The Delhi Bench of Income Tax Appellate Tribunal (ITAT) has held that income tax is payable on interest received on damages.
The bench of Sudhir Kumar (Judicial Member) and B. R. R. Kumar (Accountant Member) has observed that the receipt of damages and receipt of interest are two different components, and we hold that while the damages are the compensation received is a capital receipt, the interest received be treated as revenue receipt and hence taxable.
The appellant/assessee is a foreign company with its headquarters and registered office in the city of Wilmington, County of New Castle, Delaware, United States of America. UTH entered into an agreement with another US company, viz., M/s Escorts Agri Machinery Inc. (EAMI), for the sale of its membership interest of 49% in another US company, viz., M/s Beaver Creeks Holding LLC, for US$1.2 million, in 2006.
EAMI was a wholly owned subsidiary of M/s Escorts Ltd., a limited company having its headquarters in New Delhi. EAMI already held 51% interest in M/s. Beavers Creek Holding LLC. The payments were to be made in 4 instalments.
The purchasers paid the first two installments but subsequently defaulted on the third and fourth installments, inasmuch as they only paid part of the third installment and paid nothing thereafter. Thus, a commercial dispute arose between UTH and EAMI.
The dispute was referred to an arbitrator, who gave a unanimous verdict in 2010 in favor of UTH, awarding damages to the tune of US$ 4,75,000/- plus other expenses, viz., pre-judgement & post-judgment interest of 11.25%, counsel fee, filing fee, arbitrators’ fee, etc.
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EAMI merged with its parent Indian company, viz., Escorts Ltd., with all its assets and liabilities. UTH applied to Delhi High Court for a suit for execution of the arbitral award against M/s Escorts Ltd., the judgment debtor. The order under Section 197 was issued by the Income Tax Officer (International Taxation) directing Ms. Escorts Ltd. to deposit a sum of Rs. 6,35,94,212/- in the High Court’s treasury after a deduction of TDS. The assessee received Rs. 5,65,66,884/- after such deduction of tax.
The issue raised was whether the income received is not chargeable to tax as it has not accrued or arisen in India, especially since the assessee has no business connection in India.
The assessing officer held that the assessee is a wholly owned subsidiary of a Romanian company, and accordingly, its shareholders too are not residents of the USA. The argument of the assessing officer was that the assessee is an LLC, and in the US, the LLC is not a taxable entity, but the taxes are to be paid by the partners. Therefore, the assessee UTH is a fiscally transparent entity in its country of residence, as it allows all the income to pass through it. The assessing officer contended that the assessee, UTH, does not enjoy the benefits of the income but passes it on for the enjoyment of its partners. The main contention of the assessing officer was that since the assessee lacks beneficial ownership of the income earned by it, it is in turn not eligible to be considered a resident for the purpose of the India-USA DTAA. Applying the source rules as per Section 5(2) and Section 9 of the Income Tax Act, 1961, as the assessee is not a’resident’ for the tax purpose of the USA and since no TRC has been furnished, the AO taxed the amount at the rate of 40%.
The DRP held that damages being capital receipt in nature and reimbursement are out of the purview of taxation, and the interest on damages is treated as ‘income’ which arises out of the decree of the Court. The DRP held that interest may also be taxed in the contracting state in which it arises and according to the loss of that state, but if the beneficial owner of the interest is a resident of another contracting state, the tax so charged shall not exceed 10% of the gross amounts of the interest if such interest is paid on a loan granted by a bank carrying a bona fide banking business and 15% of the gross amount of the interest in all other cases.
The assessee contended that the amount received towards compensation/damage for settlement of the dispute is capital receipt, hence not taxable.
The tribunal, while allowing the appeal, held that the receipt of pre-award and post-award interest is a revenue receipt attributable and incidental to the business carried on by the assessee, and it bears the same character of receipts payment of which it was otherwise entitled under the contract. The disputed amount of interest is only an accretion to the assessee’s receipts from the contract business.
Case Title: Universal Tractor Holding LLC Versus DCIT
Case No.: ITA No. 2216/Del/2022
Date: 28.08.2024
Counsel For Appellant: Durgesh Shankar
Counsel For Respondent: Banita Devi Neorem
