COMPONENTS OF INTEREST TAXATION
RESIDENCE BASED DEDUCTION
KEY ISSUES AROUND ARTICLE 11
ARTICLE 11 (1) – INDIA USA TREATY – RIGHT OF STATE OF RESIDENCE TO TAX INTEREST
Interest arising in a Contracting State (Source State)
paid to a resident of the other Contracting State (Residence State)
may be taxed in that other State (Residence State) .
ARTICLE 11 (2) INDIA USA – RIGHT OF SOURCE STATE TO TAX INTEREST
However, such interest may also be taxed
in the Contracting State in which it arises,
and according to the laws of that State,
but if the beneficial owner of the interest is a resident of the other Contracting State,
the tax so charged shall not exceed :
a. 10 per cent of the gross amount of the interest if such interest is paid on a loan granted by a bank carrying on a bona fide banking business or by a similar financial institution (including an insurance company) ; and
b. 15 per cent of the gross amount of the interest in all other cases.
TEST OF BENEFICIAL OWNERSHIP ?
BENEFICIAL OWNERSHIP OF INTEREST AND NOT DEBT CLAIM
DISADVANTAGE OF GROSS TAXATION – EXAMPLE – BANKS
ARTICLE 11 (3) INDIA USA – EXEMPTION IN SOURCE STATE FOR CERTAIN INTEREST
Notwithstanding the provisions of paragraph 2 of this Article, interest arising in a Contracting State
a. and derived and beneficially owned by the Government of the other Contracting State, a political subdivision or local authority thereof, the Reserve Bank of India, or the Federal Reserve Bank of the United States, as the case may be, and such other institutions of either Contracting State as the competent authorities may agree pursuant to Article 27 (Mutual Agreement Procedure) ;
b. with respect to loans or credits extended or endorsed
• by the Export Import Bank of the United States, when India is the first-mentioned Contracting State ; and
• by the EXIM Bank of India, when the United States is the first-mentioned Contracting State, and
• to the extent approved by the Government of that State, and derived and beneficially owned by any person, other than a person referred to in sub-paragraphs (a) and (b), who is a resident of the other Contracting State, provided that the transaction giving rise to the debt-claim has been approved in this behalf by the Government of the first-mentioned Contracting State ;
shall be exempt from tax in the first-mentioned Contracting State.
ARTICLE 11(4) INDIA USA – DEFINITION OF INTEREST
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)
ARTICLE 11(4) – ISSUES FOR CONSIDERATION
INTEREST – WHAT ALL IS COVERED UNDER DOMESTIC PROVISION ?
PREMIUM/ DISCOUNT/ PROFIT ON INSTRUMENT
ARTICLE 11 (5) INDIA USA – PERMANENT ESTABLISHMENT CASE
The provisions of paragraphs 2 and 3 shall not apply if the beneficial owner of the interest,
being a resident of a Contracting State,
carries on business in the other Contracting State in which the interest arises,
through a permanent establishment situated therein,
or performs in that other State independent personal services from a fixed base situated therein,
and the interest is attributable to such permanent establishment or fixed base.
In such case the provisions of Article 7 (Business Profits) or Article 15 (Independent Personal Services), as the case may be, shall apply
INTEREST PAID BY BRANCH OF FOREIGN BANK
ARTICLE 11 (6) INDIA USA – WHEN SHALL INTEREST ARISE IN A CONTRACTING STATE
Interest shall be deemed to arise in a Contracting State
when the payer is that State itself or a political sub-division, local authority, or resident of that State.
Where, however, the person paying the interest, whether he is a resident of a Contracting State or not, has in a Contracting State a permanent establishment or a fixed base, and such interest is borne by such permanent establishment or fixed base,
then such interest shall be deemed to arise in the Contracting State in which the permanent establishment or fixed base is situated
DOMESTIC TAX LAW – SECTION 9(1)(V)
The following incomes shall be deemed to accrue or arise in India : –
(v) income by way of interest payable by –
a) the Government ; or
b) a person who is a resident, except where the interest is payable in respect of any debt incurred, or moneys borrowed and used, for the purposes of a business or profession carried on by such person outside India or for the purposes of making or earning any income from any source outside India; or
c) a person who is a non-resident, where the interest is payable in respect of any debt incurred, or moneys borrowed and used, for the purposes of a business or profession carried on by such person in India ;
COMPARISON OF TREATY AND ACT ON “ARISE”
ARTICLE 11 (7) INDIA USA – EXCESS INTEREST PAYMENT TO RELATED PARTY
Where, by reason of a special relationship between the payer and the beneficial owner or between both of them and some other person,
the amount of the interest, having regard to the debt-claim for which it is paid,
exceeds the amount which would have been agreed upon by the payer and the beneficial owner in the absence of such relationship,
the provisions of this Article shall apply only to the last-mentioned amount.
In such case the excess part of the payments shall remain taxable according to the laws of each Contracting State, due regard being had to the other provisions of the Convention.
SPECIAL RELATIONSHIP ?
IMPLICATIONS OF RELATED PARTY
EXCESS PAYMENT TO RELATED PARTY
Article 2 – Taxes Covered
Article 4 – Concept of Residence in Tax Treaties
Article 5 – Permanent Establishment
Article 6 – Income From Immovable Property
Article 7 – Business Profits
Article 8 – Shipping & Air Transport
Article 9 – Associated Enterprise
Article 10 – Dividend
Article 12 – Taxation of Royalties and Fee for Technical Services
Article 13 – Capital Gains
Article 14 – Independent Personal Services
Article 15 – Dependent Personal Services (Employment)
Article 16 – Directors Fees
Article 17 – Artistes and Sportspersons
Article 18 – Pension and Other Social Security Payments
Article 19 – Government Services
Article 20 – Students
Article 21 – Other Income
Article 23 – Elimination of Double Taxation
Article 24 – Non-Discrimination & Article 25 – Mutual Agreement Procedure (MAP)
Article 26 – Exchange of information
Artilce 27 – Assistance in the collection of taxes
Article 28 – Member of Diplomatic Mission and Consular Posts
Article 29 – Entry into Force
Article 30 – Termination