The payments relating to debt claims, service fee or other charge, could be characterized as interest provided there is privity of such contract.’
In its recent ruling Johnson Matthey Public ltd. Company v. DCIT, [2017] 88 taxmann.com 127 (Delhi-Trib.) on taxability of guarantee fee received by a foreign parent, ITAT Delhi, held that guarantee fee will not qualify as interest under the India-UK DTAA (the Treaty) or the Income Tax Act, 1961 (the Act), since it can relate only to payment by a person who has received some amount pursuant to a loan transaction. The appellant-assessee had entered into a global guarantee agreement outside India with two banks. In terms of the agreement, the banks advanced loans to the Indian subsidiaries of the assessee and the assessee received guarantee fee. It offered the sum to tax as interest though it was of the opinion that the income did not arise in India and was not taxable in India. Alternately, the assessee also contended that the income was either business income or FTS in terms of Treaty. The Assessing Officer however made an addition of the income holding that the income was did not qualify as interest and since there was no specific provision in the Treaty dealing with guarantee fee, the same was taxable as Other Income (Article 23).
The assessee sought to rely on an earlier ruling of ITAT, Mumbai dated 28-3-2016 in Capgemini SA v. DCIT (International Taxation), ITAT No. 7198/Mum/2012 wherein the Tribunal had held that guarantee fee paid to overseas parent under the terms of a global agreement for corporate guarantee, as not taxable in India since the income arose outside India. However, the Delhi Tribunal arrived at a different decision based on the following reasons.
It is necessary that the assessee should be a party to the loan transaction that gives rise to ‘guarantee fee’
A debt may be understood as an obligation to pay a sum of money at present or at a future date. A claim can be understood as an assertion of a right (in relation to the debt).
Article 12 of the India-UK DTAA defines interest as below:
‘term "interest" as used in this Article means income from debt-claims of every kind, whether or not secured by mortgage and whether or not carrying a right to participate in the debtor's profits, and in particular, income from Government securities and income from bonds or debentures, including premiums and prizes attaching to such securities, bonds or debentures but, subject to the provisions of paragraph 9 of this Article, shall not include any item which is treated as a distribution under the provisions of Article 11 (Dividends) of this Convention.
The definition as per Section 2 (28A) in the Act is wider and includes any service fee or other charge in respect of moneys borrowed. The Explanatory note to the OECD Model Convention states that interest is the remuneration received for making capital available. This is in conformity with the classic economic definition of interest being the reward for capital. However the wider definition in the Act would include service charges in respect of the debt.
The ITAT held that to qualify as interest, the payment must be made by the borrower to a person who has privity with the contract of loan. In the instant case, The assessee had not provided any loan and there was no indebtedness on part of the payer to the assessee.
One view is that guarantee fee is business income and hence it is taxable in India only if the non-resident has a Permanent Establishment (PE) in India. Different arguments have been advanced both by assessees and the Revenue to contend that guarantee fee is taxable as FTS, Interest and so on. For instance, in Idea Cellular Ltd v. DCIT, [2015] 58 taxmann.com 101 (Mum-Trib.), the Revenue contended that the payment was inextricably connected with the loan and that the definition as per the Act was wide enough to cover guarantee fee which is in relation to the loan but the ITAT did not agree with this. It held that the definition is not wide enough to bring within its ambit any third party who has not given any money and that in order to qualify as interest the sum paid should be part of the loan itself.
Tribunals and Courts have generally concluded that guarantee fee cannot be interest. In GMAC Financial Services, 2011 SCC Online ITAT 12377, ITAT Chennai, relied on the case of Vijay Breaking Corporation to conclude that the term debt-claims used in the DTAA is narrower and would cover only loans since it is further qualified by ‘whether or not secured by mortgage’. Thus the use of the term debt claim of every kind does not expand the scope of interest to include every payment in relation to the transaction.
The reasoning of the ITAT is also in line with the ruling in Container Corp. v. Comr., 134 T.C. No. 5 (2/17/10) wherein it was held that guarantee by itself is not a loan or interest but it is a payment for services which may be performed in future. The Mexican parent company had guaranteed the loans availed by its US subsidiaries in USA and charged a fee on the guarantee. The US Court further held that the income arose in Mexico and was not taxable in US and no withholding obligations arose at the hands of the US subsidiaries.
Guarantee fee falls under Article 23 of India-UK DTAA
The ITAT upheld the stand of the Revenue that guarantee fee was taxable @40% as Other Income. It held that the assessee was not in the business of extending guarantees and hence the income did not fall within the ambit of Article 7 and it did not qualify as FTS since no skill or knowledge was ‘made available’ to the payer. Since there was no specific entry dealing with taxation of guarantee fee, it would be covered by Article 23 as income arose in India. The ITAT held that guarantee fee arose only when the loan transaction happened in India and not on entering into an agreement outside India. Thus, the source has been held to be in India. This is at variance with the decision in Container Corp discussed above as regards situs of the source of income. The ITAT relied on the ruling of the Apex Court in Kancheanganga Sea Foods P Ltd vs CIT [2010] 325 ITR 540 (SC) to hold that in terms of Section 5(2), all income received or deemed to be received, arising, accruing or deemed to arise or accrue in India would be taxable at the hands of the non-resident.
To conclude
It may be possible to argue that guarantee fee should be part of business profits and be taxed in terms of Article 7. The Explanatory note to the OECD Model Convention states that every independent activity may constitute a business if it is not covered by other Articles relating to independent personal services, income for use of immovable property etc. Thus, even in the instant case, the fact that the assessee was not in the business of extending guarantees need not take it out of the ambit of Article 7. However, ITAT,Delhi has held conclusively that guarantee fee arises in India, it is not interest, business income or FTS and is taxable as other income.
[The author is Principal Associate, Direct Tax Practice, Lakshmikumaran & Sridharan, Delhi]