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TMI Blog2011 (5) TMI 562X X X X Extracts X X X X X X X X Extracts X X X X ..... the interest income as business income as against 15% as provided in para 6 of Article 12 of DTAA between India and the UK." Accepting the recommendation, the President constituted a Special Bench on 3.12.2010 to decide the aforesaid question. 1.2 In the course of hearing, it was found that the ground required some verbal change to project the real controversy. Accordingly, after consulting the rival parties, the following question has been drawn up in place of the question referred to the Special Bench by the President:- "Whether, on the facts and in the circumstances of the case, interest on income-tax refund and fixed deposits with the bank is liable to tax with reference to Article 7 read with paragraph no. 4 of Article 11 or paragraph no. 2 of Article 11 of Indo-Australia Double Taxation Avoidance Agreement?" 2. The facts of the case, as mentioned in the assessment order, are that the assessee-company is incorporated under the laws of Australia. The return was filed on 28.11.2003 declaring total income of Rs. 1,49,15,800. The assessee claimed refund of Rs. 2,64,71,450. The return was processed under section 143(1) of the Income-tax Act, 1961 (the Act), on 19.2.2004 and an ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... with the PE, then Article VII comes into operation and the interest income is taxable on a net basis at the rate applicable to a foreign company. The AO is of the view that the indebtedness is effectively connected with the PE as tax has been deducted at source from the business receipts. The ld. CIT(Appeals) has agreed with this view. The Division Bench of the Tribunal, which heard the case initially, is of the view that there is a conflict in decision in the matter in the case of B.J. Services Co. Middle East Ltd. & Pride Foramer France SAS (supra) and, therefore, the question has been referred to the President for constituting a Special Bench. The President has constituted such a bench. After consultation the question has been modified to project the real controversy and the modified question is acceptable to the assessee. 5. He referred to the provision contained in section 90(2) of the Income-tax Act to the effect that where the Central Government has entered into an agreement with the Government of another country outside India or specified territory outside India, as the case may be, under sub-section (1) for granting relief of tax, or as the case may be, avoidance of doubl ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... is concerned, it is indeed a personal one and payment thereof cannot at all be said to be expenditure laid out or expended wholly and exclusively for the purpose of earning income. Reliance has also been placed on the decision of Hon'ble Bombay High Court in the case of CIT v. Samir Diamond Exports Ltd. [2000] 245 ITR 548, in which it is mentioned that there is merit in the contention advanced on behalf of the assessee. Firstly, both the Commissioner of Income-tax (Appeals) as well as the Tribunal have followed the judgment dated January 8, 1993, in the case of Royal Cushions v. CIT (unreported). Secondly, both the above authorities have found that both the items, namely, interest on refunds and interest on loans fall under a different head of income, viz., "Income from other sources". Reliance has also been placed on the decision in the case of Collis Line (P.) Ltd. v. ITO, 'A' Ward, Company Circle, Ernakulam [1981] 135 ITR 390 (Ker.). It is mentioned that the assessee is not a banking company. It had not deposited the money by way of money-lending as a business. That is not its object. The interest arose from amounts deposited in bank otherwise than by way of business. The amount ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... in the course of carrying on the business. Accordingly, under the Act the assessee is liable to be taxed on the amount under the residuary head and not under the business head. In view thereof, the indebtedness cannot be said to be effectively connected with the business carried on by the PE. The domestic law is equally applicable to the assessee and, therefore, it cannot be said that the indebtedness is connected with the PE of the assessee. Further, the assessee is entitled to the beneficial provision of or interpretation under the domestic law in view of the provision contained in section 90(2) of the Act. 6. Coming to the DTAA, the ld. counsel explained the contents of Article XI dealing with taxation of "interest". We will paraphrase the relevant paragraphs of the article, which have been referred to by the ld. counsel, taking into account the facts of our case. Paragraph no. 1 provides that the interest arising in India to which the assessee is beneficially entitled may be taxed in Australia. Paragraph no.2 provides that such interest may also be taxed in India, according to the laws of India, but the tax so charged shall not exceed 15% of the gross amount of the interest. ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... therefore, it cannot be brought within the purview of article 8. A reference was made to the ruling of Authority for Advance Rulings in ABC [1999] 236 ITR 637, being a U.K company, in which it has been held that the interest amount in dispute has not arisen out of any business operation in India. It is the statutory interest granted on delayed refund under the provisions of the Act. There cannot be any dispute that the interest has been paid on delayed refund. Refund due and payable to the assessee is the debt owed and payable. The debt-claim is not connected in any way with any activity of the PE or base in India. The right to get interest arises because of delay in making refund of the excessive collection of tax. This is clearly a case falling under paragraph no. 2 of Article 12 of the U.K. DTAA. In the decision, it has been mentioned in paragraph no. 11 that the Authority is reminded of the maxim "generalia specialibus non derogant", according to which a special provision overrides the general provision. Therefore, the mandate of an article dealing with a distinct item of income has overriding effect over that of general article. Adverting to the facts of the case, it has been ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the debt-claim is allocated to the PE. In this very connection, our attention has been drawn to the extract of OECD commentary furnished by Shri D.P. Mittal in his book, which is the same in content as mentioned above. It has also been submitted that the words "effectively connected with" have not been defined either in the DTAA or the Act. However, our attention has been drawn towards the USA analysis, in which it is mentioned that in general, U.S. treaties expressly exclude from the scope of interest article interest that is attributable to or effectively connected with either the PE in the source Contracting State through which the obligor carries on business, or a fixed base from which the obligor performs independent personal services. Such interest is considered taxable under the Business Profits or Independent Personal Services articles. This standard is substantially stricter than that in Article 11(4) of the U.N. Model treaty, under which interest that is effectively connected with business activities carried on in the source State that are of the same or a similar kind as those effected through a permanent establishment are taxable as business profits. The term "attribut ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... es" is significant and should be given due weight. It is not enough that there is a PE of the non-resident in the source country carrying out some activities in connection with the project or the work. The PE may be effectively connected with the project and the contract from a broader prospective but the connection contemplated by paragraph no. 4 of Article XII is in respect of services that fall within the purview of royalty. The PE or the fixed base set up in the source country should be engaged in the performance of royalty generating services, irrespective of what other activities it performs. At least, it should facilitate the performance of such services. The terminology "effective connection" denotes a real and intimate connection. Coming to the facts of the case, it is mentioned that it has to be ascertained whether the PE set up in India in connection with pipelines project work is effectively connected with the services performed by the applicant under the two agreements. On a deep consideration, the AAR are of the view that the applicant has not been able to make out the effective connection in the sense in which it has been explained earlier. It has further been mentio ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... not covered under any other provisions. If at all any analogy can be drawn from the Act, it could be only between Article XXII of the DTAA and the residuary head of income in the Act. 7.2 Coming to the treaty, it is elaborated that the expression used is to the effect that indebtedness is effectively connected with the PE and not that the interest income is effectively connected with the PE. As mentioned earlier, the debt arose because of tax deduction at source from the business receipts of the PE. Therefore, if the FAR analysis is carried out, the asset will have to be allocated to the PE. Accordingly, it can be very well said that economic ownership of the debt lies with the PE. Thus, asset-test is satisfied in this case. Further, since the tax was deducted from the business receipts of the assessee, even the activity-test stands satisfied because it was in the course of the business transactions of the assessee that the debt arose. Accordingly, it is argued that both the tests are satisfied. 7.3 It is submitted that the taxation of interest-receipt does not depend upon the reason on account of which the income arose. It may be due to delay on the part of the revenue to grant ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... x refund amounting to Rs. 61,04,944 from the income-tax department. It also received a sum of Rs. 13,899 as interest from the bank on the fixed deposits placed with it. No dispute has been raised by the ld. counsel in respect of the bank interest. Therefore, the only question left now is-whether, the sum of Rs. 61,04,944 is taxable on gross basis @ 15% or on net basis at the rate applicable to a foreign company? 10. We may deal with the question from the stand point of section 90(2) of the Act. The provision reads as under:- "(2) Where the Central Government has entered into an agreement with the Government of any country outside India or specified territory outside India, as the case may be, under sub-section (1) for granting relief of tax, or as the case may be, avoidance of double taxation, then, in relation to the assessee to whom such agreement applies, the provisions of this Act shall apply to the extent they are more beneficial to that assessee." 10.1 The gist of the provision is that in a case where the provisions of the DTAA apply to an assessee, the provisions of this Act shall apply to the extent they are more beneficial to that assessee. According to us, it will beco ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ordinary circumstances paragraph no. 2 would have been made applicable. However, in terms of paragraph no. 6 of Article XII, the provisions of paragraph no. 2 shall not be applicable if the beneficial owner of the interest carries on business in India, in which interest arises through a PE situated in India and the debt-claim in respect of which interest is paid is effectively connected with such PE in India. As the factual position regarding "effective connection" was not under dispute, it was but natural for the Tribunal to come to the conclusion that Article XII (6) shall be applicable read with Article VII. However, in this case, the factual position regarding "effective connection" is under dispute. In the case of Pride Foramer France SAS, the assessee had received interest on income-tax refund. It was pleaded that no conscious effort was made through the PE to earn the interest except for pursuing the matters before the authorities. It was further pleaded that as the interest was sui generis, it could not be considered within the purview of Article XII(5). The Tribunal mentioned that Article XII of the DTAA with UK and France are in pari-materia. There is no dispute that the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... erest. 3. The term "interest" in this Article includes interest from Government securities or from bonds or debentures, whether or not secured by mortgage and whether or not carrying a right to participate in profits, and interest from any other form of indebtedness as well as all other income assimilated to income from money lent by the law, relating to tax, of the Contracting State in which the income arises, but does not include interest referred to in paragraph (1) of Article 8. 4. The provisions of paragraphs (1) and (2) shall not apply if the person beneficiary entitled to the interest, being a resident of one of the Contracting States, carries on business in the other Contracting State, in which the interest arises, through a permanent establishment situated therein, or performs in that other State independent personal services from a fixed base situated therein, and the indebtedness in respect of which the interest is paid is effectively connected with such permanent establishment or fixed base. In such a case, the provisions of Article 7 or Article 14, as the case may be, shall apply. 5. Interest shall be deemed to arise in a Contracting State when the payer is that Sta ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... poration Ltd., the decision is that the interest earned on share money is chargeable to tax under the residuary head. The case of the ld. counsel, on the basis of the aforesaid jurisprudence, is that interest received by the assessee on income-tax refund is not the business income. Similar consideration will be applicable while interpreting paragraph no. (4) of Article XI in respect of the words "effectively connected with such permanent establishment". On the other hand, the case of the ld. DR is that paragraph no. (4) overrides paragraph nos. (1) and (2) of this article. The assessee has a PE in India. The indebtedness arose as tax was deducted from the business receipts of the PE and, therefore, on asset-test the indebtedness is effectively connected with the PE. Similar provision exists in the U.K. and France DTAAs. It is further argued that the provision contained in paragraph no. (4) read with Article VII cannot be equated with the provisions contained in Chapter IVD regarding "profits and gains of business or profession". If that is done, the paragraph no. 4 will become redundant. The real test is not whether the interest is business income or not, but whether the indebtedne ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... y down the law in entirety as it misses the point mentioned above. The case of B.J. Services Co. Middle East Ltd., (supra) does not help us in deciding this issue as in that case there was no dispute that-(i) the assessee is a non-resident having PE in India; (ii) the assessee is carrying on business in India a through a PE situated in India; and (iii) the interest is effectively connected with such PE in India. However, this decision does not proceed on the footing that only that interest which is part of the business profits can be brought within the ambit of paragraph no. (4). In the case of Worley Parsons Services Pte. Ltd. (supra), the ruling is that for bringing to tax the royalties received under Article VII read with Article XII, there must be effective connection between the earning of the income and the PE or the fixed base. This ruling also does not help us incoming to appropriate conclusion for the reason that royalty is, in general, the business income, although taxable at concessional rate in absence of PE or its effective connection with the PE or the fixed base. Such is also the position in the case of Sumitomo Corporation (supra). In the case of Hapag & Loyd Contai ..... X X X X Extracts X X X X X X X X Extracts X X X X
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