In the case of Marubeni Corporation, Japan [1] (Taxpayer), issue before Mumbai Tribunal was whether interest income on credit supplies was eligible for concessional tax rate of @10% under Article 11 of India-Japan Double Taxation Avoidance Agreement (DTAA). The Taxpayer also had a permanent establishment (PE) in India. The Taxpayer received interest income from one of its customers on account of credit supplies and offered the same to tax @10% under Article 11(2) of the DTAA. Tax authority contended that since the Taxpayer had a PE in India, such interest income would be subject to tax @ 40% as business profits under Article 7.
The Tribun;al held that the concessional rate of 10% provided under Article 11 of the treaty is not applicable if the debt claim in respect of which interest is earned is effectively connected with a PE in India. Further, Article 7 of the DTAA provides that business profits of an enterprise of one contracting state carried on in another state, is taxable in such other state if the income is attributable to the PE in such other state.
Tribunal held that while every income which is attributable to a PE can be connected to the PE, but the converse is not possible and the term “effectively connected” used in Article 11 is to necessarily be understood as a “connection” which leads to taxability under Article 7. The reasoning adopted by the Tribunal was as follows:
- Article 11 provides that if the debt claim in respect of which interest is earned is effectively connected with a PE, then the provisions of Article 7 would be applicable.
- Article 11 proceeds on the assumption that when the debt claim in respect of which interest is paid is “effectively connected” with the PE, it will result in taxability under Article 7.
- Unless such interest is taxable under Article 7, exclusion under Article 11 would become meaningless, which is not acceptable.
- Suggesting that interest income is connected with a PE but is not taxable as it is not attributable to the PE would lead to a situation where the source state would completely lose the right to tax such interest income. Such an interpretation would lead to apparent incongruity and, hence, is not acceptable.
Tribunal noted that the tax authority merely indicated that the Taxpayer had a PE in India and presumably there was a connection between the interest income and existence of PE, without clarifying whether such connection would be of a nature which would result in the interest income being taxable under Article 7. Since the tax authority failed to show that the interest income is attributable to the PE, the exclusion under Article 11 is not applicable.
In respect of interest income, it can be said to be attributable to the PE when the debt claim in respect of which interest is paid forms part of the assets of the PE or when the economic ownership of the debt claim is allocated to the PE or when the PE plays a critical role in earning the interest income. None of these conditions were proved to be satisfied by the tax authority in the facts of the present case and the business profits were sought to be taxed at 40% merely because the Taxpayer had a PE in India.
Hence, basis the reasoning above, Tribunal held that the Taxpayer was right in claiming the beneficial rate of 10% in respect of the interest income.
