I-T dept seeks to tax damages earned by foreign firm under arbitration as ‘windfall gains’, HC turns down move.
The top rung of the government is vocal about a non-intrusive, non-hostile tax policy and asserts time and again that no taxpayer will be unreasonably harassed, but the taxman continues to overreach himself and often ends up biting off more than he can chew. In a move that tax experts say has no global precedents, the income tax (I-T) department recently went after a foreign-resident company seeking to tax the damages received by it from an Indian firm under an arbitral award calling these “windfall gain”.
Much to the department’s embarrassment, the Delhi High Court invalidated the move, saying the taxman “proceeded on a completely erroneous view of the matter”.
The I-T department’s contention was that the compensation of Rs 2.67 crore received by Xstrata Coal Marketing AG (incorporated in Switzerland) from Delhi-based Dalmia Bharat (Cement) for breach of contract is taxable in India as the contracting state in which the income has arisen. It sought to tax this amount as “income from other sources” at 42% (including surcharge and education cess) under the I-T Act and Article 22(3) of the India-Switzerland Double Taxation Avoidance Agreement. It also claimed a 10% tax on Rs 1.22 crore the Swiss firm got as legal costs and on another Rs 53 lakh received as cost of arbitration proceedings, treating these as “fee for technical services”.
The taxman showed remarkable ingenuity while embarking on the misadventure. Since Xstrata Coal doesn’t have a permanent establishment in India, the compensation amount, it said, could not be treated as ‘business income’, but as ‘other income’ for which too, the tax rate is the same. Curiously, the taxman said DTAA’s beneficial provisions were invoked to tax the arbitration and legal costs at a lower rate of 10%.
The Swiss firm had won the international arbitration in November 2014; Dalmia Cement subsequently contested the award in the Delhi High Court and the Supreme Court but both courts rejected its pleas. The domestic company also deposited the amount in the HC.
Rejecting the I-T department’s contention, Delhi High Court judge Rajiv Shakdher said on July 31, 2019: “To my mind, 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.”
Former additional solicitor general and senior counsel Gourab Banerji, who appeared for the petitioner (Xstrata Coal) in the tax case in the Delhi HC said: “The department is only interested in recovering taxes. They have a tunnel vision and don’t look at its larger implications. This not only hampers the country’s growth but also tarnishes our reputation. It does not send a good message internationally. This tax demand could have created a huge problem.”
Echoing his view, senior lawyer Arvind Datar said: “The department seems unconcerned about the international ramifications of its interpretation. Here is a company which has an international award in its favour and has also succeeded in the Supreme Court. Despite that, the revenue authorities are treating damages payable under an arbitral award as windfall gains and is subjecting this amount to income tax at the rate of 42%. The stand lacks any rationale and is in fact laughable.”