Interest on Refund – Whether a Debt?

Section 244A of the Income Tax Act, 1961 (the Act) provides that when any income tax refund is due to an assessee from the Government, he is entitled to receive simple interest along with the refund. Interest on refund is an automatic event and there is no need to apply for the same separately. The date of payment of tax shall be the date on which the payment is made in excess of the demand.

The Delhi HC in Court on Its Own Motion Vs. CIT and others, in [TS-5325-HC-2012(DELHI)-O] held that interest under Sec. 244A is payable, when the assesse was not at fault. In Rajaratna Mills v. CIT, Coimbatore [TS-5781-HC-2015(MADRAS)-O], it was held that interest is payable on the excess taxes paid also, irrespective of the nature of taxes paid.

Madras HC in CIT v. Cholamandalam Investment & Finance Co. Ltd., [TS-5473-HC-2007(MADRAS)-O] as affirmed in by SC in  CIT v. H.E.G. Ltd., [TS-5045-SC-2009-O]  held that even for refund of the tax paid under Sec.140A on self-assessment, the assessee is entitled to interest. Even where an assessee makes a mistake in the claim of TDS in the e-return and a demand is raised by the Assessing Officer and subsequently, the excess TDS is refunded, upon rectification, then also, the interest is payable. This cannot be construed as assessee at fault and denied interest for the period of delay in processing the refund and interest thereon. The Logic which courts have held was that the money has been utilized by the Government, for the period, from date of payment until the order for refund is issued. That means, interest is payable for the period of enjoyment of funds, which is normally done as a business practice between two parties to a financial contract. 

Hon'ble SC in Tata Chemicals Ltd., [TS-165-SC-2014-O], held in Para 38, "Providing for payment of interest in case of refund of amounts paid as tax or deemed tax or advance tax is a method now statutorily adopted by fiscal legislation to ensure that the aforesaid amount of tax which has been duly paid in prescribed time and provisions in that behalf form part of the recovery machinery provided in a taxing Statute. Refund due and payable to the assessee is debt-owed and payable by the Revenue. The Government, there being no express statutory provision for payment of interest on the refund of excess amount/tax collected by the Revenue, cannot shrug off its apparent obligation to reimburse the deductors’  lawful monies with the accrued interest for the period of undue retention of such monies. The State having received the money without right, and having retained and used it, is bound to make the party good, just as an individual would be under like circumstances. The obligation to refund money received and retained without right implies and carries with it the right to interest. Whenever money has been received by a party which ex ae quo et bono ought to be refunded, the right to interest follows, as a matter of course." 

The crux of the above para is that the right to interest follows as a matter, when refund ought to be paid. This is a general rule applicable for all contractual obligations bestowed on either parties. 

In BJ Services Company Middle East Ltd. v. Assistant Commissioner of Income Tax [TS-5713-ITAT-2008(DELHI)-O], ITAT Delhi held that the Assessee , being a resident of UK is carrying on business in India through a PE situated in India and, the interest on refund was effectively connected with such PE in India. Therefore, para 6 of Article 12 of India-UK DTAA dealing with Interest income in applicable, which provides that if interest income of a non-resident is effectively connected with its PE in India, such interest has to be taxed as Business Profits under Article 7. Thus, the assessee cannot take benefit of para 2 of  Article 12 which provides for taxation of interest at 15 per cent in view of provisions of para 6, which are overriding the provisions of para 2.

On similar principles, ITAT, Delhi Special Bench had in the case of Clough Engineering Ltd. [TS-184-ITAT-2011(DEL)-O] had held that interest on refund earned by a non-resident (an Australian company) could not be treated as business income under Article 7 of the India-Australia Treaty since such refund was not effectively connected with the PE of the taxpayer either on the basis of asset test or activity test. Accordingly, it was held that such interest was taxable at concessional rate of 15 per cent under Article 12(2) of the treaty.

Recently, Madras High Court in the case of Ansaldo Energia SPA vs. CIT [TS-5267-HC-2016(MADRAS)-O] held that the Interest on Income Tax refund to the Assessee u/s 244A is not taxable in India under Article 12(3)(a) of India-Italy DTAA which exempts interest where Government is the payer. Further, it was held that the interest shall be treated as debt payable by the government. Earlier ITAT, Chennai [TS-6180-ITAT-2015(CHENNAI)-O] held that the interest on tax refund does not fall within the list of items qualifying as interest. Hence, the exemption also stands unavailable to the Assessee.

The interest on tax refund cannot be treated as business profits under Article 7 of India-Italy DTAA, as other income earned through the PE. Let us discuss the relevant treaty provisions for better clarity. 

When we go through the provisions of Article 12(6), the first portion of Article 12(6) states that the interest will be deemed to arise in a contracting State, when the payer is that State itself. There is an exception carved out in the second part of the Article 12(6). When the person paying the interest whether the resident of the contracting State or not, has a permanent establishment in a contracting State, such interest borne by the permanent establishment will be deemed to arise in that State. In other words, if the assessee is the payer of the interest, then only the second part of Article 12(6) will arise. In the instant case of Ansaldo Energia , the payer of interest being the Government of India, the application of Article 12(6) does not arise. It is very clear from the above discussion, that this provisio is not applicable if the Government is the payer and the payment of interest which has accrued is payable to the PE or fixed base connected to the tax refund due.

Article 12(4) states that the debt claims of every kind shall form part of the “interest”. Sec. 244A of the Income Tax Act, 1961 mandates automatic trigger of interest when the tax refund is due. Hence, the tax refund takes the character of a debt and the interest thereto is part of the debt only. Further, once Article 12(4) covers this interest payment as a debt which is payable by the Government as a payer, the Article 12(3)(a) comes into play for exemption of the interest as per the respective DTAAs.

In the case of Ansaldo Energia, Madras High Court rightfully negated ITAT observations and categorically stated that the interest paid on the refund in terms of Section 244-A of the Income Tax Act, is a debt claim, within the meaning of the term "interest" under paragraph 4 of Article 12 and that therefore, it is exempt under Clause (a) of paragraph 3 of Article 12. The arguments that Article 5 read with Article 7 shall be applicable is not relevant for the interest on tax refunds as stipulated under Sec. 244A of the Income Tax Act, 1961.

From the above discussions, we can fairly conclude that the law is well settled to the effect that tax refund and interest thereon from the Government, once it becomes due, are debt claims within the meaning of Article 12(4) of India-Italy Treaty. As a consequence, they do satisfy the parameters of Article 12.3(a) and thereby, the interest component becomes exempt from tax.