By Dhishat B. Mehta | Bhaumik Goda
Chartered Accountants
7. [2020] 122 taxmann.com 65 (Mum.)(Trib.) DZ Bank AG – India Representative Office vs. DCIT ITA No.: 1815 (Mum.) of 2018 A.Y.: 2014-15 Date of order: 4th
December, 2020
Articles 11 and 7,
India-Germany DTAA – Once entire interest was taxed on gross basis
under Article 11, no taxation survived in respect of subsidiary and incident
commitment fees and agency fees under article 7 as PE income even assuming the
foreign bank had office which supported earning of such interest income – Once
tax liability is discharged in respect of interest income under Article 11, the
taxpayer is relieved of obligation to file ROI in terms of Article 11 read with
section 115A(5)
FACTS
The
assessee was a German banking company. It had set up a representative office
(‘RO’) in India after obtaining approval of the RBI, subject to the conditions
that: the RO will function only as a liaison office; it will not undertake
banking business; and all expenses of the RO will be met out of inward
remittances from the head office (‘HO’). The assessee had filed its return of
income in the name of the RO (apparently treating the RO and the HO as separate
entities) disclosing Nil income.
The A.O.
noticed that during the relevant previous year, the HO had provided foreign
currency loans to Indian companies from which payers had withheld tax. As
regards filing of returns, the assessee explained that as per section 115A(5)
of the Act a foreign company is exempt from furnishing return of income in
India if it only earns interest from foreign currency loans provided to Indian
companies. The A.O. asked the assessee to show cause why the RO should not be
considered as the PE of the HO in India and why interest and any other income
earned by the HO from operations in India should not be taxed @ 40%.
The
assessee argued that the RO did not constitute a PE of the HO under the basic
rule as no business activities were carried out from the RO. At best, the RO
was a fixed place of business engaged in ‘any
activity of preparatory or auxiliary character’, which
was excluded from the definition of PE, Article 5(4) of the India-Germany DTAA.
Besides, the RO cannot be said to be a dependent agent PE (‘DAPE’) as it had no
authority to conclude contracts on behalf of the HO or its other branches.
However,
after noting the activities undertaken by the RO on behalf of the HO, the A.O.
concluded that the business transactions of the HO with Indian clients could
not have been completed without the involvement of the RO. Thus, there was a
real relation between income-earning activity carried on by the assessee and
the activities of the RO which directly or indirectly contributed to earning of
income by the assessee. Therefore, income should be deemed to accrue / arise to
the assessee from ‘business connection’ in India.
Further,
‘auxiliary’ means helping, assisting or supporting the main activity.
Therefore, the issue was whether activities carried on by the RO only supported
the main business. Even if some functions of the RO might have been auxiliary,
the RO played a significant part in the lending business of the assessee in
India which could not be said to be auxiliary activity. Hence, the RO was a PE
of the assessee and profits attributable to the PE were deemed to accrue or
arise to the assessee.
The A.O.,
accordingly, taxed the entire interest income, commitment fees and agency fees
as income of the assessee as PE income on net basis, after allowing deduction
of expenses of the RO instead of gross basis of taxation suffered by the HO
under Article 11.
HELD
As
regards HO and RO being separate taxable entities under the Act
- The entire proceedings by
the A.O. were on the premise that the HO and the RO were two distinct taxable
entities. However, under the Act the taxable unit is a foreign company and not
its branch or PE in India. The profit attributable to the PE is taxable in the
hands of the HO. In CIT vs. Hyundai Heavy
Industries Co. Ltd. [(2007) 291 ITR 482 (SC)], the
Supreme Court observed that ‘it is clear that under the
Act a taxable unit is a foreign company and not its branch or PE in India’.
- The assessee filed the return
in the name of the RO excluding interest received by the HO. Tax on interest
was withheld and paid by payers under Article 11 of the India-Germany DTAA.
Hence, there was no loss of revenue from such error. Further, the Department
had also not objected. Hence, to avoid inconvenience to the assessee, a
pragmatic view required to be adopted.
As regards taxability under Article 11 vis-à-vis Article
7
- Interest is taxable on
gross basis under Article 11. It may be taxed on net basis under Article 7 if exception
in Article 11(5) is triggered upon two conditions being fulfilled, namely, (a)
the HO carries on business in the source state through a PE, and (ii) debt
claim in respect of which interest was paid is effectively connected with such
PE.
- There is a subtle
distinction between carrying on business
of banking vis-a-vis carrying on activities which
contribute directly or indirectly to earning of income from the business of banking.
- Even if an assessee
maintains a fixed place of business, and even if there is a real relation
between the business carried on by the assessee and the activities of the RO
which directly or indirectly contribute to earning income, as observed by the
A.O., that relationship per se will
not make that place a PE or activities taxable in India, if that place is so
maintained solely for the purpose of the activity of preparatory or auxiliary
character.
As
regards A.O. seeking to tax under Article 7
- The A.O. sought to tax
income on net basis under Article 7. This income was already taxed on gross
basis under Article 11.
- Further, the conditions
stipulated for triggering the exception under article 11(5) for taxing interest
under Article 7 on net basis were also not satisfied.
- Whether or not there was a
PE, the debt claim in question could not be said to be effectively connected to
the alleged PE. Therefore, exclusion of Article 11(5) could not have been
triggered. Consequently, taxability under Article 7 could not have come into
play.
As
regards ALP adjustment for service by the RO to the HO
- If the representative
office of a foreign enterprise performs certain activities, suitable ALP
adjustment for such activities could be in order.
- Even if RBI restricts the
representative office of a foreign enterprise from transacting any banking
business, such representative office does carry on economic activities. Hence,
ALP adjustment for the same could be made.
- Once the entire revenue
earned in India is taxed on gross basis under Article 11, no income survives
for taxation under Article 7. In such a case, making any ALP adjustment will
result in taxing previously taxed income. It will also result in taxable income
being more than revenue in India.
As regards taxability of commitment fee and agency fee
- Commitment fee and agency
fee were paid in connection with loan guarantee. Accordingly, they were not
taxable under Article 11(3)(b) of the India-Germany DTAA.
- In Hindalco Industries Ltd.vs. ACIT [(2005) 94 ITD 242 (Mum.)],
the Tribunal noted that ‘…when principal transaction
is such that it does not generally give rise to taxability in the source
country, the transaction subsidiary and integral to such a transaction also
does not give rise to taxability in the source country. In other words, the
subsidiary and integral transactions have to take colour from the principal
transaction itself and are not to be viewed in isolation’.
- Commitment charges and
agency fees were, in fact, an integral part of the loan arrangements. They were
relatable to the same loan and were part of consideration for the same loan. If
the principal transaction (i.e., interest) did not result in taxable income in
India, the subsidiary transaction (i.e., commitment fees and agency fees) could
not result in taxable income in India.
As
regards filing return in India
- On the facts and in the circumstances of this
case and in law, the assessee had no income other than interest from its
clients in India.
- Tax liability on interest was already
discharged under Article 11. Hence, the assessee had no obligation to file
return of income under section 115A(5) of the Act.
