In our experience while dealing with corporate clients in representing them in an action for damages, contractual claims etc. in arbitration proceedings or in court of law and in advising them afterwards, we have seen many companies having a question as to whether a receipt pursuant to settlement in a lawsuit or in an arbitration matter or a receipt pursuant to court decree or arbitration award after successful prosecution of claims is taxable under Income Tax Act, 1961(“ITA”).  We have indeed seen some clients offering such amounts under ITA and some settlements prescribing that the payee will raise the invoice along with Goods and Service Tax(“GST”) and the payor will consequently remit the amount along with GST. 

Such an amount may or may not be liable to be offered as income (although the payor may be able to claim a reduction in profit treating such payment as revenue expenditure) and may or may not be subject to GST.

Broder proposition is that a receipt under decree or settlement towards supply of specific goods or services will be both liable to be offered under ITA and be subject to GST whereas receipt pursuant to settlement of a claim for damages or compensation for loss suffered or a receipt pursuant to decree to that effect may be out of the purview of GST and also may not be liable to be offered under ITA while allowing the payor to deduct such amount from taxable income. 

We seek to deal with the treatment of such an amount under GST and under Income Tax Act, 1961.


Section 7(1) of the CGST Act provides that “supply” includes 

  • all forms of supply of goods or services or both such as sale, transfer, barter, exchange, license, rental, lease or disposal made or agreed to be made for a consideration by a person in the course or furtherance of business.
  • The activities specified in Schedule I, made or agreed to be made without consideration; and 
  • The activities to be treated as a supply of goods or a supply of services as referred to in Schedule II.

Apparently, receipt of the amount towards damages or compensation for loss is not supplied.  GST authorities however frequently treat such receipts towards damages / liquidated damages as the supply of goods or services considering such receipt to be following within the ambit of ‘agreeing to the obligation to refrain from an act, or to tolerate an act or a situation, or to do an act’ as appearing in Entry No.5, Clause (e). Sometimes, tax authorities treat such receipts as a consideration for the supply of service of ‘tolerating an act’ or breach or non-performance. 

Some advance rulings in favour of the department further complicate the situation.  We believe that such receipts have to be out of the purview of GST and they cannot be treated as any sort of service and they lack the element of mutual consideration as well. There could be further and detailed arguments in support of such a proposition; we however refrain from elaborating the arguments in this article.

While actual taxability could depend on specific facts, we seek to highlight for our readers that:-

  • The Bombay High Court, in the case of Bai Mamubai Trust, Vithaldas Laxmidas Bhatia, Smt. Indu Vithaldas Bhatia vs. Suchitra has held that GST is not payable on damages/compensation paid for a legal injury as payment lacks the element of mutuality of consideration. 
  • In the case of Southern Eastern Coalfields Ltd. v. Commissioner of Central Excise and Service Tax, CESTAT reversed the decision holding there could be no demand of service tax on the amount of liquidated damages or forfeiture of EMD amount.  Though the case pertains to the pre-GST regime, the analogy will squarely apply to GST. 

Under ITA, all revenue receipts are taxable unless specifically exempted and all capital receipts are not taxable unless specifically held to be taxable.  Broader principles for a determination as to whether a receipt is a capital receipt or a revenue receipt is that capital receipts are not obtained in the regular course of business whereas revenue receipts are, capital receipts are normally non-recurring ones whereas revenue receipts are recurring ones and also that the nature of receipt is decided by virtue of its character in the hands of the person receiving it. Receipt of amount under a decree/ award or settlement, if towards damages/ breach of contract/ compensation for loss, are not in the regular course of business but by way of compensation and are capital receipts.  Such receipts do not fall within the ambit of any sub-sections of s.45 and are not therefore subject to capital gains tax.  A couple of relevant decisions elucidating the position are Aberdeem Claims Administration Inc. and DCIT Vs Rishabh Infrastructure Pvt. Ltd. (ITAT Raipur) (2018).


The position that receipt of the amount under decree/ award or settlement is treated as a capital receipt for the recipient if it is towards damages/ breach of contract etc., does not necessarily imply that payment of such amount is a capital expenditure for payor and could not be used for reduction in taxable income.

Whether a settlement amount is a revenue expenditure or not depends upon the payment being penal or compensatory in nature. While any amount paid for an infraction of law and by way of statutory penalty is punitive in nature and is not deductible under section 37 of ITA, settlement amount towards damages arises out of contractual obligations and if the same is by way of normal incidence of business of payor, it is generally treated as revenue expenditure at the end of the payor and could be deducted under section 37 of ITA.  One of the relevant decisions elucidating the position is of Gujarat High Court in the case of Principal Commissioner of Income Tax v. Mazda Ltd, wherein the Court held that the deduction claimed on account of liquidated damages was allowable as revenue expenditure as damages for the delay was an inbuilt feature and inherent part of the business of the assessee and could not be disassociated from taxpayer’s normal business activities.

In practice, the nature of receipt shall be determined by extensive scrutiny of pleadings in suit and/or recitals contained in the settlement agreement and careful drafting will be quintessential.

Author of this article:
Adv. Ravish Bhatt,
Partner, R&D Law Chambers,
Dual Qualified Lawyer Solicitor | International Tax Affiliate

Connect with Mr. Bhatt on Linkedin:

  • Readers should contact their attorney to obtain advice with respect to any particular legal matter. No reader or user should act or refrain from acting on the basis of information written above without first seeking legal advice from qualified law practitioner.