2023 (1) TMI 1337 - HC - Income Tax

Accrual of income in India - income from External Commercial Borrowings ( ECB ) - claim of exemption u/s 90 r/w Article 11 of the DTAA as the company was carrying on bona fide banking business in Mauritius - ITAT allowed assessee's appeal and by the impugned order held that the interest income on securities was exempt from tax in India under Clause (c) of Article 11(3) of the DTAA - whether assessee in involved in bonafide banking activity? - Revenue's case is that Clause (c) of Article 11 of the DTAA will not apply to assessee. This is because assessee does not have a banking business license from the Reserve Bank of India. HELD THAT - To fall under Clause 3(c) of Article 11 of the DTAA, assessee need not have to be carrying on banking business in India. Assessee should only be a resident of Mauritius and must be carrying on bona fide banking business in Mauritius. We have to note that in the draft assessment order dated 30th March 2015 passed under Section 144C (1) r/w Section 143(3) of the Act, the AO while granting exemption to the interest on ECB has accepted that assessee is carrying on bona fide banking business in Mauritius. So also in the final assessment order dated 28th January 2016. Therefore, the fact that assessee is carrying on a bona fide banking business in Mauritius is not disputed. Under Article 11(3) of the DTAA interest arising in a contracting state (in this Case India) shall be exempt from tax in that State (in India) provided it (the Income) is derived and beneficially owned by any bank carrying on a bona fide banking business which is a resident of the other contracting State (Mauritius). Therefore, so long as assessee is carrying on bona fide banking business in Mauritius being a resident of Mauritius, the interest that assessee would earn in India shall be exempt from tax in India. If we have to accept, what DR submitted, that assessee should have had a banking license from the Reserve Bank of India, then what would be applicable is Clause 6 of Article 11 of the DTAA and that has not been relied upon by the AO. Moreover, the AO has, as noted earlier, granted exemption to the interest on FCB by accepting that assessee is carrying on bona fide banking business in Mauritius. No infirmity in the order passed by the ITAT. No substantial question of law.

Issues:
1. Interpretation of Double Taxation Avoidance Agreement (DTAA) regarding exemption of interest income on securities.
2. Determination of whether the assessee is involved in bona fide banking activities.
3. Analysis of the ITAT's decision regarding the exemption of interest income in India under the DTAA.
4. Consideration of the requirement of a banking license from the Reserve Bank of India for claiming exemption under the DTAA.

Issue 1: Interpretation of DTAA regarding exemption of interest income on securities
The appellant appealed under Section 260A of the Income Tax Act, challenging an order by the ITAT regarding the exemption of interest income earned on securities in India. The respondent, a Limited Liability Company from Mauritius, claimed the income as exempt under Article 11(3) of the DTAA. The AO initially disallowed the claim but accepted the exemption on income from External Commercial Borrowings (ECB) as the company was engaged in bona fide banking business in Mauritius.

Issue 2: Determination of bona fide banking activities
The ITAT allowed the appeal, holding that the interest income on securities was exempt under the DTAA. The proposed substantial questions of law raised concerns about the assessee's involvement in bona fide banking activities, the requirement of financial documentation, and the lack of a banking license in India. However, the ITAT recalled certain aspects and focused on the remaining questions.

Issue 3: ITAT's decision on exemption of interest income under DTAA
The ITAT ruled that the assessee, being a resident of Mauritius engaged in bona fide banking business there, was entitled to exemption under Article 11(3)(c) of the DTAA. The judgment emphasized that the assessee need not have a banking license from the Reserve Bank of India to qualify for the exemption, as long as it conducts bona fide banking activities in Mauritius.

Issue 4: Requirement of a banking license for exemption under DTAA
The Revenue argued that the assessee should have a banking license from the Reserve Bank of India to qualify for exemption under the DTAA. However, the judgment highlighted that the AO had already accepted the assessee's bona fide banking business in Mauritius for granting exemption on ECB income. Therefore, the absence of an RBI banking license did not invalidate the assessee's claim for exemption.

In conclusion, the High Court upheld the ITAT's decision, stating that no substantial question of law arose, and dismissed the appeal. The judgment clarified the interpretation of the DTAA provisions, emphasizing the requirement of bona fide banking activities in the assessee's resident country for claiming exemption on interest income in India.

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