In a recent judgement (CIT v Vijay Ship Breaking Corporation and others [2003] 181 CTR 134), the Gujarat High Court has held that an Indian buyer is required to withhold tax from the usance interest paid to foreign suppliers.
In this case, the Indian company, engaged in the business of ship breaking, had bought ships from suppliers in UK and Singapore. The memorandum of agreement (MOA) entered into by the parties provided for credit for 180 days usance period with interest. It also mentioned separately the amount of purchase consideration for the ships and usance interest for period of 180 days.
It was agreed that the mode of payment would be "irrevocable usance letter of credit". The Indian buyer paid entire consideration through letter of credit without withholding any tax. The revenue officer held that tax should have been withheld from usance interest and disallowed the deduction for such interest in computation of taxable profits. Under Indian tax law, expenses resulting in payment to non-residents outside India are not allowable as a deduction in computing the payer's taxable income unless the appropriate withholding tax is deducted and paid.
In the second appeal before the Tribunal, the Indian buyer contended that usance interest was an integral part of the purchase consideration of ships and hence it did not constitute interest income to the non-resident supplier. The definition of interest under the relevant articles in the India-UK and the India-Singapore Double Tax Avoidance Treaty (DTAA) did not include such an amount. Further, in any case, the entire consideration including usance interest was paid to the Indian bank issuing the letter of credit and not to the foreign supplier.
The Tribunal ruled in favour of the Indian buyer by holding that usance interest was not taxable in India. It observed that there was no right of pre-payment to the Indian buyer unlike in case of a typical loan/debt transactions carrying interest. It also observed that the definition of interest in the relevant article in DTAAs with UK and Singapore refers to "debt claims of every kind whether or not secured by mortgage" and there was no debt claim as such in this case. It also noted that unlike the DTAAs with UK and Singapore, the DTAA with Philippines specifically extends the definition of interest to provide that debt claim includes "sales on credit of any industrial, commercial or scientific equipment' and the DTAA with Indonesia specifically extends the definition of interest to include 'interest on deferred payment sales".
However, the High Court reversed the decision of Tribunal and held that usance interest was separate from purchase consideration for purchase of ships. This was borne out by the following facts:
the MOA between the parties specifically mentioned that interest was separate from purchase consideration;
two separate invoices were raised for purchase consideration and usance interest respectively;
the interest component was debited to profit-and-loss account as expense; and
the value of ships declared for customs duty excluded the usance interest.
The High Court also observed that the expression "debt claims of every kind" cannot be whittled down to mere debt claim in form of loan and hence purchase consideration for ship was also a debt claim. It held that the additional words in the DTAAs with Philippines and Indonesia are only explanatory and the definition of interest as such in DTAAs with UK and Singapore is wide enough to implicitly cover such usance interest in the relevant article.
The High Court did not accept the argument that the Indian buyer had made payment to the Indian issuing bank and not to the foreign supplier. It held that the payment of interest was mentioned in MOA itself and letter of credit was just the mode of payment. It was not agreed that letter of credit itself would constitute absolute payment. Hence, the obligation to withhold tax was on the Indian buyer.
The High Court accordingly allowed appeal of revenue authorities disallowing deduction for usance interest paid without payment of withholding tax. The High Court has not given permission to the Indian buyers to appeal to the Supreme Court and the only recourse left to it is to file a special leave petition with the Supreme Court.
This decision would have significant implications in case of transactions involving settlement of consideration through usance letter of credit. Revenue authorities are expected to scrutinize these transactions in detail to detect non-compliance with withholding tax provisions and to deny deduction of such payments for computation of taxable profits.
Rajesh Kadakia (rajesh.kadakia@in.ey.com), New Delhi
