2022 (11) TMI 1445 - AT - Income Tax

Taxability of interest on income tax refund received - CIT(A) upholding the assessment order taxing the interest on income tax refund as business income u/A 7 of the India- Malaysia DTAA @40% surcharge @ 5% cess @ 3% - contention of the assessee is that such interest is taxable under Article -11(2) of the DTAA @10%. HELD THAT - We find that issue of taxability of interest on income tax refund was considered by the Special Bench in the case of Clough Engineering Ltd. 2011 (5) TMI 562 - ITAT, DELHI held that interest on income tax refund would be taxable under Article-11 and not as business profits connected with the PE of assessee. Also see Hon'ble Bombay High Court in the case of DIT vs. Credit Agricole Indosuez 2015 (6) TMI 974 - BOMBAY HIGH COURT . We find merit in ground of appeal by the assessee. Accordingly, the Assessing Officer is directed to tax interest on income tax refund under Article 11(2) of India- Malaysia DTAA. Consequently, ground no.1 to 3 of appeal are allowed.

Summary

Issues:
1. Taxability of interest on income tax refund under the India-Malaysia Double Taxation Avoidance Agreement (DTAA).
2. Applicability of Article 7 versus Article 11(2) of the DTAA.
3. Initiation of penalty proceedings under section 271(1)(c) of the Income Tax Act.

Issue 1: Taxability of interest on income tax refund under the India-Malaysia DTAA:
The appellant contested the taxability of interest on income tax refund under Article 7 of the DTAA, arguing that it should be taxed at a lower rate of 10% under Article 11(2) of the DTAA. The appellant relied on the decision of the Special Bench in the case of Clough Engineering Ltd., which held that such interest should be taxed under Article 11 and not as business profits connected with the Permanent Establishment (PE) of the assessee. The Tribunal referred to the findings of the Special Bench, emphasizing that interest on income tax refund is not effectively connected with the PE, concluding that it should be taxed under Article 11(2) of the DTAA.

Issue 2: Applicability of Article 7 versus Article 11(2) of the DTAA:
The Tribunal analyzed the applicability of Article 7 and Article 11(2) of the DTAA concerning the taxability of interest on income tax refund. The Tribunal referred to the decision in Clough Engineering Ltd. and highlighted that interest on income tax refund is not effectively connected with the PE, thus falling under the provisions of Article 11(2) for taxation. The Tribunal also cited the decision of the Hon'ble Bombay High Court in a related case, which supported the taxation of such interest under the relevant clause of the DTAA. Consequently, the Tribunal directed the Assessing Officer to tax the interest on income tax refund under Article 11(2) of the India-Malaysia DTAA, allowing the appeal on this ground.

Issue 3: Initiation of penalty proceedings under section 271(1)(c) of the Income Tax Act:
The appellant challenged the initiation of penalty proceedings under section 271(1)(c) of the Income Tax Act. However, the Tribunal deemed the challenge premature at this stage, leading to the dismissal of ground No.4 of the appeal regarding penalty proceedings. As a result, the appeal was partly allowed, with the Tribunal directing the tax treatment of interest on income tax refund under the applicable clause of the DTAA while dismissing the challenge to penalty proceedings.

In conclusion, the Appellate Tribunal ITAT Mumbai, in its judgment, addressed the taxability of interest on income tax refund under the India-Malaysia DTAA, clarifying the applicability of Article 7 versus Article 11(2) based on relevant precedents and legal provisions. Additionally, the Tribunal considered the premature challenge to penalty proceedings under the Income Tax Act, ultimately allowing the appeal in part and providing specific directives for the tax treatment of the interest income.