IT APPEAL NO. 1708 (MUM.) OF 2016
[ASSESSMENT YEAR 2011-12]

D. KARUNAKARA RAO, ACCOUNTANT MEMBER 
AND RAVISH SOOD, JUDICIAL MEMBER

P.J. Pardiwala and Niraj Sheth for the Appellant. 
Jabir Chouhan, CIT-DR for the Respondent.

ORDER

D. Karunakara Rao, Accountant Member - This appeal filed by the assessee on 22.3.2016 is against the directions of the DRP-1, Mumbai dated 22.12.2015 and the order of the AO dated 28.11.2016 for the assessment year 2011-2012. In this appeal, assessee raised the following grounds which read as under:—

2. Briefly stated relevant facts of the case are that the assessee is a Foreign Company (NR) registered as a 'Bank' in Mauritius filed the return of income declaring the total income of Rs. 67.51 crs (rounded off). The case was referred to the TPO for benchmarking of certain international transactions entered into by the assessee with Associated Enterprise (AE). TPO found the transactions are at Arm's Length (AL) and therefore, there are no adjustments suggested on this account. During the scrutiny proceedings, the Assessing Officer noted that the assessee earned an amount of Rs. 94,57,45,856/- as 'interest income' on securities. The assessee claimed the same as exempt income under Article 11(3) of the Indo-Mauritius DTAA. On the contrary, AO proposed to deny the exemption as claimed by the assessee and also proposed to tax the same as per the provisions of section 115AD of the Act. Assessee filed various written submissions, which contains a core argument that the assessee doing in bona fide banking business in Mauritius and earned interest income from securities in India in such circumstances, the same is exempt from tax in India as per clause (c) of Article 11(3) of the DTAA with Mauritius. However, AO did not accept the same for the reasons given in para 6.5 of the draft assessment order. The essential reasoning given by the AO includes that the assessee being FII and unregistered as a bank in India, the interest income earned by such FII cannot be considered as earning out of bona fide business activities. Accordingly, he invoked the provisions of section 11(2) of the treaty for the proposition that the interest income liable to tax in source country (India) since the assessee company does not fall in the exception provided in Articles 11(3) and 11(4) of the treaty. Accordingly, the said interest income was proposed to be taxed u/s 115AD of the Income Tax Act, 1961 which provides for taxing such interest income of FII @ 20%. Assessing Officer also levied penalty u/s 234B of the Act and also initiated penalty proceedings u/s 271(1)(c) of the Act. Aggrieved with the same, assessee filed an application before the DRP-I, Mumbai.

3. The DRP considered the objections raised by the assessee and analysed the treaty provisions. Eventually, DRP confirmed the proposal of the AO for taxing the said interest income under the provisions of section 115AD of the Act giving a categorical finding that the assessee cannot be considered carrying on the bona fide banking business as proposed by the AO. Further, the additional reason given by the DRP for confirming the addition is that the assessee cannot be considered as a beneficial owner of interest as claimed by the assessee. The DRP is of the opinion that the interest so earned by the assessee shall be exempted from the tax provided the same is derived beneficially owned by any bank, carrying on a bona fide banking activities. The contents of paras 2.1 and 2.2 of the DRP's order are relevant. The objection relating to the levy of interest u/s 234B of the Act was dismissed stating that this ground does not relate to any variation in income. Further, the penalty proceedings dismissed as premature. Eventually, the Assessing Officer considered the above direction of the DRP and applied the treaty provisions of Article 11(2) to the interest receipts out of securities amounting to Rs. 94.57 crs and computed the assessed income at Rs. 94.57 crs (rounded off) against the returned income of Rs. 67.57 crs. Aggrieved with the same, assessee filed the present appeal before the Tribunal.

4. During the proceedings before us, Shri P.J. Pardiwala, ld. Counsel for the assessee explained the above facts and developments that happened before the Revenue Authorities. Further, he brought our attention to the treaty provisions of Article 11(3) and submitted that the assessee is a bank duly registered in Mauritius and is also a FII duly incorporated as such in India after obtaining approvals as per the provisions of SEBI. He also submitted that the assessee did not had any bank activities in India and assessee is not registered under RBI for doing banking activities. He also brought our attention to various documents to suggest that the assessee is a resident of Mauritius and also brought our attention to TRs issued by the Mauritius. Assessee filed the return of income in Mauritius. Mentioning that there is no dispute on the basic facts, ld Counsel for the assessee submitted that the core issue to be decided by the Tribunal relates to if the assessee is covered in the exceptions provided in Article 11(3)(c) or not? The interest income which is claimed as an 'exempt income' is not required to be charged to tax in India as per the provisions of section 115AD of the Act. Explaining the same, ld Counsel for the assessee submitted that for claiming exemption as a case of exception to the Article 11(3) of the treaty, it is a bank and it is not required to be engaged in the bona fide banking activities in India. Further, elaborating the same, ld AR reasoned that the Assessing Officer is not justified in holding that the assessee bank in Mauritius when registered as FII in India, the interest income earned by the FII in India is entitled to exemption under this Article 11(3)(c) of the treaty. Further, ld Counsel for the assessee submitted that the assessee company being a bank is not required to do any banking activities in India to avail the benefits of the treaty under the said Article. He argued that the treaty benefits are available in respect of the interest income earned on the securities. The assessee is a bank and therefore, the exemption provided in the treaty is to the person (bank specific) and the same cannot be denied when the assessee is registered as FII in India. Assessee never ceases to be a Bank in respect of interest income earned as FII in India. The said exemption is available not only to the interest earned in respect of the banking activities ie raising loans and giving advances but also in respect of the interest out of investments made in securities. Assessee cannot lose the treaty benefits in respect of the income earned in India merely because geographical location barriers. He also demonstrated that there is no requirement in the Article for assessee to earn the interest income in India so long as the assessee is engaged in the bona fide banking activities in Mauritius. Further, bringing our attention to the expression "bona fide" in clause-(c) of the Article 11(3) of the treaty, ld Counsel for the assessee submitted that this is not the case of the AO that assessee is engaged in any banking activities which are not bona fide. Ld Counsel for the assessee summed up by stating that the assessee is a bank by birth in Mauritius and it was registered as an FII in India and earned interest income from securities and engaged in bona fide banking activities. Therefore, exemption as claimed by the assessee is required to be allowed. Further, bringing our attention to Article 11(6) of the treaty, ld Counsel for the assessee submitted that such interest income will have to be taxed if the claim of the assessee is not accepted even if the interest is earned out of banking activities, which is not the intention of the Legislation. This will lead to the absurdity if the order of the AO/DRP is confirmed. Further, he submitted that this argument was not raised before the DRP/AO. He also submitted that this is a case of exception provided in Article 11(3) and therefore, the same has to be interpreted strictly and there is no express condition in the Article to demonstrate that the assessee is required to do bona fide banking transactions in India for claiming exemption in respect of the interest earned out of FII activities. In this regard, ld Counsel for the assessee relied on the judgment of the Privy Council in the case of Punjab Co-operative Bank Ltd. v. CIT [1940] 8 ITR 635 (PC) for the proposition that the banking activities relating to the purchase and sale of securities constitutes a banking activity. Further, bringing our attention to the reason given by the DRP for denying exemption ie the interest earned by the assessee out of the securities cannot be considered as beneficially owned, ld Counsel for the assessee submitted that this is the case where DRP taken as an additional reason for denying exemption on the ground of non-discharging of onus. In this regard, ld Counsel for the assessee brought our attention to various documents in the paper book and submitted that the assessee furnished the detailed bank statements saying the fund flow and application of funds earned out of the securities activities. He also submitted that the investment in securities was done out of assessee's funds involving the assessee's bank accounts. According to the ld AR, the securities were purchased by the assessee in its own name and sold the same by the assessee. The proceeds of the sale transactions were remitted to the assessee's bank account. When such facts are undisputed, assessee cannot be categorized as non-discharge of onus. When the assessee is undisputed owner of the interest income, the question of beneficial ownership does not arise and therefore, the addition reason given by the DRP is required to be dismissed.

5. We have heard both the parties and perused the orders of the Revenue Authorities as well as the voluminous paper book filed before us. On hearing both the parties and on perusal of the facts of the case, we find that the case of the Revenue is that the interest income earned from the securities in the capacity of assessee-FII is not eligible for exemption as the assessee has not earned the same in the capacity of the assessee-bank. It is an undisputed fact that the assessee is incorporated as a bank in Mauritius and not so in India. Assessee incorporated only as FII in India. As per the Revenue, the interest income derived by the bank out of banking activities in India is alone eligible for exemption under clause (c) to Article 11(3) of the treaty. Per contra, the case of the assessee is that the assessee is entitled to such exemption under the said Article even if there are no banking activities in India, a contract State.

6. For resolving this dispute, we proceed to peruse the relevant Article 11(3) of the treaty and the same reads as under:—

ARTICLE-11 Interest:

3. Interest arising in a Contracting State shall be exempt from tax in that state provided it is derived and beneficially owned by:

7. From the above, we find it necessary to elaborate the expressions viz (i) derived; (ii) beneficial ownership and (iii) bona fide banking activities. It is evident from the above extracted portion of the Article 11(3) of the Treaty that it provides for exemption in respect of the interest arising in a Contracting State ie in India provided, the interest income is derived and beneficially owned by any bank carrying on a bona fide banking activities. The dispute in question revolves around the expressions "derived", "beneficially owned" and "carrying on bona fide banking activities". The Revenue is of the opinion that the expression "derived" refers to earning of interest income out of the bona fide banking activities and not to the any bank or not out of FII activities on standalone basis in India. Regarding the expression "beneficially owned", the case of the Revenue is that the assessee failed to demonstrate that the funds invested in the securities in India belong to the assessee and therefore, the interest income earned out of such investment, which is now claimed as exempt are not for the benefit of the others. Referring to the bona fide banking activities, the case of the Revenue is that the interest earned on securities by FII is outside the scope of bona fide banking activities of the assessee in India. As per the Revenue, assessee (Mauritius bank) has not carried any bona fide banking activities in India, therefore, is not eligible for getting benefit under Article 11(3) of the treaty.

(i) Derived
8. From Article 11(3) of the Treaty, it is observed that the interest income 'derived' by any bank is exempt in India. Applying the test that the assessee is a bank, which may be having another source of income in FII activities in India fulfils the definition of the expression "derived". In our considered opinion, it is not appropriate to link the expression of 'derived' to the banking activities or the FII activities and it is appropriate to relate the said expression to "any bank" used in Clause (c) of Article 11(3) of the Treaty. The principles of literal interpretation suggest the above reasoning. From this point of view, in our view, the Revenue's reliance on the judgment of the Apex Court in the case of Liberty India v. CIT [2009] 317 ITR 218/183 Taxman 349 stands fulfilled differently and the same is in favour of the assessee.

(ii) Beneficial ownership
9. This expression is neither defined in treaty nor in the domestic law. However, an intermediary ie a bank, nominee, an agent or a fiduciary with narrow powers will not be 'beneficial owner'. Further, the conduit companies are also outside the meaning of 'beneficial owner'. There may be a situation that the banks are used by the third parties in the resident countries for transmitting their funds into the FII activities in India with the contractual understanding that the interest income so earned by the bank is for ultimate transfer of such interest income to the said third parties in Mauritius. The above fiscal scheme may also include back to back transactions, whereby the bank will not be beneficiary of such interest income earned by the bank in Indian soil. For analysis of the same and to reach relevant and proper conclusions, there is a requirement of data to be furnished by the bank/FII to the tax authorities in the assessment proceedings and if such an exercise of furnishing the data meets the requirement of the AO in the instant case. Considering the above, we infer that the 'beneficial owner' can be the one with the full right and the privilege to benefit directly from the interest income earned by the FII-Bank (Indo-food International Finance Ltd. v. J.P. Morgan Chase Bank NA London Branch [2006] EWCA case 158). The income must be attributable to the assessee for tax purposes and the same should not be aimed at transmitting to the third parties under any contractual agreement/understanding. The bank should not act as a conduit for any person, who in fact receives the benefits of the interest income concerned. The recipient of the interest income should be deemed as the 'beneficial owner' unless there is any evidence to suggest that the said interest income is for the benefit of third persons. Why must the bank own the interest income, which actually belongs to others? For this, the data must be made available by the assessee to the authorities concerned to demonstrate that the assessee is a recipient of the interest income, which is the case here, and the same is utilised by the bank and not transferred to any other parties. There is no clear-cut finding on this issue in the instant case for want of data by way of bank statements and cash flow statement etc, pertaining to the utilization of interest income earned by the FII activities in India. In our opinion, the details filed are inadequate to come to proper conclusions on the issue. Therefore, we are of the opinion that the bank is under obligation to furnish to the tax authorities the relevant bank statements involving the fund flow ie inflow and outflow into FII activities, source funds, final destination of interest income earned in India. We remand this part of the issue to the file of the AO for another round of the proceedings before AO. AO shall grant a reasonable opportunity of being heard to the assessee as per the set principles of natural justice.

(iii) Bona fide banking activities
10. This expression has to be understood in the context of 'any bank' used in clause (c) of Article 11(3) of the DTAA. The bona fide, if any, should be restricted to the banking activities which is restricted to Mauritius country in this case. The same should not be confused the FII activities in India. Further, we are of the opinion that the doing only the FII activities of the bank in India will not constitute to any mala fide to the banking activities of the bank in Mauritius. In other words, the assessee as a bank in Mauritius is qualified to perform FII activities in India since approved by SEBI and the same will not come on the way of the expression 'bona fide banking activities'. It is not the requirement of the treaty that the assessee must be doing banking activities in India as well to avail the exemption provided in Article 11(3)(c) of the Treaty.

11. Further, we have also perused the contents of paras 2.11 and 2.12 of the DRP and find it relevant to extract the same which read as under:—

"2.11. It is undisputed fact that in India, the assessee does not carry out any business of banking in India nor it is permitted by RBI to carry banking business in India. The assessee in India is registered as an FII only and permitted under SEBI regulations to make investments in India in securities as well as debt instruments. Further, it is undisputed that the interest income received by assessee from India is from its activity as FII in India. Though the assessee claims that it is a banking company but no evidence has been placed on record that it did derive any income from carrying out any bona fide banking business in Mauritius. The assessee has also not submitted its own financials to show that it was operating as a bank in Mauritius in FY 2010-2011. Further, by use of expression "derived" and ....by....(c) any bank carrying on a bona fide banking business, it is very clear that the interest which is the subject matter of relief under Article 11(3)(c) must have a first level direct nexus with the carrying of bona fide business activity. As held by the Apex Court in the case of Liberty India 317 ITR 218 (SC), expression derived connotes a first level or direct nexus of income to the activity mentioned therein. When the expression 'derived' is read in juxtaposition with the expression 'carrying on a bonafide banking business', it reinforces the view that merely having a banking licence is not enough nor merely carrying out banking activity. It is only when there is a direct nexus of interest derived from banking activity, such interest income comes under the ambit of Article 11(3)(c). Thus, what is exempt under Article 11(3)(c) is only the portion of interest which is derived directly by assessee from actually carrying out a bona fide business of banking. Thus, for the sake of argument without admitting, even if an assessee is assumed to be carrying on a bona fide business of banking outside India and it being registered as FII in India and not as a bank, then the interest earned by such assessee from India being FII, shall not be eligible for exemption under Article 11(3)(c). Hence, where the interest income is earned by non-resident from India from its activities as an FII, such income cannot fall under the exemption clause (c) of Article 11(3) and the same would be taxable under Article 11(2) of DTAA with Mauritius.

2.12. It is also an important to note that for the interest income to be exempt from tax in India, one of the prerequisite is that it should be beneficially owned by it. The assessee was asked to prove that the interest income in question was beneficially owned by it. However, no documents were placed on record to suggest that the interest income was beneficially owned by assessee. As stated earlier, the assessee was requested to explain the immediate source of funds as per its bank statement for making investment in India. However, the assessee has failed to show the immediate source of funds and also the immediate application of the income. Hence, the condition of beneficial ownership of such interest by the assessee itself being not proved, on this ground also such income cannot fall under the exemption clause (c) of Article 11(3). The interest income of Rs. 94,57,45,856/-cannot be held to be exempt from tax in India. The action of the AO of taxing the interest income of Rs. 94,57,45,856/- is, therefore, upheld."

12. From the above, we do not agree with the reasoning given by the DRP on the expressions relating to 'derived from' and 'bona fide banking activities'. It is also not a case of the Revenue that the assessee must be doing banking activities in India. Thus, the assessee should be considered as an eligible bank, who earned interest income out of bona fide banking activities. We order accordingly. That leaves us with the other issue relating to the 'beneficial ownership' of the interest income earned by the assessee out of FII activities in India. As discussed by us in the preceding paras of this order, the assessee is under obligation to furnish basic data relating to the source of funds that entered into the FII activities in India, the end utilization of the interest income earned by the assessee etc. Assessee must demonstrate that the invested funds beneficially belong to the assessee and the interest income earned out of FII activities in India are also beneficially owned by the assessee. Since, the assessee is claiming DTAA exemptions on the said interest income, the onus is on the assessee to demonstrate that the assessee is not a conduit company for the benefit of any third person and also no back to back transactions are involved in the FII activities of the bank.
13. Further also, the Assessing Officer should understand the expression 'beneficial ownership' relates to the international fiscal concept and it should be given such a meaning respecting the secrecy clauses of the assessee, if any. For this limited purpose, we remand this issue to the file of the AO for bringing clarity on various aspects of the issue relating to the 'beneficial ownership'. Accordingly, Grounds No. 1, 2 and 3 raised by the assessee are allowed protanto.

14. Ground No.4 relates to the levy of interest u/s 234B of the Act, when assessee is a non-resident, whose entire income is subject to TDS provisions and not liable to advance tax u/s 207 r.w.s 209 of the Act. In this regard, ld Counsel for the assessee filed a written submission and mentioned that assessee being a non-resident, is not liable to pay advance tax u/s 207 r.w.s 209 of the Act since its entire income is subject to withholding taxes in India. In this regard, ld Counsel for the assessee relied on the judgment of the Hon'ble jurisdictional High Court in the case of DIT (International Taxation) v. NGC Network Asia LLC [2009] 313 ITR 187 (Bom.). After hearing the ld Representatives of both the parties and on perusal of the said judgment of the Hon'ble Bombay High Court, we find, the said judgment is relevant for the proposition that when a duty is cast on the payer to deduct and pay the tax at source, on payer's failure to do so, interest u/s 234B cannot be imposed on the payee-assessee. Considering the settled position of the issue, we are of the opinion, Ground No.4 raised by the assessee should be allowed in its favour. We order accordingly and Ground No.4 is allowed.

15. Ground No. 5, which relates to the levy of penalty u/s 271(1)(c) of the Act, in our opinion is premature in nature and demands no specific adjudication at this point of time. Accordingly, the said ground is dismissed as academic.

16. In the result, appeal of the assessee is partly allowed.