Chapter XVII-B of the IT Act specifies various provisions in relation to obligation on a tax-payer to withhold tax. Withholding of tax is mandatory, whenever a payment is to be made to a non-resident, provided that the same is chargeable to tax in India. On the other hand, payment to a resident is subjected to withholding, only if such payment falls within one of the provisions of Chapter XVII-B of the IT Act. Therefore, the obligation to withhold tax, not only depends upon the residential status of the recipient, but also the characterization of payment in their hands.

The withholding obligation becomes further complicated when the payment is to be made pursuant to an arbitral award. The SC in All India Reporters v. Ramchandra D. Datar^[1], held that where a claim is merged in the decree of the Court, the amount so decreed, assumes the character of “judgement-debt” and does not retain the character of income for the purposes of IT Act. It was further held that as a general rule, no deductions are permissible from such decree, other than what has been provided therein or under the Code of Civil Procedure, 1908 (‘CPC’). While, as per applicable law^[2], an arbitral award is to be enforced in the same manner as a decree of a Civil Court, it cannot be considered as a decree, except for the purposes of execution, as per the decision of the SC in Government of India v. Vedanta Ltd^[3].

In line with the above proposition, various High Courts^[4], have held that no deduction will be allowed at the time of payment being made pursuant to an arbitral award which has been executed as per the provisions of the CPC. Therefore, where a payment is to be made pursuant to an arbitral award prior to its execution, there is no prohibition on making any deductions therefrom, under any law per se. Accordingly, in such a case, the tax-payer would be required to withhold tax as per the provisions of the ITA, unless the arbitral award itself prohibits such withholding.

Hence, the taxability of the amount so received under an arbitral award, whether prior to or post its execution, would have to be determined de hors of the position as stated above for withholding tax. Depending upon the terms of the arbitral award, the nature of income in the hands of the recipient and the applicable tax rate would have to be determined. While it may be argued that the nature of income and the applicable tax rate should draw color from the underlying arrangement qua which the dispute arose, Courts^[5] have, in some instances, taken a view that the same must be treated as “income from other sources”. Especially in the case of a non-resident recipient, it must be noted that there are limited number of DTAAs that India has, that exempt “income from other sources” derived by such non-resident from taxability in India. Therefore, while a dispute may be resolved by way of arbitration, the arbitral award passed thereunder may throw open the risk of litigation around withholding tax thereon as well as its taxability in the hands of the recipient.

[1] [1961] 41 ITR 446 (SC).

[2] Section 36 of the Arbitration and Conciliation Act, 1996.

[3] (2020) 10 SCC 1 (SC); Paramjeet Singh Patheja v. ICDS Ltd., (2006) 13 SCC 332 (SC); Sundaram Finance Ltd. v. Abdul Samad, (2018) 3 SCC 622 (SC).

[4] Islamic Investment Company v. UOI, [2004] 265 ITR 254 (Bom. HC); Glencore International AG v. Dalmia Cement (Bharat) Ltd., 2019 SCC OnLine Del 9634 (Del. HC); Voith Hydro Ltd. v. NTPC Ltd., 2021 SCC OnLine Del 1325 (Del. HC); Saroj Kumar Maheswari v. Hindusthan Motors Ltd., [1985] 154 ITR 363 (Cal. HC).

[5] Ramona Pinto v. DCIT, Order dated 02.04.2018 in ITA No. 3523/Mum/2017 (Mum. Trib.).