TMI Blog2011 (5) TMI 562X X X X Extracts X X X X X X X X Extracts X X X X ..... e from the business receipts of the PE - sense that it has arisen on account of tax deduction at source from the receipts of the PE - The bank interest in this case is an example of effective connection between the PE and the income as the indebtedness is closely connected with the funds of the PE - Appeal is partly allowed - ITA NO. 4771(DELHI)/2007 - - - Dated:- 6-5-2011 - ORDER K.G. Bansal, Accountant Member ‑ One of the grounds in the appeal of the assessee is that "on the facts and in the circumstances of the case and in law, the Commissioner of Income-tax (Appeals) [hereinafter referred to as 'CIT(A)'] has erred in treating the interest income as business income directly connected with Permanent Establishment and taxing the same CIT(A) has thereby erred in ignoring the provisions of Tax Treaty between India and Australia." 1.1 These appeals were heard by the Division Bench of the Delhi Tribunal on 21.1.2010. It was concluded that apparently there is a conflict in the decisions taken by the Tribunal in the case of Assistant CIT v. Pride Foramer France SAS [2008] 116 TTJ (Delhi) 369, and B.J. Services Co. Middle East Ltd. v. CIT, on this issue. Therefor ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... interest has been paid on the refund of tax deducted at source, made from the business receipts and, thus, it is directly connected with the business receipt. 2.2 The matter was agitated before the CIT(Appeals)-I, Dehradun. In the operative portion of his order in paragraph no. 5.2, it has been mentioned that it is an admitted fact that the assessee-company is carrying on business through the Permanent Establishment (the PE) in India. The interest income is not covered by the provision contained in section 44BB of the Act. Therefore, it has been held that the AO was right in taxing the interest income as business income. 3. Before us, the ld. counsel for the assessee has submitted that the total income of Rs. 1,49,15,800 returned by the assessee inter-alia includes interest of Rs. 61,04,944 received from the Income-tax department and Rs. 13,899 received from the bank. No dispute has been raised regarding taxability of bank interest under Article VII read with paragraph no. 4 of Article XI of the DTAA. This leaves us with the taxation of interest of Rs. 61,04,944 received from the Income-tax department. 4. The ld. counsel briefly summarized the history of the case. It is submi ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... nner as may be determined from time to time. Therefore, it may be open to the assessee-company to carry on the business of investing and dealing with the funds upon securities or otherwise. However, the question in this case is as to whether the assessee company had carried out such a business as a matter of fact. When examined in this light, it is found that it has not commenced business and, therefore, amounts not immediately required in the business have been invested for earning interest income. The receipt of interest is incidental to the deposits. The finding of the Tribunal is that the deposit of the share capital has not been made with the bank in the course of business. Therefore, it has been held that the interest amount is taxable under the residuary head. Further, reliance has been placed on the decision of 'A' bench of Bangalore Tribunal in the case of Atria Power Corpn. Ltd. v. Dy. CIT [2011] 128 ITD 322, dealing with interest earned on income-tax refunds. It has been held that the same is taxable under the residuary head and not as a part of profits and gains of the power-generation business. This decision referred to the observations of the Hon'ble Supreme Court in ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... rying on the business, it is not sufficient to look at the memorandum of association only but to find out whether the act done was in pursuance of the objects enumerated in the memorandum. Therefore, it is necessary to see whether the objects have been pursued. On the facts, it cannot be urged that the bare fact that the assessee deposited money in the bank is by itself sufficient to show that the deposits were made with a view to carry on the business. Accordingly, it has been held that the interest received by the assessee is chargeable under section 56 as income from other sources. 5.2 Our attention has also been drawn towards the provision contained in section 2(28A) where the term "interest" has been defined to mean interest payable in any manner in respect of any monies borrowed or debt incurred (including a deposit, claim or other similar right or obligation) and includes any service fee or other charge in respect of monies borrowed or debt incurred or in respect of any credit facility, which has not been utilized. Therefore, it is contended that interest received from Income-tax Department falls within the definition. 5.3 The case of the assessee on the basis of the afo ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... interest arises is effectively connected with the PE. The case of the ld. counsel is that the payment of tax is the responsibility of the foreign company and not that of the PE. Therefore, the PE is not the creditor of the income-tax department. Accordingly, the indebtedness is not effectively connected with the PE. 6.1 In this connection, reliance has been placed on the decision of "L" Bench of Mumbai Tribunal in the case of M/s. Hapag Lloyd Container Linie GmbH for assessment year 2004-05 in ITA No. 6214/Mum./2007 dated 27.12.2010, a copy of which has been placed in the paper book (2/3) on pages 59 to 74. The question before the Tribunal was-whether, the CIT(Appeals) erred in holding that interest of Rs. 12,44,428 granted on income-tax refund is covered by Article 11 of the DTAA and, therefore, taxable in India? The question was raised in a situation where the case was covered under Article 8 of the Tax-Treaty between India and Germany. It has been mentioned that interest on funds which are connected with operation of ships or aircraft in international traffic is covered within the ambit of paragraph (3) for assuming the character of profit from operation of ships or aircraft ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... tention has been drawn towards the OECD commentary on the model convention. It is mentioned therein that certain states consider that dividends, interest and royalties arising from sources in their territory and payable to individuals or persons who are residents of other States fall outside the scope of the arrangement made to prevent them from being taxed in both the States. Paragraph no. 4 is not based on such a conception which is sometimes referred to as "the force of attraction of the permanent establishment". It does not stipulate that interest arising to a resident of a Contracting State from a source situated in the other State, must by a kind of legal presumption or fiction, be related to a permanent establishment which that resident may have in the latter State, so that the said State would not be obliged to limit its taxation in such a case. The paragraph merely provides that in the State of source the interest is taxable as a part of profits of the PE, if it is paid in respect of debt-claims forming part of the assets of the PE or otherwise effectively connected with that PE. In that case, paragraph no. 4 relieves the State of source of the interest from any limitation ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... rest, which is the business-activities test. Thus, it is argued by the ld. counsel that for determining whether the indebtedness is effectively connected with the PE one of the two tests need to be satisfied. However, if all interest incomes are brought to taxation under Article VII, it will create anomaly in the sense that paragraph nos. (1) and (2) will be left with no content. Further, under Article VII only that profit is taxed as business profit which is attributable to the PE. In order to support this contention, a reference has been made to paragraph no. 60 of the decision in the case of Sumitomo Corpn. v. Dy. CIT [2007] 114 ITD 61, in which it is mentioned that the term "effectively connected" used in Article XII(5) of the DTAA is not to be construed as the opposite of "legally connected", but in the sense of something "really connected". This connection has to be seen not in form but in real substance. The income-producing activity should be closely connected in terms of relationship besides being connected economically also with the PE. Reliance is also placed on the ruling of Authority for Advance Rulings in the case of Worley Parsons Services (P.) Ltd. [2009] 312 ITR 27 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... t has not arisen out of the business transactions, but it is also a fact that tax was deducted from the monies receivable in the course of the business of the PE and, therefore, there is a direct nexus of the indebtedness with the assets of the business. 7.1 Coming to the analogy taken from the domestic law, it is submitted that if the assessee opts to be taxed under the DTAA, the classification of income is not required to be done under the five heads. In fact, no head of income has been prescribed under the treaty. Therefore, it cannot be said that the provisions contained in paragraph no. 2 of Article XI are analogous to the provisions contained in the Act regarding computation of income under the residuary head. Elaborating further, it is submitted that if such an analogy is to be adopted, it should be carried to its logical conclusion. Under the domestic law, the rate of tax is the same for business head and the residuary head of income. However, if the interest is to be assessed under Article XI (2), it will get taxed on a gross basis at the rate of 15%. If it is to be taxed under Article VII read with Article XI(4), the normal rate of tax will be applicable on the net inco ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... urged that the case of lower authorities regarding taxation under Article VII read with Article XI(4) may be upheld on the ground of economic ownership of the asset held by the PE. 7.4 It is further submitted that cases dealing with "Royalties" under Article XII are not applicable under Article XI. 8. In the rejoinder, the ld. counsel clarified that there is no question of opting for taxation under the DTAA section 90(2) of the Act provides in express-terms that if any provision of the Act is more beneficial to the assessee, the same shall be given effect to. It was further clarified that provisions of Article XII are analogous to provisions of Article XI and, therefore, it will not be correct to argue that the cases dealing with royalty or fees for technical services are not applicable. The ratio of these cases shall be applicable mutatis mutandis to the provisions contained in Article XI. It is also clarified that the treaty does not contain heads of income. The scheme is that prescription has been made in respect of certain incomes and what is not covered under the prescription is to be considered under Article XXII. Since there is no effective connection between the PE and ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... treaty and under the Act, it will be found that tax payable under the Act is more than the tax payable under the treaty. Accordingly, the aforesaid provision will come to the aid of the assessee to come to an automatic conclusion, without exercise of any option, that it should get the benefit under the DTAA. No other consideration is material for this purpose as ultimately what is to be seen is whether the provisions of the Act are more beneficial to the assessee or not. Accordingly, it is held that the assessee is entitled to the benefit under the treaty. 11. Coming to the treaty, the facts are that the tax was deducted at source from the business receipts of the PE. Therefore, indebtedness is connected with the PE. However, the treaty uses the words "effectively connected with the PE". The question was referred to the Special Bench for the reason that there is an apparent conflict of views in the case of Pride Foramer France SAS B.J. Services Co. Middle East Ltd. (supra). The admitted position in the case of B.J. Services Co. Middle East Ltd. is that no dispute existed on the facts that-(a) the assessee is a non-resident having a PE in India; (b) the assessee is carrying on t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the fund and when there is a delay in granting refund, the assessee gets the interest. Therefore, the case of the assessee was accepted by mentioning that it was not business income but income from other sources. We find that the assessee had disputed the existence of effective connection between the PE and the interest. However, the Tribunal allowed the appeal by drawing analogy from various heads of income. We are of the view that such analogy is not appropriate. The reason is that if aforesaid decision is accepted, only that interest which is in the nature of business income will go out of the purview of paragraph no. 4 of Article XI of the DTAA. This is not the intent of the paragraph. Therefore, we will have to examine as to whether the test of effective connection is satisfied in this case or not. And this brings us to the provisions of the DTAA and jurisprudence thereon. 11.1 Before proceedings with the determination of the issue, the provisions of Article XI of the DTAA are reproduced below:- "Article XI-Interest-1. Interest arising in one of the Contracting States, being interest to which a resident of the other Contracting State is beneficially entitled, may be taxed ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... been agreed upon by the payer and the person so entitled in the absence of such relationship, the provisions of this Article shall apply only to the last-mentioned amount. In that case, the excess part of the amount of the interest paid shall remain taxable according to the law, relating to tax, of each Contracting State, but subject to the other provisions of this Agreement." 11.2 In the case of Traco Cable Co. Ltd. (supra), the decision under the Act is that for an income to be business income, the actual activities and not the clauses of memorandum of association have to be looked into. In the case of Ataria Power Corporation Ltd., it has been held that the interest earned on income-tax refund is assessable under the residuary head and it does not form part of profits and gains of power-generation business. In the case of Samir Diamond Exports Ltd. (supra), it has been held that interest on refund and loans are taxable under the residuary head and, therefore, do not form part of the profits of the business computed for the purpose of the deduction under section 80HHC. In the case of Collis Line (P.) Ltd., it has been held that the main purpose of deposit was to keep idle money ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ithin the ambit of Article VII without even taking recourse of paragraph no. 4. Therefore, this paragraph contemplates a different condition upon whose satisfaction interest becomes taxable under Article VII. It is an accepted canon of interpretation that no part of the statute should be rendered null and void by interpretation. Therefore, some meaning has to be placed on the contents of this paragraph. Accordingly, we proceed with the other cases relied upon by the rival parties. 11.3 In the case of Pride Foramer France SAS (supra), it was held that interest on income-tax refund was sui generis and it was neither derived from nor attributable to the business activities of the assessee. It was also contended that the assessee is not in the business of obtaining income-tax refund and earning interest thereon. Therefore, it was held that the same is taxable under the residuary head of income under the Act. Consequently, it was concluded that the same cannot be related to the activity of the PE. We have already held that paragraph no. (4) brings within its ambit not merely the interest earned from the business but something more, i.e., interest on indebtedness which is effectively c ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ponsibility to pay the tax lies on the shoulders of the assessee-company from the final profit ascertained as on the last date of the previous year and on closing the books of account. It is for the company to pay the tax from any source available with it. It so happened in this case that the tax got automatically deducted from the receipts of the PE by operation of law. Such collection of tax by force of law would not establish effective connection of the indebtedness with the PE as ultimately it is only the appropriation of profit of the assessee company. However, we may add that we do not venture to say that the interest income has to be necessarily business income in nature for establishing the effective connection with the PE because that would render provision contained in paragraph 4 of Article XI redundant. Thus, there may be cases where interest may be taxable under the Act under the residuary head and yet be effectively connected with the PE. The bank interest in this case is an example of effective connection between the PE and the income as the indebtedness is closely connected with the funds of the PE. However, the same cannot be said in respect of interest on income-t ..... X X X X Extracts X X X X X X X X Extracts X X X X
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