2025 (7) TMI 958 - AT - Income Tax

South Korean company wins appeal on guarantee fees from Indian subsidiary under Article 22 of India-Korea DTAA

ITAT Bangalore ruled in favor of a South Korean company regarding guarantee fees received from its Indian subsidiary. The AO had taxed the guarantee fees ... Income deemed to accrue or arise in India - guarantee fees paid by the subsidiary company based in India as subject to tax in India or not? - Residential status of assessee company - India-Korea DTAA - scope of Article 22 'Other Income' of India and Republic of Korea Treaty - assessee is a company incorporated in South Korea - AO was not satisfied with the contention of the assessee on the reasoning that the guarantee fee was given by the subsidiary company to the assessee in connection with the loan availed by the subsidiary company, which was utilized in India, and therefore, the impugned guarantee fee is accruing/arising in India in terms of the provisions of section 5(2) and 9(1)(i) of the Act. HELD THAT:- It is an accepted fact that the income received by the assessee in the form of guarantee fees does not fall under Articles 6 (immovable property), 7 (business profits), or 11 (interest). The AO has not brought any material on record to establish that the transaction constitutes business profits or interest income. As such the AO has admitted the possession discussed immediately above. Accordingly, the residual clause of Article 22 squarely applies. Since the assessee is a resident of South Korea and the income in question does not fall under any specific Article dealt with earlier in the treaty, it shall be taxable only in Korea as per Article 22 of the treaty. See Daechang Seat Co. Ltd [2023 (7) TMI 343 - ITAT CHENNAI] wherein following Article 23 of Indo-Korea DTAA which specifically provides that taxability of 'other income' is only in the contracting state and in the present case, the contracting state is Korea and not India, hence taxability under the Income-tax Act is not at all desirable. We hold that the guarantee fees received by the assessee, a resident of South Korea, is covered under Article 22 of the India-Korea DTAA and is not taxable in India. Hence, the addition made by the AO is liable to be deleted. Assessee appeal allowed. The core legal question considered in this appeal is whether the guarantee fees amounting to Rs. 9,74,81,953 paid by an Indian subsidiary company to its foreign holding company, resident in South Korea, are taxable in India under the Income-tax Act, 1961 and the India-Korea Double Taxation Avoidance Agreement (DTAA).The key issues addressed include:Whether the guarantee fees paid by the Indian subsidiary to the foreign holding company constitute income taxable in India under domestic law, specifically sections 5(2) and 9(1)(i) of the Income-tax Act, 1961.The applicability and interpretation of Article 22 ('Other Income') of the India-Korea DTAA concerning the taxability of such guarantee fees.Whether the guarantee fees fall under any other specific articles of the DTAA such as Articles 6 (immovable property), 7 (business profits), or 11 (interest).The relevance and applicability of judicial precedents, including decisions of the Income Tax Appellate Tribunal (ITAT) and High Courts, in determining the taxability of guarantee fees under similar circumstances.Issue-wise detailed analysis:1. Taxability of Guarantee Fees under Domestic Law (Sections 5(2) and 9(1)(i))The Assessing Officer (AO) contended that the guarantee fees paid by the Indian subsidiary to the foreign holding company accrued or arose in India because the loan was availed by the Indian subsidiary and utilized in India. Therefore, the AO held that the income is taxable in India under sections 5(2) and 9(1)(i) of the Income-tax Act, 1961, which deal with income deemed to accrue or arise in India.The AO reasoned that since the guarantee fees were connected to a loan obtained by the Indian subsidiary, the income arises in India and is taxable here. The AO rejected the assessee's claim that the income falls under Article 22 of the DTAA, which provides for taxation only in the state of residence.The AO's approach was challenged by the assessee, who argued that the guarantee fees do not accrue or arise in India but in South Korea, the state of residence, and hence are not taxable in India.2. Applicability and Interpretation of Article 22 (Other Income) of the India-Korea DTAAArticle 22 of the India-Korea DTAA provides:'Items of income of a resident of a Contracting State, wherever arising, not dealt with in the foregoing Articles of this Convention shall be taxable only in that State.'The assessee argued that the guarantee fees are 'other income' not covered by Articles 6, 7, or 11 of the treaty, and thus fall within the residual clause of Article 22. Since the assessee is a resident of South Korea, the income should be taxable only in South Korea.The AO admitted that the income does not fall under Articles 6 (immovable property), 7 (business profits), or 11 (interest), nor did he produce any evidence to the contrary. This admission supports the application of Article 22.The Tribunal agreed with the assessee's interpretation, holding that the residual clause of Article 22 applies and the income is taxable only in the state of residence, South Korea.3. Precedential Decisions and Their ApplicationThe Tribunal relied extensively on prior decisions to support its reasoning:Daechang Seat Co. Ltd. vs DCIT: The ITAT held that guarantee fees received by a Korean company from its Indian subsidiaries were taxable only in Korea under Article 22 of the India-Korea DTAA. The guarantee fees were treated as 'other income' and not business profits or interest.Capgemini SA vs DCIT: The Mumbai ITAT held that guarantee commission received by a French company from Indian associates neither accrued nor was deemed to accrue in India, and hence was not taxable in India under the India-France DTAA. The Tribunal emphasized that income can be taxed in India only if it arises in India, and in that case, the income arose in France.Johnson Matthey Public Ltd. vs CIT: The Delhi High Court held guarantee fees taxable in India under the India-UK DTAA. However, the Tribunal distinguished this case on facts and treaty provisions, noting that the India-UK treaty's Article 23 (Other Income) differs from the India-Korea treaty's Article 22, which provides exclusive taxation in the state of residence unless otherwise specified.The Tribunal noted that the India-Korea DTAA's Article 22 does not provide for taxation in the source state (India) for 'other income,' unlike the India-UK DTAA. Therefore, the Johnson Matthey decision was held not applicable.4. Application of Law to FactsThe Tribunal found that the guarantee fees were paid by the Indian subsidiary to the foreign holding company resident in South Korea for a corporate guarantee provided by the latter to secure a loan from a foreign bank. The guarantee was given outside India, and the income arose in South Korea.The AO's contention that the fees accrued in India because the loan was utilized in India was rejected, as the income's source is the guarantee provided by the foreign company, not the loan utilization by the Indian subsidiary.Since the income does not fall under any specific Article of the DTAA and is 'other income,' Article 22 applies, and the income is taxable only in South Korea.5. Treatment of Competing ArgumentsThe AO and the learned DRP argued for taxing the guarantee fees in India, relying on the provisions of the Income-tax Act and the nature of the transaction. They also relied on the Johnson Matthey case.The Tribunal rejected these arguments on the following grounds:The AO's reliance on domestic law provisions is subject to the DTAA, which overrides domestic law in case of conflict.The guarantee fees do not constitute business profits or interest income; hence, Articles 6, 7, and 11 of the DTAA do not apply.The Johnson Matthey decision is distinguishable due to different treaty provisions and facts.Precedents from the ITAT and coordinate benches have consistently held that guarantee fees paid to a foreign resident company are taxable only in the state of residence under similar treaty provisions.6. ConclusionsThe Tribunal concluded that the guarantee fees received by the foreign holding company, resident in South Korea, from its Indian subsidiary are not taxable in India under the Income-tax Act, 1961, or the India-Korea DTAA.The addition made by the AO to the total income of the assessee was deleted, and the appeal was allowed.Significant holdings and core principles established include:'Items of income of a resident of a Contracting State, wherever arising, not dealt with in the foregoing Articles of this Convention shall be taxable only in that State.' (Article 22 of India-Korea DTAA)'Since the income received by the assessee in the form of guarantee fees does not fall under Articles 6, 7 or 11, the residual clause of Article 22 squarely applies. The income shall be taxable only in the state of residence, Korea.''The guarantee fee received from Indian subsidiaries has neither accrued nor arisen in India and therefore is not taxable in India.''The decision in Johnson Matthey Public Ltd. Vs CIT is distinguishable and does not apply to the facts of the present case due to different treaty provisions.''The AO's reliance on sections 5(2) and 9(1)(i) of the Income-tax Act is overridden by the DTAA provisions.'Final determinations on the issue:The guarantee fees paid by the Indian subsidiary to the South Korean holding company are not taxable in India.Article 22 of the India-Korea DTAA governs the taxability of such 'other income' and restricts taxation to the state of residence.The addition made by the AO treating the guarantee fees as taxable income in India is deleted.The stay petition filed by the assessee became infructuous following the disposal of the main appeal.