Interest On Income Tax Refund Not Connected To Permanent Establishment Under DTAA, Cannot Be Taxed As Business Income: Dehradun ITAT

The Assessee Baker Hughes Singapore Pte. had filed its income tax return in which it had reduced the receipts on account of Service tax and VAT out of its total receipts and had offered the remaining amount to tax under Section 44BB of the Income Tax Act, 1961. The Assessing Officer (AO) had made additions to Baker Hughes's income on account of Service tax and VAT and had treated them as part of its gross receipts. Also, the AO had taxed the interest on income tax refund received by Baker Hughes as business income at the Maximum Marginal Rate of 40 per cent under the Income Tax Act instead of 15 per cent in terms of Article 11 (2) of the India-USA Double Taxation Avoidance Agreement (DTAA). Baker Hughes had filed an appeal before the Commissioner of Income Tax (Appeal) (CIT (A)) who had ruled that the receipts on account of VAT and Service tax were not includible in the gross revenue of Baker Hughes for the purpose of computation of profits under the Income Tax Act. The revenue department had filed an appeal before the ITAT against the order of CIT (A) who had excluded the VAT and Service tax receipts from Baker Hughes' gross receipts. The CIT (A) had however upheld the order of the AO and allowed interest on income tax refund to be taxed at the marginal rate under the Income Tax Act. Against this order of the CIT (A) the Assessee Baker Hughes had filed cross objections before the ITAT.

The departmental representative before the ITAT had submitted that the receipts on account of Service tax and VAT were in the nature of Royalty/Fees for Technical Services under Section 9 of the Act and therefore should have been included in Assessee Baker Hughes' gross receipts. The departmental representative had also submitted that since Baker Hughes was carrying on business through its Permanent Establishment (PE) in India, the AO was right in taxing the interest income as business income under the Income Tax Act. It had contended that since the interest was received in the course of the business of the PE there was a direct nexus of the indebtedness with the assets of Baker Hughes' business in India. Baker Hughes had submitted before the ITAT that it was a resident of USA and was entitled to the benefits of the DTAA between India and USA. It had submitted that the interest received on its income tax refund was chargeable in terms of Article 11(2) of the India-US DTAA. It had argued that the indebtedness with respect to its tax refund could not have been said to be effectively connected with the business carried on by its PE in India.

Section 90(2) of the Income Tax Act provides that in case where the provisions of the DTAA apply to an assessee, the provisions of the Act shall apply only to the extent they are more beneficial to the assessee. Article 7 of the India-US DTAA provides that the profits of a foreign enterprise shall be taxable only in its state of residence unless the enterprise carries on business in India through a Permanent Establishment (PE). If the enterprise carries on business through a PE in India, the profits of the enterprise may be taxed in India under the Income Tax Act to the extent they are attributable to or effectively connected with the PE in India. However, Article 11(2) of the DTAA provides that tax on the interest income received by a foreign enterprise shall not exceed 15 per cent of the gross amount of interest. The term "Interest" under Article 11 of the DTAA signifies income from debt claims.

The ITAT observed that the Delhi High Court in the case of PCIT versus Mitchell Drilling International Pvt Ltd (2015) had held that Service tax was not an amount received by an assessee for the services rendered by it and that it was collected only for passing it on to the Government. The Delhi High Court had held that the Service tax collected by the assessee could not therefore be included in its taxable gross receipts under the Income Tax Act. The ITAT therefore upheld the order of CIT (A) excluding the VAT and Service Tax collected by Baker Hughes from its gross taxable receipts.

Also, the ITAT observed that the interest earned by Hughes Baker on its income tax refund was not effectively connected with the business of its PE in India under Article 7 of the DTAA. Therefore, it could not be taxed as its business income under Income Tax Act and was taxable at 15 per cent as per the provisions of Article 11 (2) of the India-US DTAA.

"On going through the above, it can be concluded that interest on income tax refund is not effectively connected with the PE either on the basis of asset-test or activity-test. Hence, it is taxable as per the provisions in the Para No. 2 of Article 11 of Indo-US DTAA."

The ITAT therefore dismissed the appeal of the revenue department and allowed the cross objections of the Assessee.

Case Title: ACIT (INTL. Taxation), Dehradun Versus Baker Hughes Singapore PTE.

Representative For The Assessee: Amit Arora, Adv.

Represenative For The Department: N. S. Jangpangi, CIT DR