India: Interest paid on income tax refund held taxable under tax treaty with United States

A case concerning interest paid on income tax refund held taxable under tax treaty with United States

Interest paid on income tax refund held taxable under tax treaty with United States

The Delhi Bench of the Income-tax Appellate Tribunal held that interest on an income tax refund was not effectively connected with the taxpayer’s permanent establishment (PE) in India, either on the basis of asset-test or activity-test. Hence, the interest was subject to tax under the provisions of Article 11(2) of the income tax treaty between India and the United States (and not taxable as business income under the statutory measures).

The case is Transocean Offshore International Ventures Ltd. v. DCIT (ITA No. 5895/Del/2017)

Overview

The taxpayer, a tax resident of United States, received interest on an income tax refund during the assessment year 2012-13. The Assessing Officer determined that such interest income received by the taxpayer was taxable (at a rate 40%).

The taxpayer contended that the interest received on the income tax refund was subject to tax under Article 11 of the India-United States income tax treaty. The tax department, however, contended that the taxpayer was conducting business through its PE in India, and thus, the interest income was rightly taxable as business income.

The tribunal agreed with the taxpayer, and held that the interest income was not effectively connected with the taxpayer’s PE and thus was subject to tax under the treaty provisions.

KPMG observation

The tax treatment of interest paid on a refund of income tax has been the subject of court and tribunal cases. In certain decisions, it was held that interest income received by a foreign tax resident on refund of tax was not to be treated as business income because the refund was not effectively connected with the Indian PE of the taxpayer. Accordingly, in those cases, the interest was typically taxed at a concessional rate under the interest article of the respective tax treaty.

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