Withdrawal Of Arbitration/Civil Enforcement Proceedings Upon Settlement Between Parties Is Not “Tolerating An Act” In GST

Introduction:

The taxable event under GST laws is ‘supply’ and the same has been defined under Section 7 of the Central Goods and Services Tax Act, 2017 (“Act”) which is the fulcrum for collection of tax under GST. The supply under Section 7 must be a supply of either goods or services. Schedule II of the Act deems certain transactions as supply of either goods or services, once they satisfy the other conditions of Section 7 of the Act, viz, presence of consideration and such activity being carried out in the course or furtherance of business. Notably, “agreeing to the obligation to refrain from an act, or to tolerate an act or a situation, or to do an act;” which was a ‘declared service’ under the erstwhile Service Tax regime, is deemed to be a supply of services under Entry 5(e) of Schedule-II.

The phrase employed in Entry 5(e) of Schedule-II of the Act has attracted considerable litigation. To clarify the applicability of such entry on liquidated damages, compensation, and penalty arising out of breach of contract or other provisions of law, Circular No. 178/10/2022-GST dated 03.08.2022 (“GST Circular”) was issued. A similar clarification was issued in Circular No. 214/1/2023-Service Tax dated 28.02.2023 (collectively “Circulars”) which identified certain decisions of the Hon’ble CESTAT against which the Board will not filing appeals, and clarified that while taxability depends of the facts of each case, the guidelines issued (independent agreement for tolerating an act) must be followed by field formations.

In short, the Circulars clarify the proposition that an agreement between parties must refer to an activity of refraining from an act or tolerate an act, and there must be a corresponding flow of consideration for this activity. The GST Circular expressly refers to the Indian Contract Act, 1872 and states that the service of agreeing to the obligation to refrain from an act or to tolerate an act or a situation, or to do an act is nothing but a contractual agreement, and the conditions of contract (two parties, express agreement by one party to do, refrain, or tolerate an act/situation, consideration agreed by the other party) must be satisfied. Essentially, there must be a necessary and sufficient nexus between supply and the consideration. The ‘service’ of doing, refraining from, or tolerating an act must therefore be an independent arrangement. This position is further clarified by the GST Circular by referencing specific situations such as payment of liquidated damages, cheque dishonour fine/penalty, penalty for violating the law, etc.

However, despite extensive clarification, the Department continues to classify several activities undertaken ancillary to a defined relationship between parties, as one party ‘agreeing to tolerate an act or situation’ and initiates litigation in clear breach of the mandate of the Circulars and other laws.

Recently, in Tata Sons Pvt. Ltd. v. Union of India, Writ Petition No. 4914/2022, the Bombay High court quashed an IGST demand of a staggering INR 1,524 crores on the amounts paid by the Petitioner to NTT Docomo Inc. (“Docomo”) pursuant to an arbitral award while examining that obligations undertaken in the course of settlement and satisfaction of an arbitral award cannot be characterized as a taxable supply in the nature of “agreeing to the obligation to refrain from an act, or to tolerate an act or a situation, or to do an act” under Entry 5(e).

Docomo was a 26% shareholder in Tata Teleservices Ltd., (“TTSL”) and their relationship was governed by a Shareholder’s Agreement (“SHA”). Upon TTSL failing to meet certain performance indicators, the Petitioner was bound to purchase or find a buyer for the shares held in TTSL by Docomo at a certain price. As the Petitioner was unable to do so, the dispute between Docomo and the Petitioner was referred to arbitration in London. The unanimous award directed the Petitioner to pay damages to Docomo. Proceedings were initiated in various jurisdictions by Docomo for enforcement of the award, including in India. The parties filed Consent Terms before the Hon’ble Delhi High Court, pursuant to which, the High Court considered the award to be enforceable in India and treated it to be a deemed decree. As per the Consent Terms, the Petitioner deposited ~INR 8450 crores with the High Court Registry, which was subsequently withdrawn and remitted to Docomo and Docomo withdrew enforcement proceedings against the Petitioner in all jurisdictions since the arbitral award was fully satisfied.

The Department initiated proceedings, alleging that Docomo, by its act of tolerating the Petitioner’s default and by refraining from initiating further proceedings against the Petitioner in relation the SHA/award, had supplied a service of the nature of agreeing to refrain from an act, or tolerating an act, thus falling under Entry 5(e) of Schedule II of the Act. The said “service” was considered an import of service, and the Petitioner was required to discharge tax on RCM basis.

While the Petitioner argued that the intimation and SCN are squarely against the Circulars, the Department argued that the Consent Terms constitute a separate agreement between the parties. The Department contended that as per the arbitral award, the award was required to be satisfied within 21 days. The Consent Terms provided the Petitioner a period of 6 months to deposit the monies awarded, and the obligations thereunder (such as withholding taxes, appointing an Authorized Dealer for remittance, suspension and withdrawal of proceedings in other jurisdictions, etc.) go beyond the arbitral award.

The question before the Hon’ble Court was, therefore, whether the settlement between the parties would amount to “supply” as per Section 7(1) of the Act. The Court answered this question in the negative as a settlement of an arbitral award, as per the Consent Terms approved by the Delhi Court, cannot amount to supply/import of services, as there is no independent transaction identifiable in the facts of the present case. The Court held that any settlement brought about under proceedings in a civil court, or even arbitration, is integral to, or is intricately connected to, the decree itself and the reciprocal obligations in relation to settlement, necessarily emanate from a decree, and this cannot be construed to be an independent agreement alien to the decree itself. Entry 5(e) cannot be read de hors the principal provision, i.e., Section 7, as there is no independent supply or consideration.

The Court also noted that merely because the award amount is large, the Department sought to issue the impugned SCN, without application of mind to the law and facts, especially when the Revenue was aware about the legal position in terms of the GST Circular. The contents of the Circulars themselves also were looked into by the Hon’ble Court, which observed that the position clarified therein is accurate.

Conclusion:

The decision of the Hon’ble Bombay High Court reinforces the scope of Entry 5(e). The mere existence of a dispute, breach, settlement, or withdrawal of proceedings does not, by itself, result in a taxable supply of services. To invoke Entry 5(e), the Department must establish a distinct and independent contractual arrangement under which one party has consciously agreed, for consideration, to tolerate an act, refrain from an act, or undertake an act.

The judgment also recognizes that obligations arising during enforcement, settlement, or satisfaction of an arbitral award are incidental and inseparable from the underlying adjudicatory process. Such obligations cannot be dissected and recharacterized as independent taxable supplies merely because reciprocal undertakings exist between the parties. Withdrawal of proceedings upon satisfaction of an award is a legal consequence of settlement and not a separate “service” rendered for consideration. This approach is fully consistent with the clarifications issued by the CBIC in the Circulars, which continue to bind the Department.

The judgment therefore serves as an important precedent against expansive and artificial interpretations of “tolerating an act or situation” under GST. It provides guidance for taxpayers involved in commercial disputes, arbitral settlements, liquidated damages claims, and enforcement proceedings, where the Department has increasingly sought to characterize compensatory or settlement payments as consideration for a taxable service. At the same time, the case highlights the continuing trend of avoidable litigation initiated by the Department, despite clear statutory guidance and binding circulars clarifying the legal position.

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