Interest on IT Refund is not taxable as per Article 12(3)

Delineation of Facts:

1. Assessee is a company incorporated in Italy. Post Assessment of Income Tax Return filed, assessee became entitled to Income tax refund.
2. On the refund granted to the assessee, A.O deducted TDS stating that interest on such income tax refund is taxable in India.
3. Assessee claimed that Interest on Income Tax Refund is covered under Article 12 of India-Italy Tax Treaty. As per Article 12, interest payable by Government is not taxable in the source country(India).
4. Assessee went to the appeal to CIT(A) and then to ITAT. Both the appellate authorities negated the view of the assessee. They held that income on income tax refund is business profits of the assessee and hence taxable in India.

Question of Law:

1. Whether interest on income tax refund is also a debt claim? If it is proved that income tax refund is a debt claim, then income on such debt claim that is interest will get squarely covered in Article 12(4) and hence exempt from tax in source country(India).

Provisions/Rulings Applicable:

1. Section 244A deals with Interest on Income Tax Refund. It provides that when income tax refund becomes due to the taxpayer, then the taxpayer will be entitled to receive interest also. So as soon as income tax refund becomes due, interest on such refund is an automatic phenomenon.
2. Article 12 of DTAA deals with taxability of Interest. Article 12 has 7 sub clauses. Below explained is the first 4 limbs of Article 12 as they are only relevant for this case under consideration.
3. Article 12(1) provides that interest will be taxable in the country of residence.
4. Article 12(2) enumerates that interest may also be taxable in the source country and circumscribes the maximum tax rate on such interest income.
5. Article 12(3) list down few scenarios when interest will not be taxable in the source country. First exception is, when the interest is payable by the Government/Local Authority/Federal Bank(RBI).
6. Article 12(4) defines the meaning of term interest. It says that interest means income from debt-claims of every kind.
7. The Apex Court Judgement in Tata Chemicals: Hon’ble SC opined that "refund due and payable to the assessee is debt-owed payable by the revenue”.

Madras HC Ruling:

1. Under Sub-section (1) of Section 244-A, an assessee is made entitled to receive in addition to any amount of refund that has become due to him, simple interest calculated in the manner provided therein. Sub-section (1) of Section 244-A uses two important expressions, namely (i) becomes due, and (ii) be entitled to. The expression "becomes due" is a clear indication that an assessee will be entitled to the benefit of Section 244-A only if the refund of any amount has become due. If a refund has become due, interest on the refund is also automatic subject to the satisfaction of other conditions. Anything that is due and which a person is entitled to collect, is naturally in the nature of a debt claim. 
2. The statement found in paragraph 38 of the decision by SC in case of Tata Chemicals that "refund due and payable to the assessee is debt-owed payable by the revenue" is actually a perfect statement of law. It is certainly a theorem, but not Euclid's theorem. 
3. Therefore, the law as we see is well settled to the effect that what was due as a refund and what was payable as interest on such refund are debt claims within the meaning of Article 12(4).

Essence of Above:

Interest paid on Income tax refund is a debt claim and will be rightfully covered in expression “interest” as defined in Article 12(4) of India-Italy DTAA. Thus interest on Income tax refund will not be taxable in the source country as per Article 12(3).