2012 (8) TMI 780 - AAR - Income Tax

Taxability on the Settlement Amount payable under the Stipulation pursuant to the judgment and Final approval of the US Court - whether the applicant is required to deduct income tax u/s 195 at the time of deposit of the Settlement Amount into the Initial Escrow Account to the final Escrow Account - Held that - Under the terms of the settlement subsequently approved by the Court,three stages in this transaction of IC (Indian Company), First, when IC deposits the amount in the segregated account in India in its own name, second when it goes from the segregated account to the initial escrow account in New York and third, when it moves from the initial escrow account to the final escrow account to be treated as Qualified Settlement Fund (QSF)- The segregated account stood in the name of IC (Indian Company)and the interest earned on the deposit belonged to IC and the principal deposited stood transferred to the initial escrow account at the conversion rate prevailing on the date of transfer of the fund. The interest was to the benefit of IC and the title to it did not pass to QSF. The right to sue arose out of the misrepresentation of IC, by the alleged manipulating of the financial statements of IC with the alleged connivance of A and B, followed by the confession of the Managing Director of IC about the inaccuracy of the financial statements. All these took place in India. The suit could be filed in India - On a settlement of the class action, the sums were agreed to be paid and the source of the compensation is the alleged tort perpetrated in India. Therefore, the right to the compensation arose in India. The source of the compensation is the alleged tort in India - Once it is found chargeable to tax in India, IC will have the obligation to withhold tax on the amount under section 195 on the transfer of the fund from the segregated account in India to the initial escrow account in the U.S. When a settlement is arrived at subject to the approval of Court and steps are taken thereunder, then the approval of court will be approval of each step taken as part of the settlement. That would mean that IC would lose its title to the fund from the date of deposit once the court approved the settlement subject to the terms of the settlement, like the stipulation regarding interest earned in the segregated account and the right to withdraw the taxes that may be found payable in India from the initial escrow account, thus the amount deposited by IC as part of the settlement of the class action dispute with Lead counsel is income from other sources in the hands of Lead counsel or the QSF and that income arises in India - the applicant is required to deduct income-tax @ 30% when the settlement amount moves from the segregated account to the initial escrow account.

Summary

Issues Involved:
1. Chargeability of the Settlement Amount to tax under the Income-tax Act.
2. Timing of tax deduction under section 195 of the Income-tax Act.
3. Applicability of tax deduction at source by the Qualified Settlement Fund (QSF).
4. Rate of tax deduction under section 195.
5. Nature of the Settlement Amount (income vs. capital receipt).
6. Application of India-US Double Taxation Avoidance Convention (DTAC).

Detailed Analysis:

1. Chargeability of the Settlement Amount to Tax:
The main issue was whether the Settlement Amount payable by IC, 'A', and 'B' under the Stipulation pursuant to the judgment and final approval of the US Court would be regarded as a sum chargeable under the provisions of the Income-tax Act, 1961, particularly under section 195.

The judgment concluded that the Settlement Amount is chargeable to tax in India. The amount agreed to be paid as part of the settlement was considered as damages or compensation for the loss suffered due to the alleged fraud perpetrated by IC, 'A', and 'B'. The cause of action arose in India, and hence, the income by way of compensation or damages accrued or arose in India. Therefore, the Settlement Amount is income from other sources in the hands of the QSF and is taxable in India.

2. Timing of Tax Deduction:
The question of when IC, 'A', and 'B' should deduct income tax under section 195 was addressed. The judgment determined that the obligation to withhold tax arises when the Settlement Amount moves from the segregated account in India to the initial escrow account in the US. This transfer signifies the passing of title to the QSF, and thus, the tax deduction should occur at this stage.

3. Applicability of Tax Deduction at Source by QSF:
The applicability of section 195 of the Act to the QSF when it distributes the Settlement Amount to the authorized claimants was examined. The judgment stated that once the tax is deducted on the fund as a whole, the obligation of the QSF to deduct further tax ends. Therefore, the QSF does not need to consider the chargeability of the Settlement Fund in the hands of the authorized claimants for the purpose of tax deduction.

4. Rate of Tax Deduction:
The rate at which income tax should be deducted was determined to be 30% of the Settlement Amount. This rate was not contested by any party involved.

5. Nature of the Settlement Amount:
The judgment clarified that the Settlement Amount is not a capital receipt but a revenue receipt. It was concluded that the Settlement Amount represents income from other sources under the Income-tax Act. This classification is crucial as it determines the tax treatment of the amount received by the QSF.

6. Application of India-US DTAC:
The judgment considered the applicability of the India-US Double Taxation Avoidance Convention (DTAC). It was argued that under Article 23 of the DTAC, the income not having arisen in India could be taxed only in the United States. However, the judgment found that the income arises in India, and thus, paragraph 3 of Article 23 of the DTAC applies, allowing the income to be taxed in India.

Separate Judgments Delivered:
The rulings were summarized for each application as follows:

- AAR No. 1045 of 2011: The Settlement Amount is chargeable to tax under section 195. Tax should be deducted when the amount moves from the segregated account to the initial escrow account at a rate of 30%.

- AAR No. 1060 of 2011: The Settlement Amount is chargeable to tax under section 195. Tax should be deducted when the amount moves from the segregated account to the initial escrow account at a rate of 30%.

- AAR No. 1078 of 2011: The Settlement Amount payable by 'A' and 'B' is chargeable to tax under section 195. The entities 'A' and 'B' cannot consider the chargeability in the hands of the authorized claimants. Tax should be deducted at a rate of 30%.

- AAR No. 1087 of 2011: The Settlement Amount is chargeable to tax under section 195 at the point specified in other applications. Tax should be deducted at a rate of 30%.

- AAR No. 1088 of 2011: The rulings are identical to those in AAR No. 1078 of 2011, with tax to be deducted at a rate of 30%.

Conclusion:
The judgment comprehensively addressed the issues of tax chargeability, timing, applicability, rate, and nature of the Settlement Amount, and the application of the India-US DTAC, concluding that the Settlement Amount is taxable in India and specifying the procedural aspects for tax deduction.