2010 (12) TMI 340 - HC - Income Tax

Interest to foreign head office not taxable in India; no TDS under section 195, no disallowance under 40(a)(i)

HC held that under the applicable tax treaty, interest paid by the Indian branch to its foreign head office is not chargeable to tax in India, as the head ... Deduction of Interest Payment - Deducted tax at source - Computation of income - section 40(a)(i) read with section 195 - appellant is a foreign company incorporated in Netherlands and having its principal branch office in India - HELD THAT:- The purpose of relief of tax which is related to avoidance of double taxation, a more beneficial provision amongst rival provisions in the agreement and the Act will apply to the assessee. We are not here concerned with a detailed interpretation of the agreement and relevant provisions of the Act. But, we are here concerned with making the necessary interpretation of the agreement read with the Act for the purpose of resolution of the issues involved in this appeal. According to the revenue under section 195 (1), the appellant’s head office is to be treated as a foreign company. When the appellant remitted interest to such head office, it ought to have deducted tax under section 195 (1). Having not so deducted the appellant is not entitled to claim the benefit, of such deduction, under section 40(a)(i). The meaning of section 40 (a) (i), is that such interest must be chargeable under the provisions of this Act. To simplify the matter, this interest must be accounted for or credited in the account of some person who is chargeable under the Act. In other words, this remittance of interest must result in an income which is chargeable under the Act. In those circumstances tax may be deducted at source. But where this interest is not so chargeable, no tax is deducted. In this case, by virtue of the above convention, the head office of the appellant is not liable to pay any tax under the Act. Therefore, in our opinion, there was and still is no obligation on the part of the appellant’s said branch to deduct tax while making interest remittance to its head office or any other foreign branch. Therefore, in the circumstances there is no scope for any argument that for the purpose of computation of expenditure the branch and the head office are to be taken as separate entities but for the purpose of payment of tax to be deducted at source on interest payment, it is to be taken as one bank and no deduction is to be made as sought to be made by the learned counsel for the appellant. Such contentions are totally unfounded in our opinion. The permanent establishment and the head office have to be taken as separate entities for all purposes. But in the making of payment of interest no tax has to be deducted under section 195(1), for the reasons above. If no tax is deductible under section 195(1) section 40(a)(i) of the Act will not come in the way of the appellant claiming such deduction as from its income. Therefore, in the circumstances the appellant would be entitled to deduct such interest paid, as permitted by the convention or agreement, in the computation of its income. No conflict at all between the agreement and the Act. It is only the tax authorities, the tribunal and to some extent the parties who have put a very complicated meaning to the provisions in the convention read with the Act. Appeal is allowed. Issues Involved:1. Whether interest payment made by the Indian branch of the appellant to its head office abroad was to be allowed as a deduction in computing the profits of the appellant's branch in IndiaRs.2. Whether in making such payment to the head office, the appellant's said branch was required to deduct tax at source under Section 195 of the Income Tax Act, 1961Rs.Detailed Analysis:Issue 1: Deduction of Interest PaymentDiscussion and Findings:- The appellant, a foreign company incorporated in the Netherlands, has a branch in India that remits interest to its head office.- Under Section 90 of the Income Tax Act, the Government of India entered into a Double Taxation Avoidance Agreement (DTAA) with the Netherlands, operational from 21st January 1989.- The DTAA's articles are significant in deciding this issue. Article 5(2) defines a branch as a 'permanent establishment,' and Article 7(2) states that this permanent establishment should be treated as a distinct and separate enterprise.- Article 7(3) read with Article 11(7) allows the deduction of interest paid by the branch to the head office.- The Supreme Court in Union of India vs Azadi Bachao Andolan established that the DTAA provisions override the Income Tax Act provisions if they are more beneficial to the assessee.- The court concluded that the permanent establishment (branch) and the head office should be treated as separate entities for all purposes, including the deduction of interest payments.Conclusion:- The interest payment made by the Indian branch to its head office is allowed as a deduction in computing the profits of the appellant's branch in India, as per the DTAA provisions.Issue 2: Tax Deduction at Source under Section 195Discussion and Findings:- Section 195(1) of the Income Tax Act mandates tax deduction at source on any interest paid to a foreign company if the interest is 'chargeable under the provisions of this Act.'- The court interpreted that the term 'chargeable' qualifies both 'interest' and 'any other sum,' meaning the interest must result in income chargeable under the Act.- As per the DTAA, the head office is not liable to pay any tax under the Act, implying no obligation for the Indian branch to deduct tax while remitting interest to the head office.- The court dismissed the argument that the branch and head office should be treated as one entity for tax deduction purposes while being separate entities for expense computation.Conclusion:- The Indian branch is not required to deduct tax at source under Section 195 when making interest payments to the head office, as the interest is not chargeable under the Act due to the DTAA provisions.Final Judgment:- The appeal is allowed to the extent that the assessment of the appellant's income for the relevant period should be done in accordance with these findings.- The permanent establishment and the head office are to be treated as separate entities for all purposes, and no tax is to be deducted under Section 195 for interest payments.- The appellant is entitled to deduct the interest paid to the head office in the computation of its income, as permitted by the DTAA.