Tax Insights
from India Tax & Regulatory Services
www.pwc.in
Delhi bench of Tribunal holds that guarantee fees is not chargeable to tax as interest or FTS under the
India-Netherlands tax treaty
June 19, 2020
In brief
Recently, the Delhi bench of the Income-tax Appellate Tribunal1 (Tribunal) held that payment of guarantee fees by an Indian company to its associated enterprise (AE) is not chargeable to tax in India either under Article 11 (Interest) or Article 12 (Royalty and Fees for Technical Service) of the India- Netherland Double Taxation Avoidance Agreement (tax treaty).
In detail
Facts
• The taxpayer was
incorporated in India and was engaged in the business of leasing motor vehicles, financial services and fleet management.
• During assessment years (AYs) 2009-10 and 2010-11, the taxpayer had paid guarantee fees to its AE based in Netherlands. This guarantee fee was paid pursuant to a tripartite agreement entered by the taxpayer (borrower) with its AE (surety) and the bank (lender). The AE provided guarantee for a fee of 1/8%
per annum for any bank loan availed by the
taxpayer. The AE agreed to pay the amount due as per the loan instrument in case
1 ITA No. 6461 & 6462/Del/2015
the taxpayer defaulted in payment.
• The contention of the taxpayer was that guarantee fee is a reimbursement against actual expenses, and therefore, it is not chargeable to tax in India;
hence, no tax is deductible at source.
• The tax officer (TO) contended that tax was required to be deducted on the guarantee fees under section 195 of the Income- tax Act, 1961 (the Act), as the services were in the nature of fees for technical services (FTS) covered under the provisions of section 9(1)(vii) of the Act.
Hence, the TO disallowed the guarantee fee on account of non-deduction of tax under section 195 of the
Act.
• The Commissioner of Income-tax (Appeals) [CIT(A)] held that the guarantee fees would be taxable as interest income under Article 11 of the India-Netherlands tax treaty, as it is income from
‘debt claim of every kind’.
The CIT(A) also supported the contention of the TO that it can be alternatively taxed as FTS, as the nature of services can be said to be within the ambit of the term
“consultancy services”.
Issue before the Tribunal Whether the payment of guarantee fees by the taxpayer to its AE was chargeable to tax in India as either interest income or FTS as per the India-Netherlands tax treaty?
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Tribunal’s ruling
Taxability as interest income
• The Tribunal concluded that guarantee fees paid by the taxpayer will not be chargeable to income-tax under Article 11 of the India-Netherlands tax treaty, since to earn interest income there should be a – - debt; and
- claim on that debt from which the income should arise to qualify as interest.
• Here the AE had not provided any capital to the taxpayer on which income was earned, and it only acted as surety to the taxpayer’s lender bank to pay the amount due in case of failure of payment by the taxpayer. The Tribunal also mentioned that in the absence
of a debtor-creditor relationship between the taxpayer and AE, there will not be a debt claim.
• Therefore, the Tribunal held that the guarantee fee paid by the taxpayer to its AE cannot be covered within the definition of interest as per Article 11 of the India- Netherlands tax treaty.
Taxability as FTS
• The Tribunal observed that the services provided by the AE are in the nature of financial services and cannot be termed as consultancy services under Article 12 of the India-
Netherlands tax treaty.
• The Tribunal also observed that the condition of make available under the Article
12(5)(b) of the India-
Netherlands tax treaty was not satisfied in the instant case.
Therefore, the guarantee fee cannot be taxed as FTS under Article 12(5)(b) of the India- Netherlands tax treaty.
The takeaways
The Delhi bench of the Tribunal re-iterates the tax position that guarantee fee cannot be taxable as interest income in the absence of any debt claim on the borrower by the surety. This decision also fortifies the principle that merely guaranteeing a loan cannot be understood as extending a loan.
Let’s talk
For a deeper discussion of how this issue might affect your business, please contact your local PwC advisor
Tax Insights
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