Treaty rate on debenture interest applied at 15% because the investment was not a loan by a bank or similar financial institution.

Interest on non-convertible debentures was treated as income from an investment in debt instruments, not as interest on a loan granted by a bank or similar financial institution. The AAR applied the ordinary meaning of "loan" and "grant" and found that the transaction was not a bilateral lending arrangement within article 11(2)(a) of the India-Singapore tax treaty. As a result, the concessional rate under article 11(2)(a) was unavailable, but the applicant could claim the more beneficial treaty rate under article 11(2)(b). The interest was therefore taxable at 15% under article 11(2)(b), with tax deduction at source required at that rate under section 195 of the Income-tax Act, 1961.

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Issues: Whether interest earned on non-convertible debentures could be treated as interest on a loan granted by a bank carrying on bona fide banking business or a similar financial institution so as to attract the concessional rate under article 11(2)(a) of the India-Singapore tax treaty, and consequently the rate of tax deduction at source on the interest payment.

Analysis: The applicant was a merchant banker and financial institution under Singapore law, but it was not a bank and had not obtained any banking licence in India. The decisive question was whether investment in non-convertible debentures could be equated with a loan granted by a lender of the kind contemplated by article 11(2)(a). The terms loan and grant were understood in their ordinary sense, and the transaction was held to be an investment in debt instruments rather than a bilateral lending arrangement. On that basis, the activity was not treated as similar to granting a loan by a bank or similar financial institution. The applicant, however, was entitled to invoke the more beneficial treaty rate under article 11(2)(b) instead of the domestic rate under section 115AD of the Income-tax Act, 1961.

Conclusion: Interest on the non-convertible debentures was taxable at 15 per cent under article 11(2)(b) of the India-Singapore tax treaty, and tax was required to be withheld at 15 per cent under section 195 of the Income-tax Act, 1961.

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