral award. Internationally, this issue appears to be far from settled.
The issue becomes further complex when the question of taxation or tax deduction arises at the stage of enforcement of a foreign award. In such a case, confusion arises as to the appropriate national jurisdiction to which an award ought to be submitted for tax assessment because while arbitration is a party-led, flexible procedure of dispute settlement where the parties agree on the seat, the tax laws invariably, operate within inflexible national limits.
This blog post is an attempt to portray the current jurisprudence around the taxability of arbitral awards in India with a focus on enforcement of foreign awards in the country. However, it is necessary to portray the law prevailing in the UK regarding taxability of foreign awards, to understand the difference in approach between these two countries.
Law Relating to Taxation of Arbitral Award in the UK
In the UK, corporation tax treatment of an award of compensation is determined by the nature of the loss to which the award refers. Firstly, in cases where damage has been caused to corporate trading activity, and the award is quantified considering the loss of trading profits, such an award is considered to be taxable trading income. Secondly, where compensation is awarded for the permanent damage caused to a fixed capital asset, such arbitral awards are taxed as capital receipts. In such cases, the tax treatment of the awards is determined by whether the damage can be related to underlying property that is a chargeable asset for purposes of calculating corporation tax on disposal. Thus, the issue of taxation of arbitral awards in the UK is far from simple and determinations continue to be made on a case to case basis.
Law Relating to Taxation of Arbitral Award in India and Recent Developments
In contrast, Indian law deems an arbitral award to be a deemed decree of the court, it is perceived to be a judgment debt and therefore no deductions are permissible from the decretal amount awarded. Further, while executing an award, it is impermissible to go behind the decree and start investigating the individual components. The awarded amount loses the character of an income once it becomes a decree and the same is a judgment debt. It is trite law that the terms damages and debt are not interchangeable with income. This position has been clarified by the Supreme Court of India in All India Reporters v. Ramachandra D. Datar [AIR 1961 SC 943], followed by Bombay High Court, speaking through Justice Bobde [the present Chief Justice of India] in Islamic Investment Company v. Union of India (UOI) And Anr. [2002 (4) BOMCR 685] and the Delhi High Court in V.K. Dewan& Co. v. Delhi Development Authority (DDA) [Execution Petition No. 194/2005]. It is clear that even a payment of interest under a decree pursuant to an arbitral award is not a payment of interest, to which the Income Tax Act 1969 applies, but such payment merges with the decree and therefore no tax is liable to be deducted from such an amount.
After a hiatus, this issue again arose before the Delhi High Court in the realm of international commercial arbitration, in two judgments, namely, Glencore International AG. v. Dalmia Cement [Execution Petition 75/2015] and Xstrata Coal Marketing AG v. Dalmia Cement [Execution Petition 334/2014]. In both these cases, the Petitioners (i.e. Decree Holder) sought execution of LCIA awards under the New York Convention. The Petitioners are companies duly incorporated in Switzerland and the Agreement was for sale and purchase of coal in the high sea. The Judgment Debtor resisted the same under Section 48 of the Arbitration and Conciliation Act 1996, which was dismissed by the Delhi High Court. However, there was a second round of litigation where the Indian Tax authorities decided to levy withholding tax on the awarded amounts.
The Revenue Department contended that the compensation received by the Decree Holder towards the breach of contract is to be taxed in India, being in nature of ‘windfall gain’ under Article 22(3) of the Double Taxation Avoidance Agreement (“DTAA”) subsisting between India and Switzerland. It was undisputed that the Decree Holder had no permanent establishment in India. What falls within the ambit of Article 22 (3) is only an 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 an income which can be taxed, if at all, in India.
Rejecting the Revenue’s contention, the Delhi High Court held that the taxability qua interest is not the subject matter of Article 22(3) of the DTAA, and further observed that once a claim merges into a decree of the Court it crystallizes into a judgment-debt and, therefore, only those adjustments and deductions can be made which are permissible under the Code of Civil Procedure 1908 (‘CPC’). The High Court disposing of the Petition held that the Decree Holder is entitled to the entire sum awarded without any deduction of income tax.
These two judgments also go on to show the pro-enforcement bias of the Indian courts which is consistent with the pro-enforcement bias of the United Nations Convention on the Recognition and Enforcement of Foreign Arbitral Awards 1958. This issue is still ripe as it has not yet been finally decided by the Supreme Court of India, however, the law, as it stands today, is the one crystallized by the Delhi High Court.
The issue of tax deduction at the host country in investment disputes and the country of enforcement in commercial disputes has gained significance over the past few years, across the globe.
Usually, the calculation of an award of monetary damages in international arbitrations is based on the principle that the claimant should be restored to the position it would have enjoyed but for the breaches found by the tribunal. Thus, one can argue that as the treatment of tax in on the awards made by tribunals in international commercial and investment treaty arbitration can have a significant impact on the value of an award to a recipient, unfair overcompensation and under-compensation are possible where taxes are not considered in calculating the damages.
In conclusion, it could be said that currently, to make India suitable for being a conducive site of international dispute settlement, it is important that a dialogue on making the position on the assessment and taxation of foreign awards and domestic awards transparent for the arbitrating parties is initiated. This becomes imperative even more as the rate of taxation of an award as an income arising from ‘other sources’ in India (40%) is substantially higher than most other jurisdictions around the world including the UK (20%), Singapore (17%), Hong Kong (16.5%) and France (33.33%). Moreover, the issue of taxability of awards from investment treaty arbitrations continues to be untouched as all the cases discussed here deal with awards in commercial disputes. Thus, unless appropriate legal reforms are brought in the area, one can foresee a future where India will witness more thematic clashes and normative disagreements within this sphere.
Note: The contributor has been a part of the team that represented the Petitioner/Decree Holder in the cases of Glencore International AG. v. Dalmia Cement and Xstrata Coal Marketing AG v. Dalmia Cement.
Ms. Raka Chatterjee is an Advocate at the Supreme Court of India, working as a Junior Counsel to Senior Advocate Mr. Gourab Banerjee.
Preferred Method of Citation –Raka Chatterjee ‘Taxability of Foreign Awards in India: Is India Truly Pro-Arbitration?’ https://www.investmentandcommercialarbitrationreview.com/post/taxability-of-foreign-awards-in-india-is-india-truly-pro-arbitration (ICAR, October 2020)
The views and opinions expressed in the article are those of the author(s) solely and do not reflect the official position of the institution(s) with which the author(s) is /are affiliated. Further, the statements of the author(s) produced herein should not be construed as legal advice.