Deductibility of Income-tax from interest paid to overseas suppliers.

1.A company, for manufacture of its products, imports various raw materials from different countries like Belgium, Japan, France, U.K., Sweden, Finland, Switzerland etc. The supplies are being procured from those suppliers under Letter of Credit opened in their favour and the terms stipulate payment after 180 days from the date of Bill of Lading. For this credit period, interest is charged by them at a rate not exceeding the prime rate of interest of the respective currency, which is as per Exchange Control Regulations. The amount of interest is charged in the invoices raised by the suppliers separately as distinguished from the value of the goods.

2.In this context, the querist has submitted that-

(a) Bank debits the account of the company on due date without physically remitting the amount to suppliers.

(b) Bank’s Account is in turn debited with their Landon/New York/ Calcutta A/c as the case may be.

(d) If the income-tax is deducted at source from interest under Section 195 of Income-tax Act, the suppliers of raw material may not be willing to accept the same because it will lower the effective rate of interest.

3..Further, in the view of the querist, according to section 10 (15) (iv) (c) of the Income-tax Act, 1961, interest payable by the company would not be treated as income of the payee to the extent to which such interest does not exceed the amount of interest calculated at the rate approved by the Central Government for this purpose having regard to the terms of the loan or the debt and its repayment. To the best of the knowledge of the querist, the Central Government has not so far prescribed any rate of interest for the purpose of aforesaid Section. However, Circular No. F. No. 21/221-64/IT(AI) dt. 24^th August 1964 reproduced on page 457 of the Income Tax Law, Vol. 1, by Chaturvedi and Pithisaria, states that “it has now been decided to issue a consolidated order of exemption covering the entire amount of loan or debt under the agreement, irrespective of whether the entire goods have been supplied or part of them are likely to follow in due course. The issue of exemption order will be made subject to ………..”.

4.From the above, it appears to the querist that an application is required to be made to the Central Government for exemption order under aforesaid clause.

5.The querist has accordingly sought the opinion of the Expert Advisory Committee on the following issues arising from the above:

(i) Whether the debt is incurred outside India and the interest income is deemed to accrue or arise outside India in view of Sections 5 & 9 (1) (v).

(ii) Whether income-tax is required to be deducted at source from payment of such interest under Section 195 of Income-tax Act, 1961.

(iii) If yes, who is responsible for deduction of tax and its payment whether the company or the Bank?

(iv) Whether an application is required to be made to the Central Government on Form ‘B’ as given in Taxmann’s Direct Tax Circulars 1988 (Vol. I, page 86).

Opinion August 18, 1989

1.The Committee notes that Section 5 of the Income-tax Act, 1961, provides as below:

“(1) Subject to the provision of this Act, the total income of any previous year of a person who is a resident includes all income from whatever source derived which-

(a) is received or is deemed to be received in India in such year by or on behalf of such person; or

(b) accrues or arises or is deemed to accrue or arise to him in India during such year; or

Provided that, in the case of a person not ordinarily resident in India within the meaning of sub-section (6) of section 6, the income which accrues or arises to him outside India shall not be so included unless it is derived from a business controlled in or a profession set up in India.

(2) Subject to the provision of this Act, the total income of any previous year of a person who is a non-resident includes all income from whatever source derived which-

(a) is received or is deemed to be received in India in such year by or on behalf of such person; or

(b) accrues or arises or is deemed to a accrue or arise to him in India during such year.

2. The Committee further notes that section 9(1)(v) of the Income-tax Act, 1961, provides as below:

“(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 use, for the purposes of a business or profession carried on by such person in India;

3.The Committee also notes that section 195 of the Income-tax Act, 1961, provides as below:

“195. Any person responsible for paying to a non-resident, not being a company, or to a foreign company, any interest (not being on securities) or any other sum chargeable under the provisions of this Act (not being income chargeable under the head “Salaries” or dividends) shall, at the time of credit of such income to the account of the payee or at the time of payment thereof in cash or by the issue of a cheque or draft or by any other mode, whichever is earlier, deduct income-tax thereon at the rates in force.

Explanation: For the purpose of this section, where any interest or other sum as aforesaid is credit to any account, whether called “Interest payable account” or “Suspense account” or by any other name, in the books of account of the person liable to pay such income, such crediting shall be deemed to be credit of such income to the account of the payee and the provisions of this section shall apply accordingly.

(2) Where the person responsible for paying any such sum chargeable under this Act (other than interest on securities, dividend and salary) to a non-resident considers that the whole of such sum would not be income chargeable in the case of the recipient, he may make an application to the Assessing Officer to determine, [by general or special order], the appropriate proportion of such sum so chargeable, and upon such determination, tax shall be deducted under sub-section (1) only on that proportion of the sum which is so chargeable:

Provided that this sub-section shall not apply to any payment to a foreign company by way of interest referred to in clause (v), or royalty referred to in clause (vi), or fees for technical services referred to in clause (vii), of sub-section (1) of section 9.

(3) Subject to rules made under sub-section (5), any person entitled to receive any interest or other sum on which income-tax has to be deducted under sub-section (1) may make an application in the prescribed form to the Assessing Officer for the grant of a certificate authorizing him to receive such interest or other sum without deduction of tax under that sub-section, and where any such certificate is granted, every person responsible for paying such interest or other sum to the person to whom such certificate is granted shall, so long as the certificate is in force, make payment of such interest or other sum without deducting tax thereon under sub-section (1).

(4) A certificate granted under sub-section (3) shall remain in force till the expiry of the period specified therein or, if it is cancelled by the Assessing Officer before the expiry of such period, till such cancellation.

(5) The Board may, having regard to the convenience of assessees and the interests of revenue, by notification in the Official Gazette, make rules specifying the cases in which, and the circumstances under which, an application may be made for the grant of a certificate under sub-section (3) and the conditions subject to which such certificate may be granted and providing for all other matters connected therewith.”

4.The Committee notes that Circular No. F. No. 21/221-64-I/T (A-I) dated 24/8/1964, issued by the CBDT, which is reproduced in Taxmann’s Direct Tax Circulars 1988 (Vol. I, page 84), inter alia, prescribes as below:

“Nature of approval to the amount of loan or debt. As you are aware, the interest payable to a non-resident firm/company by an industrial undertaking in India on any moneys borrowed or debt incurred by it in a foreign country in respect of the purchase outside India of raw materials or capital plant and machinery is exempt from payment of income-tax, under the provisions of section 10(15)(iv)(c), to the extent to which such interest does not exceed the amount of interest calculated at the rate approved by the Central Government in this behalf having regard to the terms of loan or debt and its repayment__________”.

5. The Committee also notes the clarification given in Taxmann’s Direct Tax Circulars, 1988 (Vol. I, Page 85-86) which is as follow:

“Form of application for obtaining Exemption: For the purposes of claiming exemption form income-tax on interest on loans or debts incurred by industrial undertakings in India in a foreign country for the purchase outside India of capital plant and machinery, two forms of application have been prescribed. Form A is in respect of loan and Form B is for debt incurred in a foreign country……”.

6.On the basis of the above, the opinion of the Committee on the issues raised by the querist in para 5 of the query is as below:

(i) Interest income in respect of the transaction mentioned in the query is deemed to accrue or arise in India in view of section 9 (1)(v)(b) of the Income-tax Act, 1961.

(ii) Tax should be deducted at source from the said interest income in accordance with the provisions of section 195 of the Act. The tax deduction should however be subject to the specific provisions relating to interest, if any, in the Double Taxation Avoidance Agreements with various countries.

(iii) The company is responsible for deduction of tax at source as the bank makes payment on behalf of the company.

(iv) Since the approval by the Central Government in respect of rate of interest would be decided having regard “to the terms of loan or debt and its repayment”, the company will have to make application in Form B prescribed in this behalf as referred to in para 5 above for the purpose of claiming exemption from income-tax under section 10(15)(IV)(c) of the Income-tax Act.

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