Whether an assessee can apply the domestic rates of taxation on some heads of income and rates as per DTAA for other heads of income?

Morgan Stanely Asset Management Inc vs. JT CIT (Special Range 12) (2006) 6 – SOT 384 (MUM)

Executive summary

The assessee company an FII incorporated in the USA, derived income from capital gains, dividend and interest. The assessee company applied the rates as per DTAA in respect of interest income (At 15% as per DTAA) and applied the rates as per domestic law in respect of dividend and capital gains, as the domestic rate was more favourable compared to the rates as per the DTAA in respect of dividend, and for capital gains no rates were prescribed under DTAA. The Assessing Officer adopted the tax rate of 20% on interest as per Section 115D of the Act (Domestic Tax Rate) on the ground that the assessee cannot pick and choose the rate of tax for different sources of income. (For some source as per domestic law and some source as per DTAA). The assessee ought to choose one rate for all sources of income (Either domestic rate of tax or the rate prescribed as per the DTAA) held that the assessee has the right to choose the rate of tax as per the domestic law for some source of income and the rate as per DTAA for some other sources of income.

DTAA between India and USA

Articles 10, 11, 12

Sections: 90 and 115AD of the Act

Decisions considered:

CIT vs. Davy Ashmore India Ltd, 190 ITR 626 (Cal)

CIT vs. Visakhapatnam Port Trust, 144 ITR (AP)

CBDT Circular No. 333 dated 2-4-1982

1. General concept under International Taxation:

1.1. There is a general concept in the International Taxation that the provisions of the DTAA override the provisions of the domestic law. This was at first communicated by the CBDT vide Circular No. 333 dated 2-4-1982. This concept was later embedded into the Act by insertion of Section 90(2) in the Income tax Act 1961.

1.2. In terms of section 90(2) of the Indian Income Tax Act the provisions of the Act shall apply to the extent they are more beneficial to the assessee.

1.3. Reading sections 90(1) and 90(2) it is apparent that the assessee may choose the rates prescribed in the DTAA in respect of some heads of income, wherever it is more beneficial. In respect of some other heads of income, the assessee can choose the rate as prescribed under the Act, if it is more beneficial to the assessee. The assessee thus has the benefit both under the DTAA and the Act.

1.4. However, this position was not accepted by the Tax Department. According to the Dept, the assessee has the option to choose either the rate prescribed under the Act or the rate prescribed under the DTAA.

1.5. The matter came up before the Hon-Tribunal in the matter of Morgan Stanely Asset Management Inc. vs. Jt. Commissioner of Income Tax – Special Range, Mumbai; and reported in (2006) 6 SOT 384 (Mum)

2. Facts of the case:

2.1. The assessee company, incorporated in the USA had income from three sources of income namely dividend, capital gains and interest for assessment year 1998–99. These are taxable under the domestic law and the rates are prescribed under the DTAA between India and the USA, as well.

2.2. The assessee chose to apply the Indian tax rates (Domestic rate) in respect of income from dividend and capital gains and applied the rates as per the DTAA (Article 11) in respect of interest income.

2.3. The rates of tax on dividend as per the domestic law was 20 per cent as against the rate of tax of 25 per cent under the DTAA (Article 10). In respect of capital gains rates prescribed under the domestic law is applicable as per the DTAA (Article 13). As regard interest the rate prescribed under the DTAA is 15 per cent, whereas the rate prescribed under the Act (Section 115 AD) is 20 per cent.

2.4. In short the assessee applied the rate as per domestic law in respect dividend (20%) instead of the rate as per DTAA (25%) as it was more beneficial. In respect of capital gains, the assessee chose the rate as per the domestic law, as it was so provided in the DTAA (Article 13). In respect of interest the assessee chose to apply the rate of 15 per cent as per the DTAA, instead of the domestic rate of 20% (Section 115 AD), as it was more favourable.

2.5. The Assessing Officer calculated the rates as per domestic law in respect of interest as well, at 20 per cent (Section 115 AD) disregarding the rate of 15 per cent as provided in the DTAA. The AO observed that the assessee has to choose either the rates as per the domestic law or the DTAA in respect of all sources of income. The assessee cannot opt the ‘pick and choose’ policy as may be favourable under the domestic law for some source of income and DTAA for some other source of income. The order of the AO was confirmed by the CIT(A).

3. Submissions before the Hon. Tribunal:

3.1. It was submitted that the provisions of the Treaty override the provisions of the Act and the CIT(A) ought to have applied the correct rate being the lower rate of tax under the treaty.

3.2. Reliance was placed on the decision of the Calcutta High Court in CIT vs. Davy Ashore India Ltd, 190 ITR 626, as also Andhra Pradesh High Court in the case of CIT vs. Visakhapattanam Port Trust 144 ITR, 146 and CBDT’s own Circular No. 333 dated April 2, 1982.

3.3. It was also submitted that the assessee had opted for rates of tax prescribed under the tax treaty, but had adopted the beneficial rate of tax applicable to dividends, as provided in the Income Tax Act in terms of section 90(2).

4. Analysis of the Submission and the decision:

4.1. The Honble Tribunal cited the provision of the DTAA between India and the USA in respect of Dividend (Article 10), Interest (Article 16) and Capital gains (Article 13)

4.2. The Hon. Tribunal observed that the assessee has adopted the domestic rates of tax in respect of Dividend, it being more beneficial as compared to the rate under the DTAA. In respect of interest income the rate of tax as applicable under the DTAA is 15 percent and as per section 115 AD it is 20 per cent; the same cannot exceed 15 per cent as per DTAA. For capital gains the rate or ceiling is provided in Article 13 of DTAA and hence the rate as per DTAA becomes the local rate (appropriate rate)

4.3. The assessee has not applied the policy of pick and choose for various sources of income. The rates applied by the assessee for all three sources is as per the combined reading of Income-tax Act and DTAA. Hence that assessee is liable to pay tax at the rate of 15 per cent on interest income being the maximum rate provided in the DTAA.

5. Decision

In view of the submission of the appellant and the analysis the Honble Tribunal accepted the contention of the appellant to the effect that the appellant can choose the beneficial rate based on the combined reading of the Act and the DTAA.

Observation of the authors

The general concept prevailing in the international tax that the assessee has the option to choose the beneficial rates as per the DTAA and the Income-tax Act for different sources of income, gets judicial approval. This comes as a clarification of the general concept much to the relief of tax-payers.