Arbitral Awards as Windfall Gains

Arbitral Awards as Windfall Gains

Arbitration has been constantly growing as an alternative dispute resolution mechanism whereby India is still considered to be not a preferred destination as a seat for Arbitration. The reasons for the same are manifold ranging from never-ending court proceedings leading to delay in enforcement of the awards to not yet fully embraced institutional arbitration. Although India is striving to be a hub for arbitration there are certain judgments and contentions raised in the judgments that can have a crippling effect on the efforts put forth to be an ideal seat of arbitration. One such case is Glencore International AG v. Dalmia Cement (Bharat) Limited (EX.P. 75/2015 & EX.APPL.(OS) Nos.1216-17/2015) whereby the contentions and interpretation made by the Income Tax department were absurd inasmuch as it was submitted that withholding of tax shall be applicable on foreign arbitral awards.

The Facts
A Swiss company, Glencore International AG and Dalmia Cement (Bharat) had an arbitration proceeding due to breach of a contract on account of non-acceptance of coal shipment delivery whereby the award was passed in favor of Glencore. The award was objected by Dalmia and the objections were dismissed first by the High Court and also by the Supreme Court. The decree was finally passed requiring Dalmia to make a deposit of INR 37,20,13,028 with the court out of which INR 20,20,22,530 was asked to be released to the Glencore and the remainder was directed to be retained so as to get views of Income Tax Department on whether Dalmia was entitled to withhold tax on the foreign arbitral award.

The Contentions raised by the Income Tax Department

  • Damages received for breach of contract was treated as ‘Income from other sources’ and thereby was to be dealt by Article 22(1) of the Indo-Swiss tax treaty according to which the resident country is entitled to tax the income from other sources. However, the tax department contended the income to fall under exception [clause (3) ] as it is a ‘windfall gain’ which was received due to an unforeseen event which was out of control of the recipient, making it taxable by the source country i.e., India in this case.
  • Legal Costs and Arbitration costs even though meant to reimburse the costs incurred were submitted to be treated as the ‘fees for technical services’ and therefore, as per Article 12 of the treaty shall be liable to withholding tax at the rate of 10%.
  • Interest was suggested to be covered under Article 11 of the treaty and withholding of tax was suggested to be at the rate of 10%.

The court discarded the contentions made by the IT Department and held the following: –

  • The compensation received towards breach of contract can under no stretch be treated as a windfall gain. The windfall gain provision unambiguously specifies winnings from lotteries, crossword puzzles, races including horse races, card games and other games of any sort or gambling or betting of any nature to fall under the ambit and therefore, it is only income from such winnings that can be taxed in India.

    1Article 22(1) of the Indo-Swiss Tax Treaty provides that items of income not dealt with in the foregoing articles of the Treaty shall be taxable only in the State of residence of the recipient.
    2Clause (3) of Article 22 provides that notwithstanding Article 22(1), if a resident of a State derives income from sources within the other State in the form of lotteries, crossword puzzles, races including horse races, card games and other games of any sort or gambling or betting of any form or nature whatsoever, such income may be taxed in that other State.

  • The arbitration costs and legal costs received by the decree-holder were taken to be his income and therefore proposed to be taxed. However, the court dismissed the argument stating that such costs cannot be taxed as fees from technical services.
  • The arguments raised with respect to withholding tax on the interest amount was also held to be blatantly wrong.

Additionally, the court observed that the arbitral award on acquires the status of court decree and thus any amount payable becomes the judgment debt, so only those deductions and adjustments can be possible that are permissible under the Civil Procedure Code, or any other legislation or the decree itself.

The judgment of the court in this case although a positive step in the global arbitration scenario, however, the litigation and contentions like this can drive foreign companies and MNCs away, not only making India be the least desired seat of arbitration but also an as undesirable place to do business.

Diya Mehta, Advocate
Associate, TvT Legal