Court’s Decision
The Delhi High Court ruled in favor of the petitioner, setting aside the rejection of their refund claim for excess tax deducted at source (TDS) under Section 195 of the Income Tax Act, 1961. The Court held that:
- CBDT Circular No. 07/2007, which imposed a two-year limitation period for claiming a refund of excess TDS, is ultra vires (beyond its legal authority) since it contradicts the statutory provisions of the Income Tax Act.
- Excess tax deposited under Section 195 cannot be retained unlawfully by the Income Tax Department and must be refunded.
- The interest payments made by the petitioner on Foreign Currency Convertible Bonds (FCCBs) and External Commercial Borrowings (ECBs) were not taxable in India as the borrowed funds were used exclusively for business carried on outside India.
- The rejection of the refund was based on an incorrect interpretation of Section 9(1)(v) of the Act, which provides for exceptions where interest payments made by an Indian entity are not taxable in India.
The Court ordered the Income Tax Department to process and refund the excess amount deposited by the petitioner.
Facts of the Case
- The petitioner, a pharmaceutical company, had deducted TDS under Section 195 of the Income Tax Act, 1961, on payments made as premium and interest on:
- Foreign Currency Convertible Bonds (FCCBs)
- External Commercial Borrowings (ECBs)
- These payments were made during Financial Years 2010-11 to 2012-13.
- The petitioner later realized that these payments were not liable for TDS under Indian tax laws and, on March 31, 2014, filed a refund application seeking a refund of the excess tax deposited.
- The Income Tax Department rejected the refund claim on March 27, 2018, citing two reasons:
- The claim was time-barred as per Circular No. 07/2007, which prescribes a two-year limitation period.
- The refund was not justified on merits, arguing that the interest payments did not qualify for exemption under Section 9(1)(v) of the Act.
- Aggrieved by the rejection, the petitioner challenged the validity of Circular No. 07/2007 and the misinterpretation of Section 9(1)(v) before the High Court.
Issues
- Whether Circular No. 07/2007, which imposes a two-year limitation period for refund applications, is ultra vires the Income Tax Act?
- Whether the refund claim was wrongly denied based on an incorrect interpretation of Section 9(1)(v) of the Income Tax Act?
- Whether excess tax deposited under Section 195 can be lawfully retained by the Income Tax Department despite no liability existing under the Act?
Petitioner’s Arguments
1. CBDT Circular No. 07/2007 is Ultra Vires the Income Tax Act
- The Income Tax Act does not prescribe any time limit for refund claims.
- Sections 237 and 239 allow for refunds of excess tax deposited, but they do not impose any limitation period.
- CBDT cannot introduce new conditions or limitations through an administrative circular, as this would override the Income Tax Act.
- The limitation period in Circular No. 07/2007 violates Article 265 of the Indian Constitution, which states that no tax shall be levied or collected except by the authority of law.
2. Interest Payments Were Not Taxable in India
- The petitioner argued that the interest payments on FCCBs and ECBs fell within the exception under Section 9(1)(v).
- Section 9(1)(v) provides that interest payments are taxable in India unless:
- The loan is used for a business carried on outside India; or
- The loan is used to earn income from a source outside India.
- Since the funds were borrowed to finance overseas operations (Ranbaxy Netherlands BV and Terapia SA, Romania), the interest payments should not be subject to TDS in India.
3. The Rejection Order Was Based on an Erroneous Interpretation of the Law
- The Income Tax Department wrongly held that the funds were not used for business outside India, despite clear evidence that they were used for global business expansion.
- The Department failed to apply the correct test of “commercial expediency”, which recognizes that investments made for a subsidiary’s expansion can still qualify as a business purpose.
Respondent’s Arguments
- Circular No. 07/2007 is binding
- The Income Tax Department argued that since the refund claim was filed after two years, it was time-barred under the Circular.
- Interest payments were taxable in India
- The Department claimed that since the petitioner is an Indian company, the interest payments did not qualify for exemption under Section 9(1)(v).
- The Department also argued that the funds were used by a subsidiary (Terapia SA, Romania), not by the petitioner itself, and therefore should not be treated as business expenses of the petitioner.
- No automatic refund entitlement
- The Department contended that even if tax was wrongly deducted, the petitioner had to prove its entitlement to a refund.
Analysis of the Law
1. Section 195 of the Income Tax Act, 1961
- Requires TDS on payments made to non-residents if such payments are chargeable to tax in India.
- If payments are not chargeable to tax, no TDS should be deducted.
2. Section 237: Refund of Excess Tax Paid
- If tax paid by a taxpayer exceeds actual tax liability, they are entitled to a refund.
3. Section 239: Procedure for Refund Claims
- Refund claims must be filed in accordance with Section 139, but no separate time limit is prescribed.
4. Section 9(1)(v): Taxability of Interest Payments
- Interest payments are not taxable in India if the loan is used for business outside India.
- Since the funds were used for global business operations, the interest payments should not have been taxed.
Precedent Analysis
1. Multibase India Ltd. v. Income Tax Officer (Gujarat HC, 2018)
- Held that CBDT circulars cannot override statutory provisions and refunds should be granted as per the law.
2. S.A. Builders Ltd. v. CIT (Supreme Court, 2007)
- Established that loans given to subsidiaries can be treated as business expenses if they serve a commercial purpose.
3. Vijay Gupta v. CIT (Delhi HC, 2016)
- Held that taxes wrongly deposited cannot be retained by the government.
Court’s Reasoning
- Circular No. 07/2007 cannot override the Income Tax Act.
- The tax was wrongly deducted, and the petitioner was entitled to a refund.
- The petitioner’s use of funds met the commercial expediency test.
- Unlawful retention of tax violates Article 265 of the Constitution.
Conclusion
- The two-year limitation period in Circular No. 07/2007 is ultra vires.
- The petitioner is entitled to a refund of excess tax deposited under Section 195.
- The Income Tax Department is directed to process the refund.
Implications
- CBDT Circulars cannot introduce conditions beyond the scope of the Act.
- Clarifies when interest payments are taxable under Section 9(1)(v).
- Strengthens taxpayer rights against wrongful retention of excess tax.