Treaty computation and non-discrimination principles preserve domestic disallowances, while section 12B interest-tax levy remains deductible.

Article 7(3) of the India-UAE treaty was read with article 25(1) to preserve domestic income-tax restrictions unless the treaty expressly displaced them, so disallowances such as entertainment, travel and provident fund limits continued to apply in computing profits attributable to a permanent establishment. The non-discrimination clause was construed by reference to a proper comparator of the same legal character, so a foreign bank's permanent establishment was comparable with a domestic company and not with an Indian co-operative society. Interest levied under section 12B of the Interest-tax Act was treated as compensatory and deductible, following the character of the principal interest tax levy.

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Issues: (i) Whether the domestic law restrictions on deduction, including disallowances under the Income-tax Act, applied while computing the profits attributable to a permanent establishment under article 7(3) of the India-UAE tax treaty; (ii) Whether the non-discrimination clause entitled the assessee's permanent establishment to taxation at a rate comparable to Indian co-operative societies instead of the rate applicable to foreign companies; (iii) Whether interest levied under section 12B of the Interest-tax Act, 1974 was deductible in computing taxable income.

Issue (i): Whether the domestic law restrictions on deduction, including disallowances under the Income-tax Act, applied while computing the profits attributable to a permanent establishment under article 7(3) of the India-UAE tax treaty.

Analysis: Article 7(3) was read with article 25(1) of the treaty, which preserved the operation of domestic tax laws except where the treaty expressly provided otherwise. The decision in which treaty language allowed deduction of PE-related expenses was distinguished, and it was held that article 7(3) did not create an exemption from domestic restrictions such as those governing entertainment, travelling, provident fund, and other specified disallowances. The treaty had to be read as a whole, and no specific contrary provision displaced the domestic limitations.

Conclusion: The domestic restrictions on deductibility continued to apply, and the assessee's challenge failed.

Issue (ii): Whether the non-discrimination clause entitled the assessee's permanent establishment to taxation at a rate comparable to Indian co-operative societies instead of the rate applicable to foreign companies.

Analysis: The non-discrimination clause was held to require comparison with a proper comparator having the same legal character. The form of ownership was relevant because an enterprise could not be separated from the taxable person carrying it on. A permanent establishment of a foreign banking company was therefore comparable with a domestic company, not with a co-operative society. The clause did not extend to creating parity between foreign-company PEs and Indian co-operative societies.

Conclusion: The assessee could not claim the lower rate applicable to co-operative societies, and this ground failed.

Issue (iii): Whether interest levied under section 12B of the Interest-tax Act, 1974 was deductible in computing taxable income.

Analysis: Section 18 of the Interest-tax Act, 1974 was treated as enabling deduction of interest tax and not as a restrictive provision. Since the section 12B levy was compensatory and arose from delay in payment of interest tax, it followed the character of the principal levy and was allowable as deduction.

Conclusion: The deduction was allowable and the disallowance was deleted.

Final Conclusion: The assessee succeeded only on the issue of deduction of the section 12B levy, while the treaty-based challenges to the domestic disallowances and the non-discrimination claim were rejected, resulting in a partial allowance of the appeal.

Ratio Decidendi: Where a tax treaty preserves domestic law except to the extent of an express contrary provision, treaty language allowing deduction of PE expenses does not override domestic disallowance provisions; and a non-discrimination clause comparing a PE with domestic enterprises requires comparison with a taxpayer of the same legal form.

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