2022 (6) TMI 953 - AT - Income Tax

Income accrued in India - taxation of interest income - assessee is a company incorporated and fiscally domiciled in the Republic of Japan - streams of income from its India operations - income from its permanent establishment in India - HELD THAT - Taxability under Article 7 or Article 14 is a sine qua non for triggering the exclusion clause under Article 11(6). There is no finding to or even indication of that effect. Unless the AO gives that finding excluding interest income from gross basis taxation under Article 11(6) cannot come into play. In any event triggering of exclusion under Article 11(6) does not by itself result in taxation of interest income at the normal rate of tax-unless the interest income is taxable under Article 7(1) or under Article 14(1). AO has simply proceeded on the basis that since the assessee has a permanent establishment in India it can be said to be connected with such a PE and accordingly taxation at the normal rate at which business profits are taxed 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 is irrelevant as long as the interest income is not demonstrated to be attributable to the permanent establishment. Such an attribution cannot be inferred or assumed; there has to be cogent material to establish the fact that the income in question i.e. interest income in this case is attributable to the permanent establishment. There is not even a whisper of a suggestion to that effect. For interplay of Article 11(6) and Article 7(1) in our considered view the expression effectively connected with such permanent establishment must mean a situation in which the interest income in question can be said to be directly or indirectly attributable to the permanent establishment and can be brought to tax under article 7(1) as such. That is not even the case of the Assessing Officer before us. - Decided in favour of assessee.

Summary

Issues Involved:
1. Taxability of interest income under Article 11(2) of the India-Japan DTAA.
2. Applicability of Article 11(6) of the India-Japan DTAA in relation to the Permanent Establishment (PE) in India.
3. Connection and attribution of interest income to the Permanent Establishment under Article 7 of the India-Japan DTAA.

Issue-wise Detailed Analysis:

1. Taxability of Interest Income under Article 11(2) of the India-Japan DTAA:
The assessee, a Japanese company with various income streams from its Indian operations, declared interest income received from Tata Hitachi Construction Co Ltd. This interest income was taxed at a concessional rate of 10% as per Article 11(2) of the India-Japan Double Taxation Avoidance Agreement (DTAA). The Assessing Officer (AO) challenged this, arguing that due to the presence of the assessee's Permanent Establishment (PE) in India, the provisions of Article 11(2) were not applicable.

2. Applicability of Article 11(6) of the India-Japan DTAA in Relation to the Permanent Establishment (PE) in India:
Article 11(6) of the DTAA stipulates that the concessional rate under Article 11(2) does not apply if the interest income is effectively connected with the PE in India. The AO contended that the interest income was connected with the PE and thus should be taxed under Article 7, which deals with business profits. However, the CIT(A) upheld the assessee's plea, stating that there was no connection between the interest income and the PE, and thus, the interest should be taxed at 10% under Article 11(2).

3. Connection and Attribution of Interest Income to the Permanent Establishment under Article 7 of the India-Japan DTAA:
The tribunal examined the provisions of Article 11, Article 7, and Article 14 of the DTAA to understand the scheme of taxation of interest income. Article 11(6) provides an exception to the 10% tax rate if the debt-claim generating the interest is effectively connected with the PE. However, for Article 7 to apply, the interest income must be directly or indirectly attributable to the PE. The tribunal noted that mere existence of a PE does not suffice; there must be a clear connection that leads to the interest income being attributable to the PE.

The tribunal concluded that the AO failed to demonstrate the necessary connection between the interest income and the PE. The AO's argument was based on generalities without specific evidence showing that the interest income was attributable to the PE. The tribunal emphasized that the onus was on the AO to establish this effective connection, which was not done in this case.

Conclusion:
The tribunal upheld the CIT(A)'s decision, confirming that the interest income should be taxed at the concessional rate of 10% under Article 11(2) of the India-Japan DTAA. The appeal by the AO was dismissed due to the lack of evidence showing that the interest income was effectively connected with the PE in India, which is a prerequisite for applying Article 7 over Article 11(2). The tribunal's decision was pronounced on June 17, 2022.