TMI Blog2022 (6) TMI 953X X X X Extracts X X X X X X X X Extracts X X X X ..... in the hands of the foreign companies is permissible. That approach is inherently flawed. Even if the interest income is connected with the assessee company's permanent establishment, it can only be brought to tax in India, under Article 7, when the interest income is directly or indirectly attributable to the permanent establishment. It is not even the case of the AO that the permanent establishment played any role in the supplier credit, which is the debt claim leading to the impugned interest income, being extended to the Indian customers who have paid interest on the suppliers credit. As such, no part of interest income, by any stretch of logic, can be said to be directly or indirectly attributable to the Indian permanent establishment of the assessee company. As alleged that the Indian parties from whom the assessee has received interest income are also the clients of the assessee in India with whom contracts were executed through the Permanent Establishment in India and the assessee has received fees for technical services in a previous year from them, but then the performance of contracts through the PE or receipt of fees for technical services from such clients i ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... apanese Yen LIBOR plus 0.90%. This interest income was offered to tax at the rate of 10% in terms of the provisions of Article 11(2) of India Japan Double Taxation Avoidance Agreement [(1990) 182 ITR (Stat) 380- as amended from time to time; Indo Japanese tax treaty in short]. When this issue came up for consideration before the Assessing Officer, in the course of scrutiny assessment proceedings, he noted that the assessee admittedly has a permanent establishment in India and that, in terms of the provisions of Article 11(6) of Indo-Japanese tax treaty, the provisions of Article 11(2), which provide for a lower rate of 10%, will not come into play. There is no dispute that the assessee had a permanent establishment in India for the execution of certain projects that the assessee had in India, but the plea of the assessee was that the interest income was earned by the assessee on suppliers credit for funding purchase of Excavator CKD and CBU manufactured by Hitachi Sumitomo Heavy Industries Construction Crane Co Ltd Japan and sold by the assessee company or one of its controlled entities, and that this transaction had nothing to do with the permanent establishment in India. The Ass ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ith whom contracts were executed through the Permanent Establishment in India and assessee has received fees for technical services in a previous year from them. 3. We have heard the rival contentions, perused the material on record and duly considered the facts of the case in the light of the applicable legal position. 4. Let us first take a careful look at the relevant treaty provisions, i.e. Article 11, Article 7 and Article 14, and try to understand the scheme of source jurisdiction taxation of interest income as envisaged therein. These provisions are reproduced below for ready reference: ARTICLE 11- INTEREST 1. Interest arising in a Contracting State and paid to a resident of the other Contracting State may be taxed in that other Contracting State. 2. However, such interest may also be taxed in the Contracting State in which it arises, and according to the laws of that Contracting State, but if the recipient is the beneficial owner of the interest the tax so charged shall not exceed 10 per cent of the gross amount of the interest. 3. Notwithstanding the provisions of paragraph 2, interest arising in a Contracting State shall be taxable only in ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... fixed base situated therein, and the debt-claim in respect of which the interest is paid is effectively connected with such permanent establishment or fixed base. In such case, the provisions of Article 7 or Article 14, as the case may be, shall apply. 7. Interest shall be deemed to arise in a Contracting State when the payer is that Contracting State itself, a political sub-division or a local authority thereof or a resident of that Contracting State. Where, however, the person paying the interest, whether he is a resident of a Contracting State or not, has in a Contracting State a permanent establishment or a fixed base in connection with which the indebtedness on which the interest is paid was incurred, and such interest is borne by such permanent establishment or fixed base, then such interest shall be deemed to arise in the Contracting State in which the permanent establishment or fixed base is situated. 8. Where, by reason of a special relationship between the payer and the beneficial owner or between both of them and some other person, the amount of the interest, having regard to the debt-claim for which it is paid, exceeds the amount which would have been agreed u ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ise for the enterprise. 6. For the purposes of the provisions of the preceding paragraphs of this Article, the profits to be attributed to the permanent establishment shall be determined by the same method year by year unless there is good and sufficient reason to the contrary. 7. 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. Article 14 - INDEPENDENT PERSONAL SERVICES 1. Income derived by a resident of a Contracting State in respect of professional services or other activities of an independent character shall be taxable only in that Contracting State unless he has a fixed base regularly available to him in the Contracting State for the purpose of performing his activities or he is present in that other Contracting State for a period or periods exceeding in the aggregate 183 days during any taxable year or 'previous year' as the case may be. If he has such a fixed base or remains in that other Contracting State for the aforesaid period or periods, the income may be taxed in that Contracting State b ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the source jurisdiction, i.e. India, but only to the extent, such profit is directly or indirectly attributable to that permanent establishment in the source jurisdiction, i.e. in India. What follows is that unless the profit earned by an enterprise in the other jurisdiction is directly or indirectly attributable to that permanent establishment in the source jurisdiction, it cannot be taxed even under article 7. Article 14(1), inter alia, provides that if a person providing independent personal services has a fixed base or remains in that other Contracting State for the aforesaid period or periods, the income may be taxed in that Contracting State but only so much of it as is attributable to that fixed base or is derived in that other Contracting State during the aforesaid period or periods . Therefore, even if a person has a fixed base for providing independent personal services, and an interest income can be said to be connected with the same, it cannot be brought to tax under Article 14(1) unless such an interest income is attributable to that fixed base. What essentially follows is that the mere existence of a permanent establishment in the source jurisdiction cannot, therefor ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... he source jurisdiction taxability of an interest income under Article 11(2) will be ousted because of the enterprise having a permanent establishment in the source jurisdiction, and such an interest income will also not be taxable under article 7(1) as the interest income is not attributable to the permanent establishment or under article 14(1) as the interest income attributable to the fixed base available to the assessee. Such a no man s land between the domain of Article 11(2) vis- -vis Article 7(1), or between Article 11(2) vis- -vis Article 14(1) will be an apparent incongruity. Therefore, the connotations of the expression effectively connected , in respect of Article 11(6) read with Article 7(1), must be such that unless the interest income cannot be held to directly or indirectly attributable to a PE , or attributable to the fixed base of the assessee, the taxation of such an interest income, at a rate higher than article 11(2), does not come into play, and, in such a situation also, such an interest income is to be taxed on a net basis as a part of the business profits or income from independent personal services. Viewed in the light of the above discussions, an interest ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... we have concluded earlier, such a finding is the foundational requirement triggering the exclusion clause under Article 11(6). As far as interest income is concerned, it can happen, for example, when the debt claim in respect of which interest is paid is forming part of the assets of the permanent establishment, when economic ownership of the debt claim is allocated to the permanent establishment or when the permanent establishment plays a critical role in earning of that interest income. None of these conditions is satisfied in the present case, and there is nothing more than the mere existence of a permanent establishment of the assessee company in India, which is being put against the assessee. Unless Article 7 comes into play, the jurisdiction of Article 11(2) is not ousted, Article 7 cannot come into play unless the interest income is directly or indirectly attributable to the permanent establishment, and there is not even an effort, on the part of the revenue, to demonstrate the nexus between the permanent establishment and the interest income. It is only elementary that the onus of establishing the effective connection between the debt claim with the permanent establishme ..... X X X X Extracts X X X X X X X X Extracts X X X X
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