Interest received by non-resident company having PE in India on refund of income-tax is effectively connected with PE and hence, should be characterised as ‘business profits’ and not ‘interest’ and taxed accordingly

11 BJ Services Company Middle East Ltd.
v. ACIT

The assessee was a UK Company (‘UKCo’), which was
tax-resident of UK. UKCo had a PE in India. UKCo had received interest on the
refund of income-tax.

The AO held that the interest was earned by UKCo through its
PE in India and therefore, in terms of Article 12(6) of India-UK DTAA, it should
be characterised as business profits. Accordingly, tax rate applicable to
business income (i.e., 48%) and not that applicable to interest (i.e.,
15%) was applied. The CIT(A) upheld the Order of the AO.

Editorial note :

Article 12(6) provides that if beneficial owner of interest
carries on business through a PE and the debt-claim in respect of which the
interest is paid is effectively connected with that PE, provisions of Article 7
(business profits) apply to taxation of such interest income.

Before the Tribunal, UKCo’s representative relied upon AAR’s
ruling in Application No. P 17 of 1998, In re (1999) 236 ITR 637 (AAR)
wherein the AAR had ruled that : the applicant did not have a PE in India;
interest had not arisen out of any business operation in India; the debt-claim
was not connected with any activity of a PE in India; and hence, it was a case
falling under Article 12 and liable to concessional rate of tax.

The tax authorities’ representative submitted that since
interest had arisen through PE situated in India, Article 12(2) cannot apply.
The Department contended that the AAR ruling was also not applicable, as in the
case before AAR the non-resident applicant admittedly did not have any PE in
India.

The Tribunal held that : UKCo was a non-resident having PE in
India; it was carrying on business in India through a PE in India; the interest
was effectively connected with that PE in India; and therefore, in terms of
Article 12(6), the interest was chargeable under Article 7 as business profits.
The Tribunal also held that the AAR ruling relied upon by UKCo was
distinguishable on facts.