section 193/income-tax act

[2004] 139 taxman 277 (AAR - New Delhi)

AUTHORITY FOR ADVANCE RULINGS, NEW DELHI

Yu Bo Investment Co. (P.) Ltd., In re

JUSTICE SYED SHAH MOHAMMED QUADRI, CHAIRMAN

and K.D. SINGH AND K.D. GUPTA, MEMBER

AAR NO. 596 OF 2002

MAY 4, 2004

To claim tax exemption under section 10(15), applicant must
have in its possession, either approval granted by ECB Division,
Department of Economic Affairs, Ministry of Finance on basis
of which he is required to approach RBI for approval under
FERA  or approval granted by Department of Revenue
depending  upon applicability of section 10(15)(iv)

Section 10(15), read with section 193, of the Income-tax Act, 1961 - Exemption - Interest payments - Applicant has allotted debentures to a Mauritius company with approval of RBI - RBI has granted said approval under provisions of the Foreign Exchange Regulation Act, 1973 - Applicant-company filed application under section 245Q(1) seeking ruling on question as to whether applicant is required to deduct tax at source under laws for year ended 31-3-2002 on payment of interest to foreign company especially when foreign company has no permanent establishment in India and interest income is exempt from tax - Whether approval granted by RBI under FERA cannot be equated with approval by Government of India - Held, yes - Whether to claim tax exemption under section 10(15), applicant must have in its possession, either approval granted by ECB Division, Department of Economic Affairs, Ministry of Finance on basis of which he is required to approach RBI for approval under FERA or approval granted by Department of Revenue depending upon applicability of section 10(15)(iv) - Held, yes - Whether since no such approval has been granted to applicant, it is not entitled to tax exemption under Act - Held, yes - Whether approval by RBI for terms of loan through letters does not amount to granting tax exemption by Government of India for purposes of article 11(4) - Held, yes - Whether in absence of exemption either under section 10(15)(iv) or under article 11(4), payment of interest by applicant to foreign company will attract provisions of section 193, as they stood before amendments by Finance Act, 2003 and applicant shall be obliged to deduct income-tax at rates in force on amount of interest payable - Held, yes

Facts

The applicant is a resident-company engaged in the business of development of properties and allied activities. The applicant has allotted some partly convertible debentures to a Mauritius company with the approval of the RBI. As per said approval, the applicant-company can pay interest on those debentures at a rate not exceeding 14 per cent per annum and only to the extent of profit available. The applicant-company made profits during the relevant year and the interest liability being more than the profits available, entire profit will be paid by way of interest to the foreign company. The applicant sought ruling on the taxability or otherwise of the interest paid by it to the foreign company, having regard to the terms of borrowal with the foreign company and also the clauses of the DTAA with Mauritius, especially when the foreign company has no permanent establishment in India. The Jurisdictional Commission commented that the permission granted by the RBI for the issue of shares/debentures does not indicate exemption from taxation on payment of interest on debentures either in terms of article 11(4) of the DTAA with Mauritius or under the Act.

Held

Though in common parlance, the RBI, which is a Government agency completely owned by the Government of India, can be appropriately described as ‘Government’, the said proposition may not hold good in all circumstances. There can be exceptions to that proposition by specific exclusions or by implication. [Para 15]

The applicant has filed a copy of the letter through which the RBI has granted permission under section 19(1)(d) of the FERA for issue of equity shares and partly convertible debentures with repatriation benefits to the foreign company as overseas corporate body. There is another letter of the RBI granting similar approval for issue of partly convertible debentures. [Para 16]

There is no other approval on record from any other authority either for the terms of loan or for tax exemption on interest payable thereon [Para 17]

The Economic Affairs Department of Ministry of Finance, Government of India, is the nodal agency for regulating External Commercial Borrowings. The guidelines on policies and procedures for External Commercial Borrowings (ECB) are issued by the said Department from time-to-time. [Para 18]

The current practice in regard to granting of tax exemption was reiterated explicity in the Press Note F. No. 4(48)/96-ECB, dated 19-6-1996 in regard to guidelines on Policy and Procedures for ECBs for 1996-97. [Para 20]

The said press note makes it amply clear that the work relating to exemption from withholding tax was not delegated by the Government to the RBI. The approval accorded by the RBI was only under FERA. This is also supported by the fact that the letter of approval issued by the RBI to the applicant mentions various sections of the FERA under which approval has been granted. There is no mention of exemption from tax either under the Act or under the DTAA. [Para 21]

In the facts and circumstances of the case, the approval granted by the RBI cannot be equated with the approval by the Government of India. To claim tax exemption under the Act, the applicant must have in its possession, either the approval granted by the ECB Division, Department of Economic Affairs, Ministry of Finance on the basis of which he is required to approach the RBI for approval under the FERA or the approval granted by Department of Revenue depending upon the applicability of particular sub-clause of section 10(15)(iv). Since no such approval has been granted to the applicant, the applicant is not entitled to tax exemption under the Act. [Para 22]

The exemption of interest income in article 11 is independent of the exemption granted to interest income under various sub-clauses of section 10(15)(iv). Had this not been so, there would be no need to make specific provision of exemption in the DTAA because a non-resident taxpayer is entitled to claim the benefits conferred under the domestic law in any case. This is made amply clear by the provisions of section 90(2). It provides that a taxpayer has option to be assessed on the basis of the domestic law or in terms of the DTAA between India and the country of his residence, whichever is more beneficial to him. The above interpretation gets support from the fact that even after the withdrawal of tax exemptions provided under section 10(15)(iv), the exemption approved for the purposes of article 11 of the DTAA with Mauritius is still available. [Para 23]

Therefore, the exemption of interest income under section 10(15)(iv) is independent of the tax exemption provided under article 11(4). In the circumstances, separate and transaction-based approval for tax exemption is necessary under article 11. [Para 24]

The DTAA itself define ‘Competent Authority’ for the purposes of the Agreement. [Para 25]

Even otherwise, the nodal ministry for entering into tax avoidance agreements and their implementation is Department of Revenue in the Ministry of Finance and the tax exemption under article 11(4) can be granted only by the said department of the Ministry of Finance. [Para 26]

Therefore, approval by the RBI for the terms of loan through the letters does not amount to granting tax exemption by the Government of India for the purposes of article 11(4). [Para 27]

In absence of exemption either under section 10(15)(iv) or under article 11(4), the payment of interest by the applicant to the foreign company will attract the provisions of section 193, as they stood before amendments by the Finance Act, 2003 and the applicant shall be obliged to deduct income-tax at the rates in force on the amount of the interest payable. [Para 28]

Cases referred to

DLJMB Mauritius Investment Co. v. CIT [1997] 228 ITR 268/94 Taxman 218 (AAR) [Para 7] and Transmission Corpn. of A.P. Ltd. v. CIT [1999] 239 ITR 587/105 Taxman 742 (SC) [Para 9].

Ruling

K.D. Gupta, Member. - The applicant is a closely-held private limited company incorporated in India and is engaged in the business of development of properties and allied activities. The applicant has allotted 43500 partly convertible debentures of Rs. 1000 each to Weststar Investment Holdings Ltd., a company incorporated in Mauritius. The debentures have been issued with the approval of the Reserve Bank of India. As per the approval given by the Reserve Bank of India, the applicant company can pay interest on these debentures at a rate not exceeding 14% p.a. and only to the extent of profit available. It is also stated that Weststar Investment Holdings Ltd. is not having any place of business or a permanent establishment in India. The applicant-company made profits during the year ended 31st March, 2002 and the interest liability being more than the profits available, entire profit will be paid by way of interest to the foreign company.

2. The applicant has filed this application under section 245Q(1) of the Income-tax Act, 1961 (‘the Act’) and based on the above facts has sought the ruling of this Authority on the following question:-

“Whether in the facts and circumstances of the case and having regard to the terms of borrowal with the foreign company and also the clauses of the Double Taxation Avoidance Agreement between India and Mauritius, the applicant is required to deduct tax at source under the laws for the year ended 31-3-2002 on the payment of interest to the foreign company especially when the foreign company has no permanent establishment in India and interest income is exempt from tax?”

3. The applicant admits that under domestic law, payment of interest to a non-resident on borrowings utilized in India, is deemed to accrue or arise in India under section 9(1)(v) of the Act and the liability for tax is attracted under section 9(1)(v)(c) of the Act. The amount of interest being interest on debentures treated as securities, requires tax deduction at source under section 193 of the Act.

4. Under Double Taxation Avoidance Agreement (DTAA) between India and Mauritius, liability to pay tax on interest income is dealt with in article 11. Article 11 reads as follows insofar as it is relevant for the purpose of the application before us:-

“1. Interest.—Interest arising in a Contracting State and paid to a resident of the other Contracting State may be taxed in that other State.

2. However, subject to the provisions of paragraphs 3 and 4 of this article, such interest may also be taxed in the Contracting State in which it arises and according to the laws of that State.

3. Interest arising in a Contracting State shall be exempt from tax in that State provided it is derived and beneficially owned by:

  (a)  the Government or a local authority of the other Contracting State;

  (b)  any agency or entity created or organized by the Government of the other Contracting State; or

   (c)  any bank carrying on a bona fide banking business which is a resident of the other Contracting State.

4. Interest arising in a Contracting State shall be exempt from tax in that Contracting State to the extent approved by the Government of that State if it is derived and beneficially owned by any person [other than a person referred to in paragraph 3] who is a resident of the other Contracting State provided that the transaction giving rise to the debt-claim has been approved in this regard by the Government of the first mentioned Contracting State.”

5. The applicant contends that all the limbs of paragraph 4 of article 11 are satisfied inasmuch as:-

   (i)  Payment of interest @ 14% subject to overall ceiling of the available profits has been approved by the Reserve Bank of India,

  (ii)  The lender, i.e., Weststar Investment Holdings Ltd. is resident of Mauritius. In support, the applicant has filed a copy of Certificate of Incorporation of the Company issued by the Registrar of Companies, Mauritius as well as Certificate of Residency issued by the Tax Department of Mauritius;

(iii)  The transaction giving rise to the debt claim has been approved by the Reserve Bank of India.

6. It is also claimed that since the foreign company has mere investment by way of shares and debentures in the company, neither article 7 (Business Income) nor article 14 (Professional Income) of the DTAA with Mauritius has application.

7. In Annexure to the application, reliance has been placed on the ruling by this Authority in the case of DLJMB Mauritius Investment Co. v. CIT [1997] 228 ITR 2681 . It is stated that in this case the AAR has held that Reserve Bank of India can be described as Government for purposes of article 11 of the DTA Agreement with Mauritius. Based on the said ruling, the applicant argues that the approval granted by the Reserve Bank of India amounts to approval by the Government and whatever interest is payable under the Agreement to the foreign company is not liable to tax in India as it is exempt under article 11(4) of the DTAA between India and Mauritius.

8. In the case of DLJMB Mauritius Investment Co. (supra) the relevant question and the ruling given by the Authority was as under:-

“3. Question - Whether on the facts and circumstances of the case, interest received by the applicant pursuant to a loan agreement in respect of debentures and or any other debt claims issued pursuant to the approval of the Reserve Bank of India (Hereinafter referred to as the ‘RBI’)/Government will be exempt from tax under article 11 of the Treaty?

Answer - Yes, but only to the extent the Indian tax laws confer exemption in respect of such interest, or to the extent any such exemption is conferred by the Government.” (p. 288)

9. The Jurisdictional Commissioner in his comments on the application has stated that the permission granted by Reserve Bank of India for the issue of shares/debentures does not indicate in any way the exemption from taxation on payment of interest on debentures. It is also stated that the applicant’s reliance on the ruling of the AAR in the case of DLJMB Mauritius Investment Co. (supra) is out of context and not relevant in this case. It is claimed that in the present case such exemption has neither been granted by the Government in terms of article 11(4) of the DTAA with Mauritius nor under the Act. It is also stated that the said ruling was for one particular case depending upon the facts and circumstances of that case. Relying on the ratio of the judgment of the Hon’ble Supreme Court in the case of Transmission Corpn. of A.P. Ltd. v. CIT [1999] 239 ITR 5872 , it is claimed that tax is deductible at source under the provisions of section 195(1), of the Act.

10. In his rejoinder the applicant has reiterated the facts and arguments made in the application and has stressed that the provisions of DTAA have to be taken into consideration for the purposes of tax deduction at source as explained in a number of Circulars in similar circumstances as for instance Circular No. 734, dated 24-1-1996. This circular deals with “applicable rates of taxes under the Double Taxation Avoidance Agreement between India and the United Arab Emirates” and reiterates that the rates which are enshrined in the DTAA should be strictly adhered to so as to avoid unnecessary harassment of the taxpayers.

11. In response to the notice of the Authority, none attended on the date of hearing either for the applicant or the department. The applicant has requested that their written arguments may be considered and the ruling may be given.

12. Since in the present case, the applicant has sought ruling on one question, i.e., taxability or otherwise of the interest paid by it to Mauritius company, only the issue for consideration is whether on the facts and in the circumstances of the case and ruling of the AAR in the case of DLJMB Mauritius Investment Co. (supra) the interest payable to Weststar is exempt from tax either under section 10(15)(iv) of the Act or under article 11(4) of the DTAA between India and Mauritius. Though the applicant has not sought ruling in regard to exemption under the domestic laws, the same is also being considered because of the ruling given by the Authority in DLJMB Mauritius Investment Co.’s case (supra).

13. The first question that comes up for consideration is whether approval granted by the Reserve Bank of India in all the cases, amounts to approval by the Government.

14. As already stated that for this proposition, the applicant has placed reliance on the Ruling given by this Authority in the case of DLJMB Mauritius Investment Co. Ltd. (supra). In DLJMB Mauritius Investment Co.’s case (supra), the Authority observed as under:-

“. . . . A question may be raised whether the FIPB or the RBI can be said to be the Government of India for the purposes of this article. Though the tax treaty does not define the expression ‘Government’, under article 3(2), any term not defined therein will, unless the context otherwise requires, have the meaning which it has under the laws in force in India. Both under the Constitution of India and, on general principles, the Reserve Bank of India which is a Government agency completely owned by the Government of India and the FIPB which is only a Committee of Government of India can be appropriately described as ‘Government’ for the purposes of this clause. . . .” (p. 286)

15. Though in common parlance, the Reserve Bank of India which is a Government agency completely owned by the Government of India, can be appropriately described as ‘Government’, the said proposition may not hold good in all circumstances. There can be exceptions to this proposition by specific exclusions or by implication. It has to be examined whether RBI was authorized to grant exemption from tax.

16. The applicant has filed a copy of the letter dated the 1st February, 1996 through which, the Reserve Bank of India has granted permission under section 19(1)(d) of the Foreign Exchange Regulation Act, 1973 for issue of 2500 equity shares of Rs. 100 each and 33400 partly convertible debentures of Rs. 1000 each with repatriation benefits to M/s. Weststar Investments Holdings Ltd., Mauritius, as Overseas Corporate Body. There is another letter of the Reserve Bank of India dated the 12th December, 1996 granting similar approval for issue of 10100 14% partly convertible debentures of Rs. 1000 each. In the Financial Covenants and Conditions, it is mentioned that the company will be liable to pay interest at such rate not exceeding 14% per annum as may be determined by the Board of Directors of the company. It is also stated that interest shall be payable only in the year the company makes profit and to the extent of the profit.

17. There is no other approval on record from any other authority either for the terms of loan or for tax exemption on interest payable thereon.

18. The Economic Affairs Department of Ministry of Finance, Government of India, is the nodal agency for regulating External Commercial Borrowings. The guidelines on policies and procedures for External Commercial Borrowings (ECB) are issued by the said Department from time to time.

19. Guidelines on Policies and Procedures for External Commercial Borrowings for Financial Year 1995-96 were released by the Government through Press Note - F. No. 4(37)/95-ECB, dated 28-2-1995. Part (1) of the guidelines is general and Part (2) relates to Policy and Procedures for External Commercial Borrowing Policy. Item (X) of Part (2) reads as under:

“(x)  as regards withholding tax exemption, all interest payments, commissions/fees etc. related to external commercial loans exceeding one year’s maturity and short-term borrowing of one year or less would be subject to the current practice till further review.”

20. The current practice in regard to granting of tax exemption was reiterated explicitly in the Press Note F. No. 4(48)/96-ECB, dated 19-6-1996 in regard to guidelines on Policy and Procedures for ECBs for 1996-97. Paragraph numbers 16 and 17 of Part I (ECB Policy) are relevant for the purpose of the point in issue and they are extracted below:

“16. Exemption from withholding tax - All interest payments and fees etc. related to external commercial borrowings would be eligible for withholding tax exemptions under section 10(15)(iv)(b) to (g) of the Income-tax Act, 1961. Exemption under section 10(15)(iv)(b), (d) to (g) are granted by Department of Economic Affairs while exemption under section 10(15)(iv)(c) is granted by Department of Revenue, Ministry of Finance.

17. Approval under FERA - After receiving the approval from ECB Division, Department of Economic Affairs, Ministry of Finance, the applicant is required to obtain approval from the Reserve Bank of India under the Foreign Exchange Regulation Act, 1973 and to submit an executed copy of the Loan Agreement to this Department for taking the same on record, before obtaining the clearance from RBI for drawing the loan. Monitoring of end-use of ECB will continue to be done by RBI.”

21. This makes it amply clear that the work relating to exemption from withholding tax was not delegated by the Government to the Reserve Bank of India. The approval accorded by the Reserve Bank of India was only under FERA. This is also supported by the fact that the letter of approval issued by the Reserve Bank of India to the applicant mentions various sections of the Foreign Exchange Regulation Act under which approval has been granted. There is no mention of exemption from tax either under the Act or under the DTAA.

22. In the facts and circumstances of the case, the approval granted by the Reserve Bank of India cannot be equated with the approval by the Government of India. To claim tax exemption under the Income-tax Act, the applicant must have in its possession either the approval granted by the ECB Division, Department of Economic Affairs, Ministry of Finance, on the basis of which he is required to approach the Reserve Bank of India for approval under FERA or the approval granted by Department of Revenue depending upon the applicability of particular sub-clause of section 10(15)(iv) of the Act. Since no such approval has been granted to the applicant, the applicant is not entitled to tax exemption under the Income-tax Act.

23. We are however, of the view that the exemption of interest income in article 11 of the DTAA with Mauritius is independent of the exemption granted to interest income under various sub-clauses of section 10(15)(iv) of the Act. Had this not been so, there would be no need to make specific provision of exemption in the DTAA because a non-resident taxpayer is entitled to claim the benefits conferred under the domestic law in any case. This is made amply clear by the provisions of section 90(2) of the Act. It provides that a taxpayer has option to be assessed on the basis of the domestic law or in terms of the DTAA between India and the country of his residence, whichever is more beneficial to him. This interpretation gets support from the fact that even after the withdrawal of tax exemptions provided under section 10(15)(iv), the exemption approved for the purposes of article 11 of the DTAA with Mauritius is still available.

24. It, therefore, follows that exemption of interest income under section 10(15)(iv) of the Act is independent of the tax exemption provided under article 11(4) of the DTAA with Mauritius. In the circumstances, separate and transaction based approval for tax exemption is necessary under article 11 of the DTAA with Mauritius. Since in the case of the applicant, there is no evidence to show that tax exemption under the Act has either been granted by the Department of Economic Affairs or by the Department of Revenue, and the approval of the loan granted by the Reserve Bank of India for the purposes of FERA does not amount to tax exemption under the Act, it is for consideration, if the approval to the loan granted by the RBI can be considered as tax exemption by the Government under the DTAA.

25. The DTAAs themselves define ‘Competent Authority’ for the purposes of the Agreement. Article 3(1)(h) of the DTAA with Mauritius defines the term ‘Competent Authority’ as under:-

“(h) - The term ‘competent authority’ means in the case of India, the Central Government in the Ministry of Finance (Department of Revenue) or their authorized representative; and in the case of Mauritius, the Commissioner of Income-tax or his authorized representative.”

26. Even otherwise, the nodal ministry for entering into tax avoidance agreements and their implementation is Department of Revenue in the Ministry of Finance and the tax exemption under article 11(4) can be granted only by the said department of Ministry of Finance.

27. Therefore, approval by the Reserve Bank of India for the terms of loan through letters dated 1st February, 1996 and 12th December, 1996 does not amount to granting tax exemption by the Government of India for the purposes of article 11(4) of the DTAA with Mauritius.

28. In absence of exemption either under section 10(15)(iv) of the Act or under Article 11(4) of the DTAA with Mauritius, the payment of interest by the applicant to the foreign company will attract the provisions of section 193 of the Act, as they stood before amendments by the Finance Act, 2003 and the applicant shall be obliged to deduct income-tax at the rates in force on the amount of the interest payable.

29. We accordingly rule in AAR Application No. 596 of 2002 as under:-

“Since exemption from tax has not been granted to the applicant either under the provisions of the Income-tax Act, 1961 or under the Double Taxation Avoidance Agreement between India and Mauritius, the applicant is required to deduct tax at source in accordance with section 193 of the Act for the year ended 31-3-2002 on interest paid or credited to the account of the foreign company.”

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 [S1]1. 94 Taxman 218.

 [S2]2. 105 Taxman 742.