Goldcrest Exports vs. ITO (ITAT Mumbai)

Interest On Damages Not Assessable To Tax under DTAA If No PE

The assessee, an Indian company, entered into an agreement with Swissgen NV, a UK company, for the supply of sesame seeds. The agreement was entered into through a broker. Pursuant to a dispute between the parties, the matter was referred to arbitration and an award was delivered which made the assessee liable to pay damages of Rs. 38.41 lakhs (including interest) to the UK company. The assessee claimed that the damages were nothing but difference in price ruling on the date of non-fulfillment of the contracts and contract prices and claimed the same as a deduction. The AO & CIT (A) rejected the claim on the ground that the damages paid by the assessee was chargeable to tax in the hands of the non-resident and that the assessee was liable to deduct tax at source u/s 195 and that failure to do rendered the amount disallowable u/s 40(a)(i). On appeal by the assessee, HELD reversing the lower authorities:

(i) The compensation in the hands of the non-resident recipient has the character of a business profit as it is arises out of a trading contract and is covered by Article 7 of the India-UK DTAA of UK;

(ii) The non-resident recipient did not have a Permanent Establishment (PE) in India as per Article 5 of the DTAA. As per the facts on record, the contract was only for supply of goods in India and there is nothing on record to suggest that the broker was the dependent agent of the foreign buyer. As per Article 5(5) of the DTAA, even if business is carried out through a broker or general commission agent or any other agent of an independent status, it cannot be said that the non-resident has a PE in India;

(iii) In the absence of a PE in India, the compensation awarded under the arbitration award was not taxable in India. Consequently, there was no obligation on the assessee to deduct tax u/s 195(1) and no disallowance u/s 40(a)(i) could be made. (Samsung Electronics 320 ITR 209 (Kar) not followed);

(iv) Though the damages included an element of interest, the same is not assessable because in a decree or arbitration award, the amount loses its original character and assumes the character of a judgment debt. In substance, interest partake the character of the compensation and is not assessable as “interest”. Islamic Investment 265 ITR 254 (Bom) followed.