Under the Indian Domestic tax laws, definition of interest is provided in Section 2(28A) as under : –
“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”
Section 2(28B) of the Income Tax Act, 1961 also defines interest on securities to mean –
(i) interest on any security of the Central Government or a State Government;
(ii) interest on debentures or other securities for money issued by or on behalf of a local authority or a company or a corporation established by a Central, State or Provincial Act;]
Once an income falls within the definition of interest as above, the next thing that one needs to analyse is whether, it can be taxed in India. Interest income can be taxed in India when it accrues in India or arisen in India, or it is deemed to accrue or arise in India by virtue of provision of Section 9(1)(v), discussed subsequently.
Where the interest payments made by a resident satisfy the following twin conditions, i.e., it falls within the definition of interest discussed above, and it either accrues, or arises in India, or it is deemed to accrue or arise in India, it would be taxable in India, unless the recipient comes from a Treaty country and such country provides some preferential tax treatment which could be in either of the following modes: –
- Narrower scope of definition of interest ;or
- Exclusion of certain type of interest from the definition of interest, and hence non taxable in India; and/ or
- Taxation only in the country of the recipient, i.e. no taxation in the Source country.
The scope of interest which is covered may be any one of the following, or such other payments which meet the definition of interest under respective Treaties.
- Cash deposit and securities in money form;
- Government securities;
- Bonds and debentures
- Mortgage Interest
- Participating Loans – Profit sharing
Before undertaking a detailed analysis of the definition of interest, it would be worthwhile to consider the Model draft of OECD commentary. Given that many of the Indian tax Treaties follow the OECD and UN Model, we have considered the OECD Model clause on Interest as the basis of our discussion in this chapter. According to the OECD commentary, Article 11 defines interest as under: –
1. Interest arising in a Contracting State and paid to a resident of the other Contracting State may be taxed in that other State.
2. 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 10 per cent of the gross amount of the interest. The competent authorities of the Contracting States shall by mutual agreement settle the mode of application of this limitation.
3. The term “interest” as used in this Article 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 and prizes attaching to such securities, bonds or debentures. Penalty charges for late payment shall not be regarded as interest for the purpose of this Article.
4. The provisions of paragraphs 1 and 2 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 and the debt-claim in respect of which the interest is paid is effectively connected with such permanent establishment. In such case the provisions of Article 7 shall apply.
5. Interest shall be deemed to arise in a Contracting State where the payer is a 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 in connection with which the indebtedness on which the interest is paid was incurred, and such interest is borne by such permanent establishment, then such interest shall be deemed to arise in the State in which the permanent establishment is situated.
6. 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 this Convention.
On a broad basis, if one were to summarize the typical interest clause, one would find the following scheme in various clauses: –
|Right of the Source State to tax interest arising therein and of Resident State|
|Quantum of taxation by way of withholding in Source State|
|Definition of interest|
|Exclusion of taxation under this Article wherein the recipient has a PE in Source State|
|Accrual and Deemed accrual of interest|
|Payments of interest in cases where the payer and recipient have special relationship.|
Each of these aspects have been considered in detail in subsequent section of the Series.