Interest income to be taxed under Article 7 should be directly or indirectly attributable to PE: ITAT

The assessee is a company incorporated in, and fiscally domiciled in, the Republic of Japan. It has various streams of income from its India operations- income from its permanent establishment in India Rs 8,47,64,383, income earned from India as fees from technical services Rs 31,76,15,635, income from shipping business Rs 1,09,53,179, and income from interest on suppliers’ credit Rs 2,25,89,136, apart from other incidental incomes. This interest income was offered to be taxed at the rate of 10% in terms of the provisions of Article 11(2) of the India Japan Double Taxation Avoidance Agreement by the assessee.

AO noted that the assessee had a permanent establishment in India and under Article 11(6) of the Indo-Japanese Tax Treaty, the provisions of Article 11(2), which provide for a lower rate of 10%, will not come into play.

The AO held that interest income of Rs 2,25,89,136 at 40% as per the India Japan DTAA taking into account the presence of the permanent establishment in India in the year under consideration.

Appeal before CIT(A): Aggrieved, the assessee carried the matter in appeal before the CIT(A) who upheld the plea of the assessee and concluded that the interest income in question is required to be taxed at 10% in terms of the provisions of the Article 11(2) as there is no connection between the interest income and the permanent establishment.

Appeal before ITAT: The Assessing Officer being aggrieved by the order filed an appeal before the Tribunal. The tribunal observed that there is nothing more than the mere existence of a permanent establishment of the assessee company in India, which is being put against the assessee. Unless Article 7 comes into play, the jurisdiction of Article 11(2) is not ousted, Article 7 cannot come into play unless the interest income is directly or indirectly attributable to the permanent establishment, and there is nothing shown by revenue, to demonstrate the nexus between the permanent establishment and the interest income. The onus of establishing the “effective connection” between the debt claim with the permanent establishment is on the AO, but he simply proceeded on the basis that since the assessee has a permanent establishment in India, interest income can be connected with such a PE and to be taxed at normal rate is permissible. This approach is inherently flawed.

The tribunal held that the expression “effectively connected with such permanent establishment” must mean a situation in which the interest income in question can be said to be “directly or indirectly attributable to the permanent establishment” and can be brought to tax under article 7(1) as such. That is not the case with the Assessing Officer before us. Therefore, the appeal is dismissed in favour of the assessee.

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