Case Note & Summary
The case involves an appeal by the Director of Income Tax (International Taxation) against an order of the Income Tax Appellate Tribunal (ITAT) which dismissed the revenue's appeal and partly allowed the cross-objections of the respondent, M/s. Credit Suisse First Boston (Cyprus) Ltd., a company incorporated in Cyprus and a tax resident there. The respondent carried on banking business and was registered with SEBI as an approved sub-account of a Foreign Institutional Investor, permitted to invest exclusively in debt securities including government securities. The respondent followed the mercantile system of accounting and filed its return for assessment year 2001-2002 declaring total income of Rs.5,94,28,493/-. The Assessing Officer determined the total income at Rs.47,69,48,530/- by including Rs.1,21,57,517/- as interest accrued but not due on securities held as on 31st March 2001, and also treated gains from sale of securities as taxable. The respondent contended that interest had not accrued as it was not due on that date, and that the sale of securities was covered by Article 14 of the India-Cyprus Double Taxation Avoidance Agreement (DTAA) as business profits, not capital gains. The CIT(A) and ITAT upheld the respondent's contentions. The High Court admitted the appeal on two substantial questions of law: (i) whether interest can be said to have accrued on 31st March 2001 even though not due; and (ii) whether the CIT(A) and ITAT were right in holding that the sale of securities was covered by Article 14 of the India-Cyprus tax treaty. The court held that under the mercantile system, income accrues only when the right to receive it arises, and not merely because the financial year ends. Since the interest on the government securities was payable every six months and was not due on 31st March 2001, it did not accrue on that date. Regarding the second issue, the court held that the sale of securities by the respondent, being a bank and holding securities as stock-in-trade, constituted business profits under Article 14 of the DTAA, and not capital gains under Article 13. Therefore, the gains were taxable only if the respondent had a permanent establishment in India, which was not the case. The appeal was dismissed, and the order of the ITAT was upheld.
Headnote
A) Income Tax - Accrual of Interest - Mercantile System - Interest on government securities held by a foreign institutional investor does not accrue on the last day of the financial year if the interest is not due on that date - The court held that under the mercantile system, income accrues only when the right to receive it arises, and not merely because the financial year ends - The Assessing Officer's addition of interest accrued but not due was set aside (Paras 1-4). B) Double Taxation Avoidance Agreement - Business Profits - Article 14 of India-Cyprus DTAA - Sale of securities by a Cyprus resident constitutes business profits under Article 14, not capital gains under Article 13 - The court held that since the assessee was a bank and the securities were held as stock-in-trade, the gains were business profits taxable only if the assessee had a permanent establishment in India - The CIT(A) and ITAT were correct in holding that the sale was covered by Article 14 (Paras 1-2).
Issue of Consideration
Whether interest on securities held by a foreign institutional investor accrues on the last day of the financial year even if not due; Whether sale of securities by a Cyprus resident is covered under Article 14 of the India-Cyprus Double Taxation Avoidance Agreement
Final Decision
The appeal is dismissed. The order of the Income Tax Appellate Tribunal is upheld.
Law Points
- Interest accrues only when due
- not on last day of financial year under mercantile system
- Sale of securities by Cyprus resident covered by Article 14 of India-Cyprus DTAA as business profits
