In a ruling favouring a US-based LLC, the New Delhi Bench of the Income Tax Appellate Tribunal (ITAT) has held that the interest component of a foreign arbitral award, once deemed a decree of the Delhi High Court under Section 49 of the Arbitration and Conciliation Act, assumes the character of a ‘judgment-debt’ and falls outside the scope of the Income Tax Act.
The Tribunal observed that the statutory definition of ‘interest’ under Section 2(28A) of the Income Tax Act covers interest payable in respect of money borrowed or debt incurred. Since the impugned interest arose from a court decree and not from any borrowing or debt, it does not fall within the statutory definition.
The Tribunal also held that the India-USA Double Taxation Avoidance Agreement applies only to ‘interest’ as understood under the treaty, and since the receipt had lost its nomenclature and characteristic as interest upon merger into the decree, the DTAA could not be invoked to tax it in India.
The Division Bench comprising Vikas Awasthy (Judicial Member) and Naveen Chandra (Accountant Member) observed that the dispute was between two foreign entities over the sale of a membership interest in another US company, and the default occurred entirely outside India. The interest awarded by the Arbitral Award related to the period between the dates of default and the date of the award, and the amount neither arose nor accrued in India; it was merely received in India through the execution of the Delhi High Court’s decree giving effect to a foreign award.
The Tribunal placed strong reliance on the Delhi High Court’s explicit direction in its order dated 13 July 2012, which deemed the foreign award, including the interest component, to be a decree of the court under Section 49 of the Arbitration Act. The Bench also relied on the Supreme Court’s decision in Islamic Investment Co. [(2004) 265 ITR 254], which held that once interest becomes part of a decree, it must be executed strictly under the CPC, and there is no provision in the Income Tax Act, particularly Section 195, permitting a debtor to deduct tax from a decretal amount on the ground that it contains an interest component.
The Tribunal further noted that the term ‘interest’ as defined in Section 2(28A) of the Income Tax Act means interest payable in respect of any money borrowed or debt incurred, and since the interest in this case arose not from any money borrowed or debt incurred but from a decree of a civil court, it does not attract the statutory definition.
Briefly, Universal Tractor Holding LLC (UTH), a limited liability company registered in Philadelphia, USA, sold its 49% membership interest in another US company, Beavers Creek Holding LLC, to Escorts Agri Machinery Mart Inc (EAMI), also a US entity, for USD 1.2 million payable in four instalments. EAMI paid the first two instalments but defaulted on the balance. A suit was filed in the Wake County Superior Court, North Carolina, USA, which referred the matter to arbitration.
During the arbitration, EAMI was taken over by the Indian company Escorts Ltd. and was substituted in the proceedings. The Arbitral Award dated 24 August 2010 was decided in favour of UTH, directing payment of damages for breach of contract (USD 475,000), simple interest on the defaulted instalments computed at USD 550,713.87 (equivalent to INR 2.47 crores), counsel fees, arbitrator fees, and expenses. When Escorts declined to honour the award in the USA, UTH filed execution petition before the Delhi High Court declared the foreign award enforceable under Section 49 of the Arbitration and Conciliation Act and deemed it a decree of the court.
The assessee applied for a nil tax deduction certificate, which was rejected. The TDS was deducted at 40% on damages and 15% on interest. UTH filed its return for AY 2019-20 disclosing NIL income. The Dispute Resolution Panel (DRP), invoking Article 11(2) of the India-USA DTAA, held the interest component taxable in India at 15%, and assessed income at Rs. 2.47 crores.
