Finance Bill 2015 Proposal- Foreign Bank- Taxability of Interest Income from Indian Branch

Finance Bill 2015- Proposal-Foreign Bank – Taxability of Interest Income from Indian Branch.

Finance Bill 2015 has proposed an explanation to section 9(1)(v) as under:-

“It is hereby declared that in the case of a non-resident, being a person engaged in the business of banking, any interest payable by the permanent establishment in India of such non-resident to the head office or any permanent establishment or any other part of such non-resident outside India shall be deemed to accrue or arise in India and shall be chargeable to tax in addition to any income attributable to the permanent establishment in India and the permanent establishment in India shall be deemed to be a person separate and independent of the non-resident person of which it is a permanent establishment and the provisions of the Act relating to computation of total income, determination of tax and collection and recovery shall apply accordingly.”

It provides that Non-resident Banking entity’s Head office or any other branch office outside India will be liable to pay tax on interest income in India, hereinafter referred to as HO Interest Income, earned from Branch in India.

My observation on said proposal is as under:-

Income Test

1.       Section 9 provides test for determination of accrual of income in India. But before this test can be applied, it is essential that amount involved is the income concerned. Unless the amount is income, there is no need to apply section 9, as the same is not chargeable to tax under the Income Tax Act

2.       Section 2(24) defines Income in inclusive manner but it is established principle that Act envisaged taxation of real income, unless there is specific provision for taxation of Notional income.

3.       A person cannot earn income from himself and there cannot be taxation of such notional income in ordinary course, unless Act specifically provides for the same.

4.       Section 45(2) is an exception to the rule stated at point no. 3  and specifically provide for chargeability of income arising from conversion of capital asset into stock in trade under the head Capital Gains i.e provide for taxability of income earned by person from himself.

5.       For Taxability of HO Interest Income, neither the Income definition nor Interest Definition u/s 2(28A) has not been extended to cover in their ambit the Interest Income of HO from Branch in India.

6.       Thus unless income or interest definition is amended, merely explanation in section 9(1)(v) will fail to test the judicial scrutiny at higher forum for taxability of HO Interest Income.

Double Taxable Avoidance Agreement

Position under DTAA for taxation of HO Interest Income

1.       Under DTAA, Permanent Establishment is treated as separate entity, distinct from its HO, only for the purpose of attribution of business profit under Article 7. In other words, for all other Articles, PE is not a separate entity.

2.       Article relating to Interest, define Interest as income from debt claim of every kind. Since PE is not treated as separate entity for said article, it cannot be said that HO earned interest income attributable to debt claim from Branch in India. Thus in instant case, HO cannot claim the benefit of concessional rate envisaged in Said Article, since income is not interest income as per said Article.

3.       Thus DTAA neither provides for taxation nor exclude taxation of HO interest Income. It is outside the scope of DTAA.

4.       Further Article relating to Elimination of Double taxation, provide that residence state (HO state) will allow credit for taxes paid in Source state (India) under laws of India and in accordance with the provision of DTAA. 

5.       In view of afore-said, whether a position can be taken  by Source state’s Income tax Authorities that Tax on HO interest Income is not in accordance with DTAA and hence may denied the benefit of elimination of Double taxation.

6.       The only exception to aforesaid is provision in India- USA, DTAA, where under Article 14, India can levy tax on Interest income paid by Indian Banking Branch to USA HO at rate not exceeding the rate specifying in Article 11, the reference of the same is also given in the memorandum explaining the finance bill 2015.

Non-Discrimination Clause

1.       DTAA generally have a Non-discrimination clause which provides that National of Contracting state shall not be subjected to in the other Contracting State to any taxation or any requirement connected therewith which is other or more burdensome than the taxation and connected requirements to which nationals of that other State in the same circumstances are or may be subjected.

2.       In India, there is no provision for taxation of Interest Income paid by Indian Branch to HO in India or Interest Income paid by Indian HO to foreign Branch.

3.       Thus for the proposed amendment, foreign Bank may take shelter under Non-discrimination clause and may avoid paying taxes on HO Interest Income.

4.       At this stage, it is worth mentioning Article 26 of India-USA DTAA dealing with Non-Discrimination, specifically exclude the levy of tax under Article 14 from purview of discrimination and permit said levy.

Thus I suppose that merely appending explanation to section 9(1)(v) will not serve the desired purpose unless consequential changes as stated above is also carve out.