INSIGHT: Treatment of Assured Returns on Advances under India–U.K. Tax Treaty

A recent case in India clarified the tax treatment of assured return as interest on advance payment.

Facts

Mohinder Singh Sanghera and Jatinder Singh Chatta (“the taxpayers”), tax residents of the U.K., invested in Indian developer’s project along with other investors. The taxpayers paid an advance amount to the extent of 95 percent of the sale price for provisional allotment of commercial floors in a proposed commercial complex being developed.

The Indian developer, on receipt of such advance, was obligated to pay periodic assured returns to the taxpayers until the possession of commercial space. The amount was repayable by the developer on complying with the applicable withholding tax obligation for nonresidents under Indian domestic laws at 15 percent under Article 12 of the India–U.K. tax treaty (“tax treaty”).

The revenue authority reassessed the taxpayers’ case and asked them to file tax returns in India. The taxpayers filed a tax return offering such tax on such assured amount at 15 percent treating it as interest income.

Alternatively, the taxpayers argued that the income related to acquisition of capital assets be regarded as capital receipt outside the purview of any tax liability in India. However, the revenue authorities treated such assured return received by the taxpayers as return from investment instead of interest resulting in adjustment to their total income. The first appeal upheld the order of the revenue authority. The matter reached the Chandigarh Tribunal (“Tribunal”).

Tribunal Ruling

On reading of the reasons recorded for reassessment, the Tribunal observed that the revenue authority did not use the term “interest income” but regarded assured returns as investment income from commercial properties of the developer based on certain information. The reassessment proceedings were held as valid on the premise that the revenue authority was eligible to evaluate taxpayers’ income only where they file tax returns in India, and cannot automatically assume its character or taxability.

The taxpayers argued that, according to Indian domestic tax laws, a nonresident was absolved from furnishing a tax return where its income comprised of only income specified under the specific tax regime for nonresidents, including interest income subject to withholding tax. The taxpayers did not have any other income except interest income received from the developer that was subject to withholding tax at 15 percent under the Interest Article of the tax treaty. Hence, the taxpayer was not obligated to file a tax return in India.

The Tribunal observed that the allotment letter of the developer revealed that until the property agreement was executed and registered, the developer had complete authority over the proposed unit and all payments by the taxpayer are regarded as a token without granting any lien or interest in the said property. The property, against which the taxpayers made payments, was merely proposed and not in existence at the time of payment. Subsequently, the proposed property was incapable of being commercially exploited to generate yield or any form of income as rent, lease, etc.

The Tribunal interpreted that the assured return cannot be construed by any means return from property where the taxpayers made payments. The taxpayers advanced money to the developer resulted into nothing but a state of debt claim against the developer until the proposed property was developed or possession was granted to the taxpayers owing to registration of the property agreement.

Further, the taxpayers were not entitled to any form of right or lien on the property since being developed, thus resulting in a financial transaction without any creation of capital asset. Accordingly, the taxpayers’ claim of capital receipt not liable for tax was not tenable.

The Tribunal characterized the assured return on advances as interest received by the taxpayer under a financial transaction, where such finance provided to the developer was utilized for the development of property. Accordingly, the assured return received by the taxpayers as interest income was rightly offered to tax under the applicable tax treaty in their tax returns. Thus, the Tribunal concluded that the developer had rightly withheld tax under Article 12 of the tax treaty on such assured return paid to the taxpayers.

Planning Points

Even though the reassessment proceedings were treated as valid, the Tribunal dealt with the case on merits for taxability of the assured return received on advance payment to the developer by relying on the Gujarat High Court in the case of Nathalal Dayabhai where interest on earnest money was not treated as business income but taxable as other income.

Technically, by considering the reassessment proceedings as valid, the Tribunal diverted from the charging provision of Indian domestic tax laws that prescribe no obligation for nonresidents to file tax returns in India, especially where the entire tax liability on such income was discharged through withholding tax.

In fact, it would have been prudent for the Tribunal to also clarify the position of the tax return filing in India in such specific cases, in light of the recent amendments to Indian domestic tax laws where nonresidents are free to obtain a tax registration number in India on satisfaction of specific conditions and furnishing of prescribed information.

The Tribunal is in line with the term “interest” used in Article 12 of the tax treaty to mean any income from debt claim whether or not carrying a right to participate in the debtor’s profits. Hence, the ruling confirms the correlation of the income associated with the immovable property only where the property is in existence or possession, without which such financing transactions would be treated as a pure debt arrangement.

Shailendra Sharma is a chartered accountant with a multinational tax consulting firm, India.