Arbitral Damages & Enforcement Proceedings Settlement Not Taxable as GST Supply: Bombay HC

Damages under an Arbitral Award and Settlement of Enforcement Proceedings Do Not Constitute a Taxable Supply and not taxable under GST-Bombay High court.

Summary: The Bombay High Court in Tata Sons Private Ltd vs UOI and others Writ Petition No. 4914 of 2022, held that settlement of an arbitral award between Tata Sons and NTT Docomo did not amount to a “supply” under Section 7(1) of the CGST Act, 2017. The dispute arose after DGGI treated Docomo’s refraining from further recovery proceedings following payment of the arbitral award as a service under Entry 5(e) of Schedule II, attracting IGST under reverse charge. The Court observed that Entry 5(e) requires an independent agreement involving an obligation to refrain from an act, tolerate an act or do an act, with consideration, and cannot independently create a levy unless the transaction qualifies as a supply under Section 7. It held that the settlement and proceedings concerning enforcement of the arbitral award were integral to the award and did not constitute an independent agreement. The Court also referred to CBIC Circular No. 178/10/2022-GST dated 3 August 2022, under which liquidated damages compensating injury, loss or damage from breach are not consideration for supply. The Court concluded that no GST liability arose and did not comment on the constitutional challenge to Section 7 read with Entry 5(e).

Background of the Case

The petitioner-Tata Sons Private Limited is principal investment holding company of the Tata Group, as also the promoter of its operating companies, and the owner of the Tata brand and trademarks. It is principally engaged in the business of making and holding investments. NTT Docomo Inc. had invested in the shares of Tata Teleservices Limited along with Tata, such relationship between the parties was governed by a Shareholders agreement. On account of commercial dispute matter ultimately referred for adjudication in arbitral proceedings by Docomo The arbitral proceedings culminated in an unanimous arbitral award to be payable by Tata to Docomo.

Prior to the remittance of the said amounts to Docomo, Tata received a letter from DGGI stating that an enquiry was proposed to ascertain facts relating to levy of Service Tax on such amounts being paid by Tata to Docomo. Tata was called upon to submit documents including the SHA with Docomo, details of damages paid/payable, copies of any invoice/debit note raised and service tax paid on the damages. Tata was also directed to depute an authorized representative to appear and tender evidence in relation to the said matter. Documents and information is submitted by Tata in pursuance to the proceedings.

DGGI Alleges Supply of Service Under Entry 5(e) of Schedule II

Later, intimation of tax ascertained as payable under Form DRC-01A was issued, advising Tata to pay Integrated Goods and Services Tax (“IGST”) along with interest and penalty under Section 74(5) of the Central Goods and Services Tax Act, 2017 (“CGST Act”). alleged that Docomo by its act of tolerating the contractual defaults by Tata and by refraining from initiating any further proceedings against Tata in relation to the SHA and/or the Award had rendered “supply of service” of the nature of agreeing to refrain from an act or tolerating an act, falling within the ambit of Entry 5(e) of Schedule II under Section 7 of the CGST Act. And Tata was liable to discharge IGST on reverse charge basis as the said service was considered to be an import of service. Which is duly replied.

Further, Tata was issued a Show Cause Notice under Section 74(1) of the CGST Act by the Joint Director, DGGI, Zonal Unit, Mumbai (Respondent No. 4), calling upon Tata to show cause within 30 days of receipt of the notice as to why IGST along with applicable interest and penalty under Section 74(5) of the CGST Act should not be demanded from it. In paragraph 11 of the said Show Cause Notice.

Court Observation

Entry 5(e) Requires an Independent Agreement

Under Entry 5(e) of Schedule II to the CGST Act ‘supply of services’ includes ‘agreeing to the obligation to refrain from an act, or to tolerate an act or a situation, or to do an act;”. Thus, the words “agreeing to the obligation…” are a pointer that necessarily there needs to exist an independent agreement, where the parties in the normal course of business bind themselves to refrain from an act, or to tolerate an act or a situation, or to do an act involving consideration, which would amount to supply of services of such nature. As to whether such ingredients would at all fit into, what the parties have agreed under the award, as being found relevant by the department to be the charging element, i.e., Docomo agreeing that having received the award amounts, it would not pursue the recovery proceedings initiated before the U.S., U.K. and Indian Court.

Settlement Proceedings Integral to Arbitral Award

Any award of damages being recognized, in the context of its enforcement applying the Indian law, namely, the ACA and recognition of the principles for award of damages under the Indian Contract Act form part of a legal scheme integral to the arbitral process. Conversely, if it were not so, even assuming that such award of damages was not in the arbitral proceedings but under a decree of a Civil Court in a civil suit, on the defendant not discharging its obligation under the decree, necessarily the decree would be subjected to execution under the provisions of Order XXI of the Code of Civil Procedure, 1908. Any settlement brought about thereunder necessarily becomes “integral to” and or “intricately connected”, to the decree itself. The reciprocal obligation even in settlement of a decree necessarily emanates from a decree, which cannot be construed to be an independent agreement de hors the decree and/or alien to the decree itself.

The proceedings which are incidental, integral to the execution of the decree and falling under the decree (here an arbitral award) also cannot be considered to be alien to the decree, as such proceedings certainly partake the character of the original/principal proceedings, namely, execution of a decree.

Entry 5(e) Cannot Independently Create GST Levy

The reason being Section 7 which defines ‘Scope of supply’ categorically provides that “supply” would inter alia include all forms of supply of goods or services or both of the nature such as sale, transfer, barter, exchange, license, rental, lease or disposal made or agreed to be made for “a consideration” by a person in the course or furtherance of business. Coupled with this, in the present case what is being applied is the provision of Schedule II Entry 5(e) to the effect of which is “a party agreeing to the obligation to refrain from an act, or to tolerate an act or a situation, or to do an act”. However, Schedule II Entry 5(e) itself cannot create the independent levy of Tax unless, same is qualify as Supply under Sec 7 of CGST Act.

CBIC Circular on Liquidated Damages

Also It is clear from the contents of the circular No 178/10/2022 dated 3 August 2022, that, in cases where the amount of liquidated damages are paid, the same is regarded by the Department being amount paid, only to compensate, for injury, loss or damage suffered by the aggrieved party, due to breach of the contract and such amounts are regarded not to be any independent agreement, express or implied, in the hands of the aggrieved party receiving the liquidated damages, so as to infer that the aggrieved party would refrain from or tolerate an act or to do anything for the party paying the liquidated damages. Such receipt of amount is regarded as a mere flow of money from the party, who causes breach of the contract to the party, who suffers loss or damage due to such breach.

Once liquidated damages are an amount being received by a party on account of breach of contract, receipt of such amount would not constitute consideration for a supply and accordingly, such amounts would not be taxable.

Conclusion by the Court

The settlement as brought about between Docomo and Tata before the Delhi High Court settling the arbitral award would not amount to supply within the meaning of Section 7(1) of CGST Act, 2017. The consent terms entered between the parties on the basis of which the Delhi High Court passed the final orders on the proceedings filed by Docomo under Sections 47 and 48 of the ACA, cannot be construed to create any independent agreement between the parties, de hors the arbitral award and/or bring about any legal consequence other than recognizing Docomo’s entitlement for the award amounts.

However court have not commented on the constitutional challenge as mounted to Section 7 read with Entry 5(e) to Schedule II of the CGST Act being illegal and ultra vires.