In a multinational framework, it is common that one of the group entities stand as surety / guarantor for another group entity or its subsidiary – Indian or otherwise, sometimes for a charge. When given to an Indian entity, it may be required to pay charges to the guarantor. The Revenue Authorities have tried bringing guarantee charges to tax in India either by regarding it as Interest or as fees for technical services or as other income. The judiciary is also divided on this.
Recently the Delhi Tribunal had an occasion to examine the taxability of guarantee fee under the India-Netherlands Double Tax Avoidance Agreement (DTAA). We, at BDO in India, have summarised the ruling of Delhi Tribunal and provided our comments on the impact of this decision.
Facts of the case
The taxpayer, a private company, is engaged in the business of leasing of motor vehicles, financial services and fleet management. It is a subsidiary of Netherland based bank - Lease Plan Corporation NV (LP NV). Pursuant to tripartite agreement between the banks (credit), the principal debtor (taxpayer) and the guarantor (LP NV), the taxpayer availed loan facilities from banks in India. As per this agreement, the guarantor was to pay any amount due on a loan instrument in the event of default by the taxpayer. For this, the taxpayer paid guarantee charges to LP NV.
During the course of assessment proceedings, the tax officer observed that while in the tax audit report guarantee is shown as disallowable for not withholding taxes from the payment, no such disallowance has been made by the taxpayer. The Tax Officer treated guarantee charges by treating them to be taxable either as interest or fees for technical services as defined in Article 11 and Article 12 of India-Netherlands DTAA respectively. Hence, the tax officer disallowed guarantee charges under section 40(a)(i) of the Income-tax Act, 1961 (IT Act) for non-deduction of tax. The First Appellate Authority upheld the disallowance made by the tax officer. Aggrieved by the decision of the Authority, the taxpayer filed an appeal before the Tax Tribunal.
Tribunal considered the submissions made by the taxpayer and Revenue Authority. After going through the guarantee agreement and relying on various judicial pronouncements (including the decision of United States Tax Court), the Tribunal held that the guarantee charges are neither taxable as Interest nor as fees for technical services. While rendering the judgement, the Tribunal observed that:
- To consider income as ‘interest’, firstly there should be ‘debt’ and there should be a ‘claim’ on that debt and ‘form’ which income should arise to qualify as ‘interest’. Thus, two criteria that need to be satisfied:
- Provision of capital and
- It should be in form of debt claim.
- In instant case, LP NV has not provided any capital to taxpayer. Also, there is no ‘debt claim’ as no existence of debtor-creditor relationship (lender-borrower). In view of this, guarantee charges paid to LP NV cannot be covered in the definition of interest under Article 11 of India-Netherlands DTAA.
- Article 12 of India-Netherlands DTAA contains make available clause. The nature of ‘service’ provided by LP NV in providing guarantee is a financial service and can by no stretch of imagination be called ‘consultancy service’. Even otherwise it does not cross the threshold of ‘make available’ under clause 5 of Article 12 of the DTAA. Thus, Tribunal held that guarantee charges cannot be considered as FTS.
- Since India-Netherlands DTAA does not have other income article, the Tribunal did not give its observation on taxing it under other income and treated the guarantee fee as taxable under business income.
This decision will give clarity to guarantee fees paid to Netherlands’ entity by an Indian entity. While this decision could be helpful for matters involving make available clause, it remains to be seen how the taxation occurs for treaties having Article for ‘Other Income’, especially in light of Delhi Tribunal decision in the case of Johnson Mathey wherein it was held that guarantee fees is neither interest not FTS and also not business income but chargeable in terms of Article 23 Other Income of India-UK DTAA.
 Lease Plan India Pvt Ltd vs DCIT (ITA no 6461 & 6462/DEL/2015)
 Container Corporation Versus Commissioner of Internal Revenue of United States Tax Court Report [134 T.C. 122 (U.S.T.C. 2010) 134 T.C.]
 Johnson Mathey Public Limited Company vs DCIT (International Taxation) [88 taxmann.com 127]