2012 (4) TMI 206 - AT - Income Tax

India-US DTAA - Tax on interest on refund of income tax - AO applied 40% rate of tax - Held that - the use of the expression attributable to in the Indo-USA DTAA has therefore to be understood either as equal to effectively connected or as having a narrower meaning than the word effectively connected - the said technical explanation is in the context of attribution of profits of the PE and is relevant to taxation of an Indian enterprise having PE in USA - the case of the Assessee would stand squarely covered in favour of the Assessee by the decision of the Special Bench in the case of Asstt. CIT v. Clough Engineering Ltd. 2011 -TMI - 210052 - ITAT, DELHI -- the interest income on income tax refund is to be charged to tax only under Article 11 (2) of the Indo-USA DTAA and not under Article 11(5) thereof - in favour of assessee.

Summary

Issues Involved: Taxation of interest income on income tax refund under Article 11(2) vs. Article 11(5) read with Article 7 of the India-US DTAA.

Detailed Analysis:

Background and Appeals:
The case involves two appeals concerning the tax treatment of interest income received by a non-resident company, incorporated in the USA, on an income tax refund. The Assessee appealed against the application of a 40% tax rate by the AO, which was confirmed by the CIT(A), arguing that the interest should be taxed at 15% under Article 11(2) of the India-US DTAA. Conversely, the Revenue appealed against the CIT(A)'s decision that the interest income falls under Article 11(2), asserting it should be taxed under Article 11(5) read with Article 7.

Key Issue:
The primary issue is whether the interest income should be considered under Article 11(2) of the India-US DTAA, which taxes interest at 15%, or under Article 11(5) read with Article 7, which applies a 40% tax rate if the interest is attributable to a permanent establishment (PE) in India.

Reference to Special Bench Decision:
The tribunal referred to the Special Bench decision in Asstt. CIT v. Clough Engineering Ltd., which dealt with a similar issue under the Indo-Australian DTAA. The Special Bench ruled that the critical factor is whether the indebtedness is effectively connected with the PE. It concluded that interest on income tax refunds is not effectively connected with the PE, as it arises from tax deducted at source from business receipts, which is an appropriation of profit rather than an expenditure for earning income.

Arguments and Interpretations:
The Revenue argued that the term "attributable to" in the India-US DTAA has a broader scope than "effectively connected" and should include the interest income as connected with the PE. They relied on interpretations under the Income Tax Act, 1961. However, the Assessee countered with Klaus Vogel's commentary and the Technical Explanation of the India-US DTAA, which suggest that "attributable to" should be interpreted similarly to "effectively connected" or even more narrowly.

Tribunal's Conclusion:
The tribunal agreed with the Assessee, noting that the term "attributable to" in the India-US DTAA should be construed as equivalent to "effectively connected." This interpretation aligns with Klaus Vogel's commentary and the Technical Explanation, which indicate that the term avoids technical issues under US domestic law but does not broaden the scope beyond "effectively connected." Consequently, the tribunal held that the interest income on the income tax refund should be taxed under Article 11(2) of the India-US DTAA at 15%, not under Article 11(5).

Final Judgment:
The tribunal allowed the Assessee's appeal, confirming that the interest income is taxable at 15% under Article 11(2) of the India-US DTAA. The Revenue's appeal was dismissed, affirming that the interest income is not attributable to the PE and thus not subject to the higher tax rate under Article 11(5) read with Article 7.

Result:
- The Assessee's appeal is allowed.
- The Revenue's appeal is dismissed.