Treaty interest exemption and non-resident withholding rules clarified for Mauritius bank income and section 234B exposure.

Article analyses treaty relief for interest income earned by a Mauritius bank registered as an FII in India under Article 11(3)(c) of the India-Mauritius tax treaty. It explains that "derived" was read as referring to the recipient being a bank, and that "bona fide banking business" is assessed with reference to the banking business carried on in Mauritius, so FII activity in India does not by itself defeat the condition. It also notes that beneficial ownership must be established on facts, including fund flow, source of investments and end-use of income. Separately, it states that section 234B interest is not leviable on a non-resident where the income was subject to withholding tax in India.

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Issues: (i) Whether interest income on securities earned by a Mauritius bank registered as an FII in India was exempt under Article 11(3)(c) of the India-Mauritius tax treaty on the meanings of "derived" and "bona fide banking business", and how the claim stood on the question of beneficial ownership; (ii) Whether interest under section 234B of the Income-tax Act, 1961 was leviable on a non-resident whose income was subject to tax deduction at source in India.

Issue (i): Whether interest income on securities earned by a Mauritius bank registered as an FII in India was exempt under Article 11(3)(c) of the India-Mauritius tax treaty on the meanings of "derived" and "bona fide banking business", and how the claim stood on the question of beneficial ownership.

Analysis: The expression "derived" in Article 11(3)(c) was held to relate to the recipient being a bank, and not to require that the interest must arise only from banking operations carried on in India. The expression "bona fide banking business" was understood with reference to the banking business carried on in Mauritius, and the fact that the assessee also carried on FII activities in India did not, by itself, negate the treaty condition. However, the question whether the assessee was the beneficial owner of the interest income required examination of fund flow, source of investments, and end-use of the income. On that aspect, the material on record was found insufficient and the matter was sent back for fresh verification.

Conclusion: The assessee succeeded on the interpretation of "derived" and "bona fide banking business", but the question of beneficial ownership was remanded to the Assessing Officer for fresh adjudication.

Issue (ii): Whether interest under section 234B of the Income-tax Act, 1961 was leviable on a non-resident whose income was subject to tax deduction at source in India.

Analysis: In the case of a non-resident whose income was liable to withholding tax in India, and where the obligation to deduct and pay tax lay on the payer, interest under section 234B could not be charged on the payee-assessee when the payer failed to deduct tax.

Conclusion: The levy of interest under section 234B was not sustainable.

Final Conclusion: The appeal was allowed in part, the treaty interpretation was accepted in principle, the section 234B levy was deleted, and the beneficial ownership aspect was restored to the Assessing Officer for reconsideration.

Ratio Decidendi: For Article 11(3)(c) of the India-Mauritius tax treaty, "derived" is linked to the bank as the recipient of interest and "bona fide banking business" is not confined to banking activity carried on in India; however, beneficial ownership must be established on facts before exemption can be granted, and section 234B interest is not chargeable to a non-resident where the tax was deductible at source by the payer.

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