2023 (4) TMI 990 - AT - Income Tax

Taxability of interest earned on External Commercial Borrowings ( ECB ) loans - Permanent Establishment - Undisclosed income / TDS - Not claiming credit of TDS on the ground the income is not taxable in India and Tax Burden is born by the Deductors themselves - income earned by the head office/overseas branches has been subjected to TDS at 10% under the India Netherlands Double Taxation Avoidance Agreement ( DTAA ) - HELD THAT - AO as well as the learned CIT(A) though held that the interest income is includable in the hands of the assessee however did not analyse the applicability of the provisions of the DTAA in the present case. Assessee has also not made any submission before the lower authorities as regards the provision under which this income is taxable under the DTAA - As during the assessment proceedings the assessee merely requested that the income be taxed at the rates prescribed under the treaty. Before us the assessee has prayed for the applicability of the rate of tax of 10% as per Article 11(2) however the assessee has also not proved the beneficial ownership of the interest for the applicability of the aforesaid rate of tax under Article 11(2) of the India-Netherlands DTAA - remand this issue to the file of the AO for de novo adjudication after examining the applicability of the India-Netherlands DTAA in the present case - assessee shall be at liberty to adduce all the evidence in support of its submission of taxability @10% under Article 11(2) of the India-Netherlands DTAA. As a result grounds no.1-4 raised in Revenue s appeal are allowed for statistical purposes. Addition in respect of interest received by the head office/overseas branches from the Indian branch - HELD THAT - Special Bench in Sumitomo Mitsui Banking Corporation 2012 (4) TMI 80 - ITAT MUMBAI held that the interest paid by the Indian branch is not taxable in the hands of the head office or overseas branches all being the same entity. As regards the reliance placed upon the amendment to section 9(1)(v) of the Act vide Finance Act 2015 w.e.f. 01/04/2016 by the AO we find that the said amendment was held to be applicable prospectively from 01/04/2016 and not prior thereto by the coordinate bench of the Tribunal in JP Morgan Chase Bank N.A. 2020 (1) TMI 19 - ITAT MUMBAI . Thus this amendment is not applicable to the year under consideration and would only be applicable to the assessment year 2016-17 and onwards - No infirmity in the impugned order passed by the learned CIT(A) on this issue. As a result ground raised in Revenue s appeal is dismissed.

1. ISSUES PRESENTED and CONSIDERED

The legal judgment addresses the following core legal questions:

Whether the interest earned on External Commercial Borrowings (ECB) loans by the Indian branch of a foreign bank should be taxed as business income at the rate of 40% or as per the rate prescribed under the India-Netherlands Double Taxation Avoidance Agreement (DTAA).
Whether the interest received by the head office/overseas branches from the Indian branch should be considered as income and taxed accordingly.

2. ISSUE-WISE DETAILED ANALYSIS

Issue 1: Taxability of Interest on ECB Loans

Relevant Legal Framework and Precedents: The case hinges on the interpretation of the India-Netherlands DTAA and the Income Tax Act, 1961. The DTAA provides specific provisions for taxing interest income, potentially at a lower rate than the domestic tax rate.
Court's Interpretation and Reasoning: The court noted that the assessee did not claim the TDS credit on the interest income as it pertained to the head office/overseas branches. However, the assessee accepted the addition of this income during assessment, requesting that it be taxed under the DTAA rate.
Key Evidence and Findings: The assessee's branches operate independently, and the ECB loans were disbursed by the head office/overseas branches, with interest income directly paid by Indian companies. The AO added the undisclosed income to the assessee's total income and taxed it at 40%.
Application of Law to Facts: The court found that the applicability of the DTAA was not adequately analyzed by the lower authorities, leading to a remand for fresh adjudication on the tax rate applicable under the DTAA.
Treatment of Competing Arguments: The Revenue argued for taxation at 40% as business income, while the assessee sought a 10% rate under the DTAA. The court remanded the issue for further examination of DTAA applicability.
Conclusions: The issue was remanded to the AO for a de novo adjudication on the applicability of the DTAA, allowing the assessee to present evidence supporting a 10% tax rate.

Issue 2: Interest Received by Head Office/Overseas Branches

Relevant Legal Framework and Precedents: The Special Bench decision in Sumitomo Mitsui Banking Corporation and subsequent tribunal decisions were pivotal, stating that interest paid by a branch to its head office is not taxable as income.
Court's Interpretation and Reasoning: The court upheld the CIT(A)'s decision, which relied on precedents that treated the head office and branch as a single entity for taxation purposes, negating the need for tax on intra-entity transactions.
Key Evidence and Findings: The assessee maintained accounts with its head office and overseas branches for fund movement, and interest was paid on these accounts without TDS.
Application of Law to Facts: The court found that the amendment to section 9(1)(v) of the Act was prospective and not applicable to the years under consideration.
Treatment of Competing Arguments: The AO's reliance on the amendment was dismissed as it was not applicable to the assessment years in question.
Conclusions: The court dismissed the Revenue's appeal on this ground, affirming the CIT(A)'s decision that such interest payments are not taxable.

3. SIGNIFICANT HOLDINGS

Preserve Verbatim Quotes of Crucial Legal Reasoning: "The purpose and function of article 7 is to determine whether the source State may tax the profit of an enterprise carried on by a resident of another contracting State through a PE in the source State and if so, how much of the profits the source State may tax."
Core Principles Established: The judgment reinforced the principle that intra-entity transactions between a branch and its head office are not taxable as income, and the DTAA provisions must be thoroughly examined to determine the applicable tax rate on cross-border interest income.
Final Determinations on Each Issue: The court remanded the issue of ECB loan interest taxability for further examination under the DTAA and dismissed the Revenue's appeal regarding interest payments to the head office, affirming they are not taxable.

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