Reproduced with permission from Tax PlanningInternational Asia-Pacific Focus, Bloomberg Tax,08/31/2018. Copyright � 2018 by The Bureau of NationalAffairs, Inc. (800-372-1033) http://www.bna.com

August 2018

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India Clarifies Taxabilityof Fees Paid for Debtunder India–France TaxTreaty

Shailendra SharmaMultinational Consulting Firm in India

The Authority for Advance Ruling, in the case of Societe DePromotion Et De Participation Pour La Cooperation Economique,held that all kinds of fee involved in a loan transaction, exceptfront-end fee received for appraisal, is taxable as interest due tothe inherent association of the fee with the approval of financialarrangement under the India–France tax treaty.

The Authority for Advance Ruling (‘‘AAR’’) concludedthat, front-end fee received for loan appraisal applica-tion is not regarded as interest payable under theIndia–France tax treaty (‘‘tax treaty’’). However, front-end fee (other than appraisal fee) as commitment fee,cancellation fee, monitoring fee and amendment feeafter approval of finance were treated as interestunder the India–France tax treaty. The AAR confirmedthat front-end fee received for loan appraisal applica-tion is not characterized as Fees for Technical Ser-vices (‘‘FTS’’) but is taxable as business profits subjectto the determination of Permanent Establishment(‘‘PE’’).

Facts

Societe De Promotion Et De Participation Pour La Co-operation Economique (‘‘applicant’’) is a limited liabil-ity company incorporated under the French domesticlaws. It is a subsidiary of Agence Francaise de Develop-

ment, a government owned financial institution. It isengaged in private sector financing in various coun-tries, including in India. The applicant entered intoloan facility arrangements with its clients engaged inthe business of developing infrastructure projects inIndia. Pursuant to the financing arrangements, the ap-plicant will earn the front-end fee income like com-mitment fee; cancellation fee; monitoring fee;amendment fee and reimbursement of out of pocketexpenses, in addition to interest on such loans.

In the arrangement, the total front-end fee payableis 1.25 percent of the approved credit facility. The firsttranche of front-end is invoiced and payable to the ap-plicant before the due diligence at 0.25 percent of theaggregate amount. The balance fee of 1 percent is in-voiced after considering the amount of credit facilityapproved and recovered after executing the transac-tion documentation. In this case, the balance front-end fee is payable when the credit facility is approved,

ShailendraSharma is achartered ac-countant witha multinationalconsulting firmin India

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agreement between debtor and creditor is drawn, credit facilityis invoiced and transaction documentation is signed.

The applicant, in order to obtain certainty arising from theproposed transaction, filed an application before the AAR toseek clarity taxability on the following questions:q Would front-end fees earned be characterized as interest or

FTS under the India–France tax treaty?q Where the front-end fees are not regarded as interest or FTS,

would such fee earned be treated as business income and notliable to tax in the absence of a PE in India?

q Whether actual reimbursement of expenses by the clients to-wards legal, advisory fee and out of pocket expenses initiallyincurred by the applicant are treated as business income?

AAR Ruling

The revenue argued that, the applicant was not bound to sanc-tion credit facilities, and was entitled to appraise the project todecide whether or not to sanction the credit facilities hence, thepayment of front-end fee was mandatory and did not depen-dent or was connected with the loan advanced but, was obli-gated to pay the fee even if the loan transaction was notsanctioned or approved. In support of this argument, the rev-enue relied in the case of Bombay Commonwealth DevelopmentCorporation (‘‘BCDC’’) of Bombay High Court wherein it washeld that, the front-end appraisal fee is not interest in absenceof a debt claim in existence when the front-end fee was payable.Since conditions of the Bombay High Court are satisfied, thefront-end fee received for appraisal by the applicant is not in-terest. The AAR recognized the applicant as a tax resident ofFrance for availing the benefits under India–France tax treatyrelying on the Supreme Court ruling in the case of AzadiBachao Andolan.

In evaluating when a debt claim comes into existence and de-termine if the front-end fee relates to a debt claim the AAR ob-served that, the BCDC ruling relied by the revenue had directrelevance as front-end fee is paid post approval but prior toactual disbursement of the loan facility. In the present case, thefront-end fee other than appraisal fee (balance portion of front-end fee) is payable only after the credit facility is approved,agreement between debtor and creditor has been drawn, creditfacility is invoiced and transaction documents are executed.Hence, debt claim is in existence post credit facility is granted/approved becomes connected with the loan that the lender isbound to advance in accordance with the agreement.

Effectively, the amount earned from commitment fee, cancel-lation fee, amendment fee and monitoring fee is construed asdirectly related to the debt claim since, such front-end fee arecharged after the disbursement of credit facility. It was clarifiedthat the AAR did not conclude that fee relates to debt claim onlyafter the loan is disbursed. However, once the loan is disbursedthere is no doubt that debt claim has come into existence.Hence, the front-end fee other than the appraisal fee related tothe loan is treated as interest income under the India–Francetax treaty. Conversely, the applicant contended that, commit-ment fee is a percentage of loan not drawn, and thus not relatedto the loan disbursed.

The AAR observed that, once a debt claim is in existence thefee charged is inextricably linked to the debt claim due to thecommitment of debt claim regardless of any method to com-pute the fee. Similarly, the cancellation fee is for un-availedcredit facility withdrawn which is after disbursal of loan con-nected with the credit facility sanctioned and subsequently can-celled. This makes it directly related to and on account of loanadvanced thus, would qualify the fee to be treated as interest.The AAR clarified that, irrespective of whether the amendment

fee relates to interest rate or principal amount, such fee is inconnection to the debt claim already in existence hence, is re-garded as interest under the India–France tax treaty. Further, asthe applicant is monitoring the financials and constantly in-volved in the review of credit arrangement, monitoring fee isalso characterized as interest for tax purposes.

The evaluation of whether front-end fee is in the nature of ap-praisal services under FTS is based on the analysis if the ap-praisal services satisfy the ‘‘make available’’ clause under India–Portugal tax treaty by applying the Most Favored Nation(‘‘MFN’’) provision read into India–France tax treaty withoutany notification. The AAR relying on the Supreme Court deci-sion in the case of GVK Industries Limited stated that, in ab-sence of ‘make available’ clause in a tax treaty, services wouldbe regarded as FTS. However, if the applicant impart any tech-nical knowledge, experience, skill, know-how to the borrower,‘‘make available’’ clause is satisfied hence, excluding appraisalservices from FTS clause under the India–France tax treaty.

The Delhi High Court ruling of Steria (India) Ltd dealt withthis issue to conclude that, the benefit of lower rate or restrictedscope of FTS under the India–France tax treaty is not contin-gent on any action by the respective governments. It was con-cluded that, beneficial provision or restricted scope of FTS in atax treaty entered by India with another OECD member coun-try can be applied to India–France tax treaty by invoking theMFN provision from the date on which the India–France taxtreaty or such other tax treaty is effective. The AAR followingthe Delhi High Court ruling concluded that, front-end fees re-ceived by the applicant in absence of ‘‘make available’’ condi-tions is excluded from FTS clause of the India–France taxtreaty.

On the question of existence of a PE it was observed that, de-termination of PE is based on the facts of each case each yearthat was not a subject matter before the AAR. The applicantthrough a certificate confirmed that, it does not have a PE inIndia, to be examined by the revenue. Further, in absence ofavailable facts about the actual nature of reimbursement of ex-penses, the AAR could not conclude on the true character of thereimbursement expenses.

Practical Points

The subject of income characterization in the comprehensivefinancial contracts and arrangements has been a subject matterof evaluation from taxability perspective under the tax treaties.Usually, the form of transaction or classification is resolvedafter analyzing the facts of each case. In the instant case, AARapplied the nexus theory to assess existence of debt claim andconclude that all forms of fee involved in the loan transaction,except for the front-end fee towards appraisal, is taxable as in-terest owing to the inherent association of the fee post the ap-proval of the financial arrangement.

The concept of MFN clause in the tax treaty is widely ex-plored by the taxpayers to avail the tax treaty benefits. MFNclause is not merely applied to restrict the scope of definitionbut, is also extended on the exemption clause under the appli-cable tax treaties. Interestingly, in the case of Production Re-source Group, Belgium the AAR held that, by virtue of MFNclause of the India–Belgium tax treaty, a restricted scope of FTSprovided under the India–Portugal tax treaty can be importedinto the India–Belgium tax treaty to conclude that. the servicesprovided by the applicant is not taxable as FTS. Although, theguidance on classification and MFN can be implemented uni-versally, the AAR ruling are binding on the applicant and haspersuasive value on taxability of similar transactions for othertaxpayers.

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Shailendra Sharma is a chartered accountant with a multinationalconsulting firm in India.

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