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22 December 2017 Indian Tribunal rules guarantee fee is taxable in India as other income In the instant case, the taxpayer (the Taxpayer), a foreign company and a United Kingdom (UK) tax resident, provided a guarantee under a global agreement to a foreign bank on behalf of its Indian subsidiaries and received a guarantee fee. The Indian Appellate Tribunal (the Tribunal) held that the guarantee fee is taxable in India. It further stated that the fee is neither in the nature of interest income despite the wide scope of the definition of interest pursuant to the Indian Income Tax Law (ITL) nor is it interest covered by Article 12(5) of the India-UK Income Tax Treaty (the Treaty). The Tribunal reasoned that the guarantee fee cannot be characterized as interest since the Taxpayer was not a party to the loan agreement between the foreign lender and the Indian subsidiary. The guarantee fee is also not in the nature of business income since the Taxpayer was predominantly engaged in the manufacturing business, and not in the business of providing corporate/bank guarantees to earn income on a regular basis. Accordingly, the guarantee fee is taxed at 40% under the ITL, since it would be treated as "Other Income" under Article 23 of the Treaty which grants full taxing rights to India. The Taxpayer entered into a global corporate guarantee agreement with certain foreign banks for providing a guarantee for loans granted by the banks to its group companies across various countries. Accordingly, the foreign banks also extended the loan facility to two subsidiaries of the Taxpayer in India. The Taxpayer received a guarantee fee from its subsidiaries, which was treated as interest and subject to a 15% reduced withholding tax under the Treaty. The tax authority held that the guarantee fee did not fall within the definition of interest under Article 12, but is taxable as other income under Article 23, which grants taxing rights to India. Consequently, the guarantee fee is subject to 40% tax under the ITL applicable to foreign companies. The Taxpayer filed an objection before the Dispute Resolution Panel (DRP) on the re-characterization of the guarantee fee and imposition of a higher tax. However, the DRP confirmed the tax authority's action. The Taxpayer thereafter filed an appeal before the Tribunal. The guarantee fee accrued or arose in India since the Indian subsidiary received a loan from foreign banks and the loan transaction took place in India. It was the act of the subsidiary of borrowing the funds that resulted in income accruing to the Taxpayer. Since the loan transaction took place in India, the related income from the guarantee fee also accrued in India. The Tribunal relied on an Apex Court ruling which held that in cases of income receipts created by legal fiction under the source rule of the ITL, the nonresident had received the income in India. A definition of interest under the provisions of the ITL and the Treaty should be interpreted in the context of the usage and with reference to other words and phrases used in the definition. Although the definition includes the words "claims of any kind" or "service fee or other charges," such terms need to be understood in relation to the transaction or contract of loan. Under the ITL, the term "interest" is defined as any payment pursuant to a loan transaction, if it is made in the context of a loan and in relation to the contract between the parties, even in the absence of a debtor-creditor relationship. However, a payment made to a person not a party to the loan transaction or contract cannot be treated as an interest payment even though the payments are incidental to the loan. If the definition of interest under the ITL or the Treaty were expanded, it would also cover other payments incidental to the actual loan agreement, which would not reflect the true intention of the legislature or treaty policy. The Taxpayer is not a party to the loan transaction, and the guarantee contract is different from the loan contract; accordingly, a guarantee fee does not fall within the definition of interest under the provisions of the ITL and the Treaty. The global guarantee agreement is entered into for the limited purpose of enabling its subsidiaries to secure loans and the guarantee income is incidental in nature, since the Taxpayer was not in the business of providing corporate/bank guarantees to earn income on a regular basis. Accordingly, the guarantee fee cannot be treated as business income which, in the absence of a permanent establishment in India, is not taxable in India under Article 7 of the Treaty. As a result, the guarantee fee falls under the "Other Income" Article of the Treaty and, consequently, fully taxable in India. It is common for a global parent to enter into global corporate guarantee agreements with a global bank. The parent may also recover guarantee fees from the subsidiaries under an appropriate transfer pricing policy. Interestingly, in the present ruling, the Tribunal did take note of an earlier ruling of the Mumbai Tribunal, which had held that a guarantee fee was not taxable in India since it did not accrue or arise in India, nor can it be deemed to accrue or arise in India. However, the Tribunal neither distinguished nor dissented from the earlier ruling. Taxpayers would need to factor in the above conflict of views while making tax compliance based on the facts and circumstances of the case. Document ID: 2017-5070 |
