Compensation received by UK buyer pursuant to arbitration award, on account of failure of Indian entity to meet its export obligation — Business income — In absence of PE, not chargeable to tax in India.

The taxpayer (GCE) was engaged in the business of
export/import and trading in various commodities. Through the involvement of an
Indian broker, GCE entered into contract with the UK buyer (UKCO) for supply of
certain commodities. GCE cancelled the contract. Pursuant to arbitration
proceedings initiated by UKCO, the arbitrators awarded compensation to UKCO. The
compensation was based on the difference between market price of the commodities
agreed to be supplied and the contracted price. GCE was also asked to pay
interest from the date of arbitration award till the date of payment.

GCE made provision in respect of the compensation
and the interest payable and claimed that as business expenditure.

The tax authorities denied the deduction primarily
on the ground that no tax was deducted at source in respect of the provision.

The ITAT held that :

(i) The compensation was in the nature of
business income as it was arising out of the trading contract between GCE and
UKCO. Hence, it was covered under Article 7 of the DTAA.

(ii) In absence of PE of UKCO in India, there was
no tax liability. Consequently, there was no tax withholding obligation on GCE.
Involvement of an independent agent in India does not alter the position.

(iii) Compensation payable pursuant to
arbitration award loses its original character and assumes the character of a
judgment debt. Interest payable also partakes the character of compensation.