Johnson Matthey Public Ltd. [1](Taxpayer) is a UK-based specialty chemicals manufacturer, having subsidiaries worldwide, including in India. In the tax year 2010-11, the Taxpayer provided guarantees on a global basis to foreign banks outside India for credit facilities offered to its Indian subsidiaries. This was formalized through an Intra Group Parental Guarantee and Indemnity Services Agreement in March 2010. The Taxpayer in its tax return filed in India, classified the guarantee fee received by the Indian subsidiary as ”interest” under Article 12 of the India-UK Double Taxation Avoidance Agreement (DTAA). However, the tax authority challenged this classification, assessing the fees as ”other income” under Article 23(3) of the DTAA in the draft assessment order which was also upheld by the Dispute Resolution Panel (DRP).
Aggrieved by the DRP order, Taxpayer filed appeal before the Income Tax Appellate Tribunal (ITAT). However, the ITAT ruled against the Taxpayer. Firstly, on the situs of accrual of the guarantee fee, the ITAT ruled that the guarantee fees both accrued and was received in India since the guarantee was necessary for the Indian subsidiary to borrow a loan in India. Secondly, on the classification of the income, the ITAT ruled that it could not be considered as interest income because the Taxpayer did not lend monies to Indian subsidiary and the definition of “interest” under Section 2(28A) of the Income Tax Act does not encompass guarantee fees.
On Taxpayer’s further appeal to the Delhi High Court, it agreed with the ITAT that the guarantee fee accrues or arises in India but for a different reason. While evaluating this issue, the HC laid down following principles on the interpretation of the term “accrue” or “arise”:
- The term “accrue” or “arise” means a periodical monetary return being received with some regularity.
- The accrual of income is not dependent upon actual receipt but is governed by the principle of “right to receive”.
- Every income that accrues or arises in India is liable to be taxed, regardless of its destination or disposal or what happens afterwards.
Basis the above general principles, the Delhi HC concluded as follows:
- Guarantee fee answers to the description of a periodical monetary return received with regularity.
- Guarantee fee was payable irrespective of failure or default on the part of the Indian subsidiaries. The intra group agreement provided that where there is a default in payment of the guarantee fee, the Taxpayer could discontinue its service of extending the guarantees on behalf of the Indian subsidiaries.
- Thus the guarantee fee was anchored to the intra group agreement with the Indian subsidiaries and the guarantee service provided to the Indian subsidiaries in India. The obligation to pay was incurred in India, in respect of service utilized by Indian subsidiaries in India.
- The fact that the guarantee fee could be utilized by the Taxpayer to meet its liabilities towards the foreign bank in case of default by the Indian subsidiaries would be wholly irrelevant for examining whether income accrues or arises in India.
- While on default by Indian subsidiaries to pay the loan, there could be recourse against the assets of the Taxpayer outside India, but such ultimate impact or adverse consequence of grant of guarantee is not determinative of where the guarantee fee accrues or arises.
The HC also disagreed with the Mumbai ITAT decision in the case of Capgemini[2] and held that it does not agree with Mumbai ITAT conclusion that the contract with the foreign bank was the source from which guarantee fee accrues. In fact, the HC held that in the facts before it, the guarantee fee was sourced from the Intra Group agreement which was entered only between the Taxpayer and its Indian subsidiary. The said fee was payable irrespective of a default or a failure on the part of the Indian subsidiary to discharge its obligations to the financial institution from which it may have received credit.
