[ASHUTOSH SHUKLA IS A 3RD YEAR B.A.,LL.B.(HONS.) STUDENT AT HIDAYATULLAH NATIONAL LAW UNIVERSITY, RAIPUR]
Introduction
One of the ignored factors that significantly contributes towards assessing a particular jurisdiction as arbitration friendly is the taxation of Arbitration Awards. This is because uncertainty in a tax system can result in entrapment of the Award holder (party or entity that wins the Arbitration) in litigation with the tax administration authorities, creating challenges for such Award holder in effectively reaping the benefits of such favorable outcome. As opposed to this, certainty in taxation of Arbitration Awards can make such jurisdiction into a popular seat/ place of Arbitration. In India, there continue to be some challenges in respect of taxation of Arbitration Awards, both under the direct tax system (Income Tax) as well as the indirect tax system (Goods and Services Tax). Therefore, this article is aimed at unveiling the challenges faced in the taxation of Arbitration Awards under the Income Tax Act, 1961 as well as the Goods and Services Tax (GST) statutes that has come in the way of India becoming a full- fledged pro- Arbitration jurisdiction. Furthermore, this article, also aims to provide potential solutions for tackling such challenges highlighted in the taxation of Arbitration Awards in India.
Arbitration Awards and Income Tax
The general mechanism is that any income received from Arbitration Awards by a taxable person (including juridical persons) has to be treated as ‘income from other sources’ u/s 56 of the Income Tax Act, 1961. This is applicable irrespective of whether the Award monies consist of principal amount, costs or interest. However, issues have arisen when Income Tax authorities have sought to tax income which has been accrued, but not has actually been received by the Award- holder, stating the date of accrual as the date on which the tax liability arises. This creates significant difficulties for the Award- holder as the enforcement period of the Award before national Courts is generally lengthy. This controversy had come up before Hon’ble Bombay High Court which has held that Income Tax would be levied specifically on the date of the receipt of the Award monies and not on the mere accrual of such income.
The scenario would be completely different in case an Award results in receipt of moneys by a taxable person (including juridical person) out of an International Arbitration Award. This is because the taxability of such an Arbitration Award would be determined by the ‘permanent establishment test’ and only if the Award- holder has a permanent establishment in India, only then Income Tax would be applicable on such Award monies. This view was taken by Hon’ble Income Tax Appellate Tribunal, New Delhi. Similarly, Hon’ble Delhi High Court had taken a view that withholding tax under the Income Tax Act, 1961 would not be applicable on an Arbitration Award as it was to be treated as a judgment debt. However, liberty was granted to the Income Tax Department to tax specific components of the Arbitration Award should they be of the opinion that such amounts were subject to Income Tax in India.
At the same time, Hon’ble Bombay High Court has also held that any amount received under an Arbitration Award as compensation would not be taxable under the Income Tax Act, 1961 as it would be a capital receipt. The deviation in the view by the same Court can result into difficulties for parties as every Arbitration Award can be treated as compensation by the parties resulting them to be under the belief that the said amount is not taxable, resulting in scrutiny to be initiated by the Income Tax Department for creation of demand and subsequent recoveries.
GST on Arbitration Awards
Another important aspect pertaining to the taxation of Arbitration Awards in India is the applicability of GST on monies received by the Award- holder. There is a divergence in view in respect of the applicability of GST on Arbitration Awards. One school of thought claims that no GST would be applicable on Arbitration Awards as it is liquidated damages, whereas, at the same time, a Circular has been issued by the Ministry of Finance, Government of India treating liquidated damages to be taxable under GST. As Arbitration Awards are passed by Arbitrators which are creatures of contract, it can be said that the amounts being received by the Award- holder would be subject to GST. This view was also affirmed by Hon’ble Bombay High Court, but only to the limited extent of Award monies received after the introduction of GST.
There are further difficulties under the GST statutes when the Award results in restoration or grant of properties instead of monetary amounts. This is because the Award- holder can be treated to be the supplier of service of tolerating the act or situation of breach by the Award- sufferer resulting in the restoration of grant of properties which would be taxable as GST is applicable on exchange transactions and the consideration payable need not be solely in monetary consideration.
Solving Challenges and Way Forward
It is undoubtedly true that, Indian Courts and Tribunals have attempted to resolve the issues in taxation of Arbitration Awards as discussed above. However, because of the fact that the doctrine of res judicata does not apply to tax cases in India, the respective tax authorities continue to have the right to assess taxpayers by differentiating the judgments which have been passed with an attempt to settle the issue. Furthermore, in some respects there is divergence of view amongst High Courts themselves resulting in increased risk of litigation for the Award- holders who might be subjugated to tax litigation after the conclusion of the Arbitration proceedings.
In light of the foregoing, it is necessary that the challenges in taxation of Arbitration Awards are solved. This can only occur when delegated legislation is specifically introduced for the purposes of clarifying the actual nature of Arbitration Awards. The treatment of some monies received under an Arbitration Awards as capital receipts (outside the purview of Income Tax), some monies as income from other sources (where Income Tax is applicable) and monies under an Arbitral Award to be treated as liquidated damages would create accounting and reporting difficulties for parties and result in creation of demand against the Award- holder.
It is always open for parties to choose Special Economic Zones in India as a seat of arbitration for availing the multitude of tax benefits that are available for the monies that may be received by the Award- holder. This is because GST is not applicable in Special Economic Zones as they are treated to be foreign territories and furthermore, immense benefits exist under the Income Tax Act, 1961 for income earned in SEZ units. However, the limited number of institutions available would render this solution only as a stop- gap arrangement and if India is to be truly seen as a pro- arbitration jurisdiction, it is necessary that tax regulators also play their part sufficiently to clarify and confer finality on the several challenges in the taxability of Arbitration Awards in India
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