AAR Rules On Tax Exemption Of Interest Payments Under Indo-Mauritian Treaty

by Lorys Charalambous, for LawAndTax-News.com, Cyprus

11 June 2004

According to reports in the regional media, the Indian Authority for Advance Rulings (AAR) has ruled that interest on debentures paid to a Mauritius-resident investor is subject to withholding tax in India unless specifically exempted.

The AAR was asked to examine transactions undertaken by an Indian-based private company, which allotted partly convertible debentures to an overseas corporate body (OCB) incorporated in Mauritius. The Indian company reportedly secured the approval of the Reserve Bank of India (RBI) for the payment of interest on the debentures at a rate of not more than 14%, and only to the extent of the profits.

However, according to reports, in the year which ended in March 2002, the interest liability exceeded the profits, meaning that the entire profits were payable as interest to the Mauritius-based investor. This led the Indian company to approach the AAR in order to ascertain whether it would be liable to deduct tax at source for the year in question.

Although the Indian company acknowledged that under India's tax laws, payment of interest to a non-resident on borrowings utilised in India is liable for Indian tax, it argued that the payment should be exempted under the Indo-Mauritian tax treaty. It also suggested that approval of the deal by the RBI should be taken as approval by the Indian government.

However, the AAR argued that the approval granted by the RBI was only under the Foreign Exchange Regulation Act, and that tax exemption under Article 11 (4) of the bilateral tax treaty can only be granted by the Finance Ministry, therefore obliging the Indian firm to deduct tax at source.

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