ABC International Inc USA (2011) 199 Taxman 211 / 241 CTR 289 / 55 DTR 393 (AAR)
Foreign corporates with subsidiaries in the country are not subject to payment of withholding tax for financial services like discounting of bills provided to their Indian arms. In a ruling, the Authority of Advanced Rulings (AAR) also held such companies are also not liable to pay income tax in case the firm is based in a country which has a Double Taxation Avoidance Agreement (DTAA) agreement with India.
“The applicant will not be subject to withholding of tax…,” the AAR said.
The ruling came in response to an application filed by US-based ABC International. The firm has an Indian subsidiary — ABC India Pvt Ltd — which is engaged in the business of trading food products and other activities. ABC International provides various financial services to its subsidiary, including discounting of bills of exchange or promissory notes and buying and underwriting negotiable instruments and commercial papers.
The company had sought to know whether income earned by it by way of providing financial services to its subsidiary is liable to be taxed in India under the Income Tax Act, 1961, or the Double Taxation Avoidance Agreement between the country and USA. It also asked whether the income will be subject to withholding tax, in which case the company withholds the tax before the money is spent for any purpose and is paid to the government.
“Discounting of a bill of exchange or promissory note, being a purchase of the instrument as it were and especially when it is discounted without recourse… the applicant is not liable to tax in India in view of the DTAA between India and USA,” the AAR said. It said in view of the fact that double taxation is not applicable, the firm is also not be subject to withholding tax. AAR further said there is no need for filing transfer pricing documentation for this kind of transaction.
BEFORE THE AUTHORITY FOR ADVANCE RULINGS
(INCOME TAX) NEW DELHI
3rd Day of May, 2011 PRESENT
Mr Justice P.K. Balasubramanyan (Chairman)
Mr. J. Khosla (Member)
Mr. V.K.Shridhar (Member)
A.A.R. No. 840 of 2010
|Name & address of the applicant||ABC International Inc.
|Commissioner Concerned||Director of Income-tax(International Taxation-I) New Delhi|
|Present for the Applicant||Mr. Percy Pardiwalla, Sr. Adv.Ms. Preeti Goel, Advocate Mr. Prashanti Khatore, CA Ms. Vanita Bansal, CA Mr. Banish Bansal, CA Mr. Vivek Sawhney, CA Ms. Sonam Khanna, CA|
|Present for the Department||Mr. G.C. Srivastava, AdvocateMr. Alok Malviya, DCIT|
R U L I N G
[By Justice P.K. Balasubramanyan]
1. The applicant has approached this Authority being desirous of obtaining an advance ruling on a transaction which is proposed to be undertaken. The nature of the activity as set out by the applicant in its application is as follows:-
“ABC International Inc., the applicant is a company incorporated under the laws of United States of America (USA) and is a tax resident of USA.
The applicant provides various financial services to its group companies as well as to the other companies. The financial activities consists of wide range of activities including to subscribe, buy, underwrite or otherwise acquire, own, hold, sell or exchange securities or investments of any kind including negotiable instruments, commercial paper etc. As a part of its business, it draws, makes, accepts, endorses, discounts, executes and issues promissory notes, bills of exchange etc. The applicant has been providing financial services to US and Europe entities, and has now started providing services to Asian entities as well.
ABC India Pvt. Ltd. (“ABC India”) is a group company incorporated in India and is engaged in the business of trading in wheat, grains, soyameal, oilseeds, sugar, cotton and other food products. ABC India also manufactures, processes and refines edible oils and plastic films, manufactures and trades in animal feeds, nutrition, artificial flavours and emulsions. In addition to the above, ABC India undertakes merchanting trade in goods/commodities traded across the globe, as per Indian Exim Policy and DGFT guidelines.
The applicant as part of its regular finance business wants to carry out bill discounting activities for ABC India without having any physical presence in India.
ABC India proposes to transact with the applicant for purchase of bills of exchange drawn by them on the buyer in pursuance of goods sold under normal/merchanting trade as well as purchase of promissory notes (PN) issued by such buyer. The PN is more frequently used instrument by ABC India. The applicant will enter into a discounting agreement with ABC India for purchase of the PN at a discount specifying the details of PN to be discounted, face value, discounted value, rate of discount, name of the company who issued the PN, date of maturity of PN, bank details for payment etc. The discount for purchasing the PN will be calculated on the basis of various factors such as prevalent LIBOR plus certain margin depending upon the market condition.
ABC India will send the requisite set of documents alongwith endorsed PN to their bank with instruction that the bank will send the documents to the applicant for discounting of PN and will collect payment from the applicant.
After receiving the documents and endorsed PN from the bank, the applicant will make the payment of PN purchased (after deducting its discounting charges as per the agreement) to the bank, which in turn will make the payment to ABC India.
The applicant will discount the PN on “without recourse” basis and make the remittance of the purchase price (i.e. face value minus discounting charges) to ABC India. The endorsement of PN „without recourse‟ basis signifies that all risk and rewards of the PN are transferred to the applicant and in no case the applicant makes ABC India liable to make payment to the applicant in case of delay or default in payment by the entity who issued the PN.
The applicant may further sell the PN or hold it till maturity date or if the buyer is desirous of prepaying the bill before the maturity, accept such request depending upon its own commercial considerations. In any of these situations payment will be received by the applicant from a party outside India and will be received outside India”.
2. On the basis of the facts as set out above, the applicant has sought an advance ruling on six questions which it had formulated in its application. This Authority while admitting the application for a ruling has set out the questions on which it proposes to give a ruling. They are extracted below:
3. It is submitted on behalf of the applicant that the Indian entity, which belongs to its group and which sells goods to a foreign entity and receives in lieu of payment of the price then and there, a promissory note payable without interest at a future date proposes to get it discounted with the applicant. The discount is one without recourse. The applicant would present the instrument on maturity and would recover the proceeds or discount the promissory note with another entity, but accepting the risk in respect of the promissory note. Since the applicant has no Permanent Establishment in India, the amount of discount given by the applicant to the Indian entity is not taxable in India and it is really the business income of the applicant that has to be assssed outside India. It is contended that the discounted margin cannot be described as income by way of interest within the meaning of Section 2(28A) of the Income-tax Act read with Section 9(1)(v) of the Act. Discounting of a promissory note or a bill of exchange is a well understood mercantile practice and while discounting the instrument there is no advance of a loan or creation of a debt. It is really a purchase of a negotiable instrument. What is made out of the transaction by the applicant is the difference between the sum for which the promissory note was executed realized on maturity and the discounted amount paid to the Indian entity even before maturity.
4. It is highlighted on behalf of the Revenue that the proposed transaction is a case of merchanting trade. The goods that are dealt with by the ABC entity in India are goods from outside the country. They are purchased from another ABC entity that is a non-resident and the promissory note in lieu of price is taken from that entity. The ABC Indian entity then discounts the promissory note with another ABC entity in USA, the applicant. The percentage of discount given is really the interest taken by the applicant upfront, on the money advanced by it to the Indian entity. This is clearly a ruse to avoid payment of taxes in India and this Authority should decline to answer the questions raised and even if it is inclined to answer them, they have to be answered by keeping this in mind.
5. On behalf of the Revenue, it is contended that it is really a case of the applicant advancing a loan to the Indian entity which discounts the promissory note and the percentage of discount given is really the interest charged on the loan but appropriated upfront and that such a payment would satisfy the definition of „interest‟ under section 2(28A) of the Act. It is submitted that the entity that seeks discount on the promissory note is getting the sale proceeds from the sale of the goods to a foreign buyer on a price to be paid at a future date for use immediately. By this process, the cost of getting the pre- mature payment, is the percentage of discount and that percentage depends upon the interest rate in the market. Thus, it is a case where the applicant is really getting interest on the amount from the entity in India. The interest is collected in advance in India. Under the Double Taxation Avoidance Agreement (DTAA) debt claims of every kind is provided for and this is one mode of financing an export. The amount is debited to the account of the seller as expenses for raising the money immediately. Thus, the amount is taxable as interest in India.
6. It is also contended on behalf of the Revenue that two other companies belonging to the Group of the applicant are already in such business and the Authorities under the Income-tax Act have initiated proceedings against them for recovery of the taxes due. In respect of one of those entities, the jurisdictional ITAT has held that the amount is not taxable and the appeal taken to the High Court has been heard and the judgment is awaited. In the other, proceedings before the Authorities are going on. Since a similar question was already pending before the concerned Income-tax authorities under the Act as regards the other group companies of the applicant, this is not a case for giving an advance ruling under section 245R of the Act.
7. As far as the objection that the question sought to be raised before us is pending before the Assessing authorities or the Appellate Authority under the Act and hence, we should decline to give a ruling is concerned, the same is met by Sr. Counsel for the applicant by referring to a ruling of this Authority in the case of LS Cable Limited (AAR No. 858-861 of 2009). This Authority while dealing with an argument of this nature on behalf of the department, took the view that the transaction in respect of which the ruling was sought was different from the one in which other entities are involved and consequently the bar created by Clause (i) of the proviso to Section 245R(2) of the Act was not attracted. We may also notice that the applicant in this case is different, while at the same time we take note of the fact that the expression “in the applicant‟s case” that occurred in the proviso, was deleted by Finance Act, 2000. In the case cited, this Authority proceeded to hold in a situation like the present one that the application cannot be said to be barred under clause (i) to proviso to section 245R(2) of the Act. For the purposes of this case, especially when the application has been admitted or allowed under section 245R(2) of the Act for an examination of the further materials for the purpose of giving a ruling under section 245R(4) of the Act, we do not think it necessary to further consider this objection and we think it proper to give a Ruling on the questions posed.
8. A reference to authorities shows that discounting of a bill is distinguishable from a pledge or deposit of security. They also show that it is distinguishable from a bill left for collection. In Ditchfield V. Sharp [(1983) 3 ALLER 681], the expression „discount‟ was explained as a deduction made from the amount of a bill of exchange or promissory note by one who gave the value for it before it was due. In Lomax V. Peter Dixon & Co. [(1943) 2 ALLER 255], It was stated that in discounting of bills of exchange, exchequer bill etc., the discount is the reward and in a normal case (since such bills do not as a rule carry interest) the only reward which the person discounting the bill obtains for his money. In Buchanan vs. McDonald (33 SLR 200) it was stated that discount has no technical or universal meaning. In what is perhaps, its most common meaning, it is equivalent to the payment of interest in advance e.g. when a banker advances the amount upon a bill of exchange which is not yet due, discounting the interest upto the date of payment. In P. Ramanatha Aiyar’s Law Lexicon, the meanings given are “an allowance or deduction generally of so much percent, made for pre-payment or prompt payment of a bill or account, interest taken in advance, a reduction.”
9. In Dena Bank v. M.P. National Textiles Corporation Limited [1982 AIR (MP) 85], a Division Bench of the Madhya Pradesh High Court explained the position thus:
“It may also be noted that under the banking laws when the bills are handed over to the banker by his customer in order that the same be collected when due, and the proceeds be credited to the customer’s account, then they are called. “Bills for collection”. This term distinguishes from the term, “Bill negotiated” or “Bill discounted”, which are bills for which the banker has given value at once, instead of waiting till the banker has actually received the proceeds of the bills when collected. Thus, in the case of the bills handed over to the banker by the customer for collection when due and to credit the amount in the account of the customer after the proceeds are actually collected, it is not a case of sale and purchase of negotiable instruments or documents of title relating to goods because these bills are merely handed over to the banker for collection and credit when received and the banker has no property in them. But the “Bills negotiated” or Bills discounted” stand on a different footing by which the discounter is a holder for full value and gets absolute title over it. In this behalf a reference may be made to Sheldon’s Practice and Law of Banking. Tenth Edition, at page 306, wherein the author has discussed that “to discount a bill” is to buy it, to become the transferee of it, by having it endorsed or transferred by delivery by the holder, giving him a price settled, either by agreement or by the current rate in the money market. It has been further stated that a discounter is a holder for full value and not a pledgee: he can deal and part with the bills as he likes, his title to the bill and to sue on it is absolute and covers the whole face value; he is in no sense a trustee for the previous holder as to any part of the bill or its proceeds and that the person who gets the bill discounted is a transferor if by endorsement there with all the liabilities of a indorser if a transferor by delivery, then with the liabilities attaching to that character. In either case, he parts with all rights, title and interests in the bill and its proceeds.”
Their Lordships also referred to Section 50 of the Negotiable Instruments Act dealing with the effect of an endorsement, to notice that the property in the instrument then passes to the endorsee. The observation in Halsbury‟s Law of England noticed therein is that where the transaction is really one of discounting, the banker is of course at liberty to deal with the bill as he pleases re discounting or transferring it.
10. Thus, the position appears to be that discounting of a bill amounts to purchase of the negotiable instrument and it does not involve any relationship of debtor and creditor between the endorser and the endorsee. As a general rule, an endorsement of a promissory note does not also result in an assignment of the original debt.
“Interest” means interest payable in any manner in respect of any moneys borrowed or debt incurred (including a deposit, claim or other similar right or obligation) and includes any service fee or other charge in respect of the moneys borrowed or debt incurred or in respect of any credit facility which has not been utilized.
As per the definition, for any interest to accrue, there must be a borrowing, debt, deposit or obligation to repay. In the absence of any of those elements present, it is difficult to postulate accumulation of interest or its payment. When a promissory note is discounted, no doubt keeping in mind the prevailing rate of interest, no obligation is incurred for repayment of the money by the person who discounts the instrument or the person who gets it discounted, except that in thecase of a discounting with recourse, the person who gets it discounted continues to be liable to the endorsee. In a case of endorsement without recourse, even that possibility does not arise. Of course, the person who gets the instrument discounted pays for getting present payment on an instrument that becomes due for payment at a later date. But that consideration cannot be treated as payment of interest upfront in the context of the Law Merchant and the Negotiable Instruments Act and the commercial and legal implications of a discounting of an instrument.
13. The decision of the High Court of Madras in Viswapriya Financial Services and Securities Ltd. v. CIT (258 ITR 496) while dealing with the definition of interest in the Act, after taking note of the expanded nature of the definition, concluded “even in cases where there is no relationship of debtor and creditor or borrower and lender, if payment is made in any manner in respect of any monies received as deposits or on money claims or rights or obligations incurred in relation to money, such payment is, by the statutory definition, regarded as interest”. The decision of the Privy Council in Bennison v. Shiler (AIR 1946 PC 145) and that of the Supreme Court in Radha Kissen Chanria v. Keshardeo Chanria [AIR 1957 SC 743] show that as a matter of contract, amounts that are not otherwise loans could be held to be treated as loan by the parties and could also generate interest as known to law.
“4. The term “interest” as used in this Convention 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 or prizes attaching to such securities, bonds, or debentures. Penalty charges for late payment shall not be regarded as interest for the purposes of the Convention. However, the term “interest” does not include income dealt with in Article 10 (Dividends).”
The underlying element that can give rise to interest is the existence of a debt claim. In other words, a debt has to exist for interest to be generated. Only if we are able to hold that discounting of a promissory note involves the creation of a debt or the coming into existence of a debtor-creditor relationship, we would be justified in holding that the discount given represents interest paid upfront by the resident company when it gets the note discounted. We have already indicated that it is not possible to take such a view. Hence, the discount given could not be held to be interest within the meaning of Article 11 of the DTAA.
16. We may notice once again that the purchase price payable for the goods is represented by the promissory note executed by the purchaser and it is payable in future without interest. So, all that the discounting achieves is that it enables the seller to realize the price of the goods then and there or prematurely but at a cost. That cost cannot be termed as interest paid by the seller.
17. According to the applicant, discount charges are in the nature of business income that are earned outside India. It cannot be taxed in India unless the applicant has a business connection in India or the income is earned from or through any property in India or through or from any asset or source of income in India or through the transfer of any capital asset situated in India. It is submitted that the applicant does not have any presence or agent in India and the income earned is outside India.
18. The promissory note taken by the seller, an Indian tax resident in lieu of the price to be paid, is a promissory note payable on demand. This is clear from the facsimile of the promissory note produced by the applicant. No place of payment is specified, nor is it put forward that the purchaser, the debtor, would apply to the seller to specify the place of payment. Hence applying the normal rule that the debtor must seek the creditor‟, the payment is to be made in India to the Indian entity. It is this promissory note payable in India that is discounted by the applicant. The discounted amount is sent to India as can be seen from the Discounting Agreement produced. On discounting, the income accrues or is deemed to accrue. An amount can accrue or arise if a legal right to receive it is acquired. On discounting the promissory note, the legal right to receive the proceeds accrues to the applicant. If so, the income to the applicant accrues in India. It is not disputed that it is the business income of the applicant. That business income accrues in India, though realized later. Such business income is taxable in India under the Income-tax Act subject to the rights conferred by or the protection afforded by the DTAA.
19. Under Article 7 of the DTAA, the profits of an enterprise of a contracting State shall be taxable only in that State unless the enterprise carries on business in the other contracting State through a permanent establishment situated therein. It is the case of the applicant that it has no permanent establishment in India. We have assumed for the purpose of this ruling that the applicant has no permanent establishment in India as clarified while answering question no.3 set out for ruling. Since we have held that the income is not interest income, Article 11 of DTAA is not attracted. Thus, it has to be ruled that the income of the applicant from discounting would not be taxed in India, on the case set out by the applicant in the light of Article 7 of DTAA..
20. It is true as pointed out by learned counsel for the Revenue that the transactions are among ABC entities. The original seller of the goods is a ABC entity which is a non-resident. The goods sold are outside the country. They are purchased by the Indian ABC entity. The goods are then sold by the Indian entity to another non-resident ABC entity. For the price, the promissory note in favour of the Indian ABC entity is then executed by the non-resident ABC entity. Then the bill is discounted by the Indian ABC entity with the ABC entity in USA which is the applicant before us. Learned counsel summits that a process has been evolved to take away the income from India without payment of tax on it here and such an attempt should not be countenanced. We do see some force in this submission. He also submits that proviso (iii) to Section 245R(2) of the Act gives us ample jurisdiction to see thorough the transaction and not to give a ruling on the questions posed.
21. Counsel for the applicant countered the argument by pointing out that the proviso (iii) to section 245R(2) of the Act comes into play only when the question of admitting the application is taken up for consideration under section 245R(2) of the Act and that the proviso cannot be applied once the application is allowed under that provision or admitted for a ruling. He also submits that the jurisdiction to enquire under proviso (iii) to Section 245R(2) of the Act is very limited and it is only to take a prima facie view at the stage of admission and it must be a patent or obvious case of attempt at avoidance of tax that attracts the provision. A detailed inquiry into such a question is not contemplated. He also cited the decision of the Supreme Court in Union of India v. Azadi Bachao Andolan [2003 (363) ITR 706] to contend that we are precluded from trying to pierce the veil while interpreting the effect of DTAAs in terms of the relevant provisions of the Income-tax Act.
22. This Authority has jurisdiction to see whether the transaction is designed prima facie for avoidance of Income-tax. We think that Section 245R(2) of the Act must receive a purposive interpretation. We are pronouncing on an activity or a proposed activity as projected by the applicant before us. The proviso to section 245R though placed in the context of the initial allowing of the application (really, admitting for consideration) for consideration and for giving a ruling, its object is clear. It seeks to prevent the obtaining of a ruling when the question is already in the seisin of the regular authorities under the Act, when it involves a determination of fair market value of any property or when it relates to a transaction or issue that is designed prima facie for the avoidance of income-tax. It is true that at the stage of allowing the application under Section 245R(2) of the Act, the Authority can and should consider all these questions. But does that fact prevent the Authority from considering the question when the application is taken up for rendering a ruling under sub-section (4) of Section 245R of the Act? We do not think so. After all, the object of the proviso to Section 245R(2) is very clear. It is to tell the Authority to decline a ruling if any one of those aspects is involved. If after the order under section 245R(2) is made and while the application is being considered under section 245R(4), it becomes apparent that one of the provisos is attracted, it behoves this Authority to decline a ruling. After all, section 245R is an integrated section not only dealing with the admission of an application but also its final disposal and the mere fact that the disabilities are placed at the earlier stage, cannot lead to the position that the disabilities should be ignored even when they become discernible when the application is taken up for final disposal.
23. The decision of Supreme Court in Azadi Bachao Andolan, is obviously binding on all courts and Tribunals in this country. But as far as this Authority is concerned, it seems to have a little leeway in considering for itself the questions concluded by that decision. Proviso (iii) to Section 245R(2) of the Act gives us the jurisdiction to test the transaction projected before us to see whether it is designed prima facie for the avoidance of income-tax. Azadi Bachao Andolan did not have occasion to consider the scope of this proviso. That decision was concerned with a public interest challenge to circulars issued by the Income-tax Department on the binding nature of the evidence of incorporation of a company or Corporation under foreign laws, the effect of the grant of certificate by the Tax Authorities on the residential status of the company or corporation and the general right of court to pierce the veil to find out the real nature of the company or transaction. Proviso (iii) to Section 245R(2) enables this Authority to test the transaction or issue for finding out whether as put forward, it was designed for the avoidance of income-tax. This power conferred on this Authority cannot be said to be taken away by the decision in Azadi Bachao Andolan. It is one thing to say that the said decision is binding on the Authority. But that is different from saying that the said decision precludes us from independently considering the nature of the transaction put forward before us in the context of proviso (iii) to Section 245R(2) of the Act.
24. What is the effect of the use of the expression prima facie in the provision? According to the P. Ramanatha Aiyar‟s Law Lexicon, prima facie means, „at first sight, on the first appearance, on the face of it; so far as can be judged from the first disclosure, presumably; a fact presumed to be true unless disproved by some evidence to the contrary, arising at first sight, based on the first impression‟. We may notice that the expression used is not ex-facie, meaning, in the light of what is apparent. The use of the expression prima facie thus, gives a little leeway to this Authority to consider the question of avoidance of tax, but still, it gives to this Authority only the jurisdiction to consider the question prima facie. This seems to suggest that this consideration can only be at the initial stage of the application. But as we have observed earlier, to confine it to that stage would really defeat the purpose of the introduction of the proviso. But since the intention appears to be not to confer on this Authority the jurisdiction to thoroughly examine the facts and circumstances to come to a definite conclusion as to whether a scheme for avoidance of tax is involved, the inquiry in this regard can only be of a limited nature. Thus, considered on the facts of this case, it is difficult to say prima facie that there is a scheme for avoidance of income-tax. Counsel for the applicant pointed out that in terms of the Treaty, the income would be the „business income‟ of the applicant and would be taxable under the Statute in the USA. We have also to notice that all ABC entities involved have separate corporate identities and legal existence. It is one thing to say that one can pierce the corporate veil in an appropriate case but quite another to say that we can ignore the existence of a series of legal entities validly incorporated under the relevant laws. There is also nothing illegal in one subsidiary dealing with another subsidiary. There is no case here that the transactions leading to the discounting of the promissory note are sham or illegal. When it is so, we have to test the transaction in the light of Law Merchant wherever apt and the provisions of statute law wherever they apply. So, tested, we cannot say that the well-known concept of discounting of a bill of exchange should be understood differently for the purpose of testing the transaction put forward in the anvil of the Indian Income-tax Act with particular reference to this Authority‟s jurisdiction. It for the executive Govt. and the legislature to decide whether it is necessary or feasible to change the position. It is not for this Authority to make any suggestions in that regard.
Accordingly, the ruling is pronounced on this the 3rd day of May, 2011.
Sd!- Sd!- Sd!-
(J . Khosla) (P. K. Balasubramanyan) (V. K. Shridhar)
Member Chairman Member
F.No. AAR/840/2010 Dated …………………