The Delhi Bench of the Income Tax Appellate Tribunal (ITAT) has held that interest awarded under a foreign arbitral award, which subsequently formed part of a decree of the Delhi High Court, assumed the character of a “judgment debt” and was not taxable in India in the circumstances of the case.

The bench of Vikas Awasthy (Judicial Member) and Naveen Chandra (Accountant Member) deleted an addition of ₹2,47,82,124 relating to interest on damages. The Dispute Resolution Panel (DRP) had treated the interest component as taxable at 15% under Article 11(2) of the India–USA Double Taxation Avoidance Agreement (DTAA), while accepting the assessee’s claim that the decree damages were exempt from tax.

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The assessee, a US resident limited liability company, had entered into an agreement in 2006 with another US company, Escorts Agri Machinery Mart Inc. (EAMI), to sell its 49% membership interest in Beavers Creek Holding LLC for USD 1.2 million. The consideration was payable in four installments.

EAMI paid the first two installments but defaulted on the remaining payments. The dispute reached a court in North Carolina, USA, which directed the parties to arbitration through a consent order.

Meanwhile, EAMI was taken over by the Indian company Escorts Ltd., which was substituted for EAMI in the arbitration proceedings. The Tribunal recorded that the assessee had no business dealings with any person in India, no presence in India and no permanent establishment in the country.

The arbitral award dated August 24, 2010 decided the dispute in the assessee’s favour. It provided for damages of USD 475,000 for breach of contract, interest at 11.25% on the relevant amounts, and amounts towards legal and arbitration expenses. The interest component at issue in the tax appeal was recorded at ₹2,47,82,124.

After Escorts declined to honour the award in the USA, the assessee approached the Delhi High Court for enforcement in India.

The High Court held that the foreign award was enforceable under Section 49 of the arbitration legislation. The High Court expressly stated that the award was deemed to be a decree of the court.

That treatment became central to the Tribunal’s determination of the taxability of the interest included in the award.

The assessee applied for a certificate permitting payment without deduction of tax. The application was rejected and tax was deducted before the deposited award amount was released.

For assessment year 2019–20, the assessee filed a return declaring nil income and claimed that the damages and interest were not chargeable to income tax in India. It also disclosed the tax deducted at source.

The Assessing Officer initially proposed to tax the entire amount in the draft assessment. On the assessee’s objections, the DRP accepted its claim concerning the decree damages but held that the interest had a distinct character and remained taxable under Article 11(2) of the India–USA DTAA.

Consequently, the final assessment order dated July 18, 2022, passed under Section 143(3) read with Section 144C(13) of the Income Tax Act, assessed income at ₹2,47,82,124 against the nil returned income.

The assessee argued that the interest awarded by the arbitrator lost its separate character once the Delhi High Court enforced the award as a decree. It submitted that the amount had merged into a judgment debt and could not thereafter be treated as an independent interest receipt for the disputed tax treatment.

The assessee relied on the Supreme Court’s decision in Islamic Investment Company, as cited in the Tribunal’s order, concerning the execution of a decree and deduction of tax from its interest component. It also referred to decisions dealing with interest forming part of court decrees.

It further contended that the underlying default arose outside India in a transaction between foreign entities. According to the assessee, the award amount had neither arisen nor accrued in India and was received through proceedings to enforce the foreign award.

Addressing Section 2(28A) of the Income Tax Act, the assessee argued that the receipt did not represent interest on money borrowed or debt incurred in the sense contemplated by that provision. It maintained that the use of the word “interest” in the arbitral award did not determine the receipt’s character after its incorporation into the decree.

The assessee also distinguished the McDermott International decision relied upon by the tax authorities, submitting that it involved materially different facts, including an Indian dispute and interest for a period after the decree.

The department supported the orders of the Assessing Officer and the DRP. Its representative also drew a distinction between interest included in the award and interest earned on amounts lying in a bank deposit, contending that the latter was taxable in India.

The Tribunal’s operative reasoning, however, concerned the disputed ₹2,47,82,124 received as part of the court decree. The order does not contain a separate analysis determining the tax treatment of bank-deposit interest.

The ITAT noted that the Delhi High Court had expressly held the damages, including interest, to constitute a decree under Section 49.

Relying on the judicial principle discussed in Islamic Investment Company, the Tribunal observed that amounts incorporated into a judgment debt lose their original character and that a civil court decree must be executed subject to the deductions and adjustments permissible under the Code of Civil Procedure.

The Bench also agreed with the assessee that, despite the nomenclature used in the arbitral award, the disputed receipt did not attract the definition of interest under Section 2(28A).

It held that the damages, including interest, had assumed the character of a judgment debt and were beyond the purview of the Indian Income Tax Act in this case. Accordingly, the interest amount received as part of the court decree was held not exigible to tax, and the addition was deleted.

The assessee additionally requested that the refund of taxes be released in US dollars into its bank account in the USA.

The Tribunal did not issue a specific direction granting that request. It stated that the assessee could take up the matter with the Income Tax Department for the necessary directions.

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