Introduction
The issue of taxability of the guarantee charges received by the foreign company from its Indian subsidiary and the nature of the income arising therefrom has been debatable with different judgements on the subject matter from time to time in this article we seek to analyse the judgment of Delhi High Court in the case of Johnson Matthey Public Limited Co. V/s. CIT[1] and give our comments on future possibilities for different interpretation as well as our recommendations for having such income taxable outside India.
Apart from this specific topic on taxability of guarantee charges in India, for details on taxability of different types of income in India, contesting a tax litigation, tax notice and strategies as also on various topics pertaining to commercial litigation and arbitration in India, you are requested to visit https://rdlawchambers.com/research-articles/
Facts of the case: –
The appellant had extended guarantees to overseas branches of the foreign banks on a global basis in relation to the credit facilities extended by those financial institutions to appellants Indian subsidiaries. The issue that arose in the case was pertaining to taxability of receipt of the guarantee charges by Johnson Matthey Public Limited Co. from its Indian subsidiaries in terms of an intragroup parental guarantee and counter indemnity services agreement dt. 29th March 2010.
Appellant’s Contentions
The contentions of the appellant were that the income arising out of the guarantee charges was an interest come in terms of Article 12 of DTAA between the United Kingdom & India and was taxable in the United Kingdom in terms of said article.
The appellant alternatively contended that the receipt guarantee charges would fall within the ambit of “Business Income” and the same will be governed by Article 7 of the Double Taxation Avoidance Agreement; the same could not be taxable in India as the assessee didn’t have any permanent establishment in India for taxing such income in terms of Article 7 of DTAA
The appellant further argued that even if the guarantee charges were considered to be other income in terms of Article 23 of the DTAA, as the income could not be said to have accrued or arisen in India in terms of Section 5 of the Income Tax Act, the same could not be taxable. The appellant in this connection relied upon the judgment in the case of Capgemini S.A. versus ADIT (International Taxation) and the judgment of the US Court of Appeals for 5th Circuit In the case of Container Corporation versus Commissioner of Internal Revenue, where the court had held that the guarantee was not by way of loan and that it was in the nature of secondary obligation which must be performed outside the United States and consequently view taken by the tax court regarding taxability thereof in the US was incorrect.
Views of ITAT and Delhi High Court: –
On income being in the nature of Interest
The Tribunal reading the definition of interest from the DTAA observed that interest meant any income from “debt claims of every kind” irrespective of whether they were secured by mortgage or carried a right to participate in debtor’s profit. However, the appellant was not concerned with the loan and was not even a party to the loan contract between its subsidiaries and the banks. The appellant had guaranteed the repayment of the loans extended to its subsidiaries and it received charges as per stipulations contained in the Intergroup agreement which did not satisfy the test of being “interest”.
The Delhi High Court approved the view of the ITAT observing that it had correctly found that the Appellant was neither a party to the loan agreement nor was there any privity of contract that could be said to exist and therefore the payments received by the appellant would not fall within the ambit of Article 12 of the DTAA.
On Income being from business and taxability under Article 7
The Tribunal further held that a taxpayer could not be said to be engaged in the business of providing the corporate bank guarantees to earn income on a regular basis and as the guarantee agreement was entered into for the limited purpose of securing the loans extended to its subsidiaries and thus enabling the subsidiaries to avail the loan, the guarantee charges could not be considered to be business profit.
This aspect was not gone into by the Delhi High Court as the appellant had not addressed any requests for framing of additional questions about business income and ambit of Article 7 of DTAA before the ITAT.
On other Income and Taxability under Article 23 of DTAA
The Tribunal treated the income from guarantee charges as other income falling within the ambit of Article 23 of DTAA and held that the same was taxable in India. ITAT held that the income could be considered to be arising in India because of the loan transaction that took place in India and for determining whether income arises in India, the fact of entering the guarantee agreement outside India would not be relevant.
The high court analysed the decisions in the case of E. D. Sassoon and Company Ltd vs The Commissioner of Income-Tax, Bombay to elucidate the meaning of “earned”, “is received”, “accrues” and “arise”. Relying upon the observations in the case of Colquhoun (Survey of taxes) vs. Brooks, it observed that the words arising or accruing are descriptive of a right to receive profits. It held that the income accruing would not be dependent upon actual receipt, but would be given by the principle of “right to receive” and that when the right to receive came into existence, income would be considered to have a reason or accrued.
The High Court distinguished the decision of the Mumbai tribunal in the case of Capgemini, observing that in the case of the appellant, guarantee charges were not based on any agreement between the appellant and foreign bank, but were completely stemming from the agreement with the subsidiary. The high court held that any adverse consequences the appellant may ultimately face would not be determinative of the question of where the income had arisen or accrued.
Author’s comments and suggestions
In our opinion, while loan transactions being entered in India are one way of looking at things for determining the place of accrual or rising of the income as done by the Delhi High Court, the fact that the guarantee charges could be said to be in the nature of charges for the provision of services (secondary obligation, if required to be performed) that will be provided out of India is a very relevant aspect and likely to be considered by courts while determining place of accrual of income and taxability.
The guarantee agreement and the provisions of the guarantee agreement pertaining to jurisdiction for dispute resolution between the parties i.e. the foreign holding company and a subsidiary in India, the place of execution of this agreement and other recitals in the agreement will likely be considered for determining the place of accrual or rising of the income.
Other “Source rules” and/or “pay rules” could be applied for determining the aspect of the place of accrual or rising of the income.
All such aspects do not appear to have been elaborately argued before the Delhi High Court in the case of Johnson Matthey Public Limited Co. V/s. CIT. Additionally, the Delhi High Court did not elaborate on the question of whether the income could be characterized as business income and whether Article 7 of the DTAA could apply.
With all the above factors considered in detail, it is possible that other high courts in India and the Supreme Court of India may come to different conclusions about the place of accrual or the arising of guarantee charges in India.
As of now, our recommendation will be to have any guarantee charges agreement properly in place to clearly indicate the place of execution of the agreement, the place of performance of the obligations under the guarantee agreement and, the place of performance of any other obligations under the agreement, which will be relevant factors for determination of the question pertaining to place of accrual of income. For details on contesting a tax litigation, tax notice and strategies as also on various topics pertaining to commercial litigation and arbitration in India, you are requested to visit https://rdlawchambers.com/research-articles/
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[1] ITA 727/2018