Recently, the Mumbai bench of the Income Tax Appellate Tribunal (the Tribunal) in the case of Gold crest Exports Vs. ITO (ITA No. 442/Mum/2009) held that the compensation payable due to the cancellation of contract was arising out of the trading contract and therefore, such income in the hands of payee (UK entity) was in the nature of business profit under Article 7 of the India-UK tax treaty (the tax treaty). However, in the absence of Permanent Establishment (PE) of UK entity in India the compensation awarded was not taxable in India. Further, it was held that interest on such compensation partake the character of the compensation.
Accordingly, the Tribunal held that the taxpayer was not liable to withhold tax on such compensation under Section 195 of the Income-tax Act, 1961 (the Act) and there was no justification for disallowing amount of the compensation claimed by the taxpayer under Section 40(a) of the Act.
Facts of the case
- The taxpayer entered into a contract for supply of Indian Natural Whitish Sesame Seeds with a UK entity through a broker. Subsequently, the taxpayer repudiated the contract on the ground that the seller did not obtain the export contract duly signed by the buyer and contract was merely signed by the broker. The foreign buyer invoking arbitration clause claimed the compensation from the taxpayer through the arbitration proceedings. The Arbitrator passed the award determining the claim of the foreign buyer against the taxpayer of US $ 81,225, payable with interest @ 5 percent per annum.
- The taxpayer made the provision of INR 3.84 million in respect of the compensation to be paid to foreign company and claimed the same as expenditure under Section 37(1) of the Act.
- The AO rejecting the claim of the taxpayer held that the compensation paid by the taxpayer was taxable in India under Section 9(1)(i) of the Act since it was an income deemed to accrue or arise in India. Therefore, the taxpayer was required to withhold tax under Section 195 of the Act. In the absence of such withholding of taxes by the taxpayer, the AO disallowed the sum amounting to INR 3.84 million under Section 40(a) of the Act. The Commissioner of Income-tax (Appeals) upheld the order of the AO.
Taxpayer’s contentions
