As per the Income-tax Act, 1961 (IT Act), interest income earned by a non-resident from an Indian borrower is taxable in the hands of such non–resident in India and the Indian borrower is required to withhold taxes on such interest pay-outs by them. The IT Act prescribes specific withholding rates (i.e., 5% or 20%, as the case may be) subject to Double Tax Avoidance Agreement (DTAA) benefits.
Section 194LC of the IT Act provides for the deduction of tax at source (TDS) on income by way of interest payable to a non-resident. The person responsible for making the payment, shall at the time of credit of such income or at the time of payment deduct tax thereon at the rate of 5%. Further, in case of interest other than covered in section 194LC of the IT Act, section 115A of the IT Act provides for TDS at 20% of the gross amount on interest payable by the Government or an Indian entity to a non-resident on the sum borrowed or debt incurred by it in foreign currency.
In this regard, recently, the Mumbai Tax Tribunal in the case of Rabobank1 has analysed whether interest income earned from External Commercial borrowings (ECBs) should be taxable according to general or specific clauses articulated in India-Netherlands DTAA. We, at BDO in India, have summarised the said ruling of the Mumbai Tax Tribunal and provided our comments on the impact of this decision.
Facts of the Case
The taxpayer, an Indian Branch of Rabobank Netherlands has earned interest income from ECB. The Bank declared its total income of INR 240.3mn which includes interest income from ECBs. The tax officer observed an undisclosed TDS credit of INR 69.6mn while assessing its income and brought to tax the difference of undisclosed gross receipts as per Form 26AS and further made an addition of INR 632.7mn representing interest income from ECBs. The tax officer sought to tax the said interest income as normal business receipts taxable at 40% as applicable to a foreign company instead of applying the rates provided in Article 11 of the India-Netherlands DTAA. Aggrieved, the taxpayer filed an appeal before the First-Appellate Authority which held in favour of the taxpayer by relying on the taxpayer’s own case for fiscal year (FY) 2009-10, wherein in view of provisions of section 115A(i)(a)(ii) of the IT Act it was held that interest income earned by the taxpayer would be chargeable to tax at 20%. Aggrieved, the tax officer filed an appeal before the Mumbai Tax Tribunal.
Mumbai Tax Tribunal Ruling
The Mumbai Tax Tribunal made the following observations while ruling in favour of the taxpayer that the interest income on ECB should be taxed as per Article 11 of the India-Netherlands DTAA at 10%:
- Article 7(6) of India-Netherland DTAA specifies that where profits include items of income which are dealt with separately in other articles of this convention, then the provisions of those articles shall not be affected by the provisions of this article.
- India Netherlands DTAA has a separate Article provided for taxability of Interest i.e., Article 11. Hence, it would be just and fair to apply Article 11(2) for the purpose of determining taxability.
- Such interest may also be taxed in the contracting state in which it arises and according to the laws of that state, but if the recipient is the beneficial owner of the interest, the tax so charged shall not exceed 10% of the gross amount of the interest.
BDO in India Comments
Grant of treaty benefits to non-residents has always been a subject matter of litigation, especially for cases where the non-resident taxpayer has a Permanent Establishment (PE) in India. The characterisation of income earned by such non-residents on ECB is attributable to business profits and generally taxable at 40% under the Act by the revenue authorities.
This ruling has made a clear distinction on the taxability of interest income from ECBs under the specific Article on interest under the DTAA rather than the business profits. The Mumbai Tax Tribunal has opined that since there is a separate provision i.e., Article 11 for taxability of interest available under the DTAA, the taxpayer should get the benefit of the same.
As far as units in IFSC are concerned, they may continue to get the concessional tax benefits on such income under the existing regime.
This ruling is a welcome judgement as it once gain reinforces the position of applying the principle of ‘specific’ versus ‘general’ and most importantly on the position of availing DTAA benefits for non-residents earning Business Income from a PE in India.
1 DCIT (International Taxation) Vs M/s. Cooperative Rabobank UA, ITA No.2260/Mum/2022 (Mumbai Tax Tribunal)