2012 (4) TMI 80 - AT - Income Tax

Interest Paid by Foreign Bank's PE to Head Office Not Deductible Domestically but Allowed Under Indo-Japan DTAA

Sumitomo Mitsui Banking Corporation Versus Deputy Director of Income-tax, (IT), Rg. 2 (1), Mumbai

The ITAT Mumbai held that interest paid by the Indian PE of a foreign bank to its head office or overseas branches is not deductible under domestic law as ... Indo-Japan Treaty - Japanese Banking company having branch offices in India - loan advanced by HO to PE on which interest has been provided by the PE - deductibility of interest payable to the H.O. and other Overseas Branches in the hands of branch offices in India - taxability of interest payable by PE in the hands of Head Office in India - deduction of tax at source from interest payments - purpose and scope of article 11(4) of the OECD Model Convention - Held that:- In so far as the taxability of interest payable by PE in India in the hands of GE under the domestic law is concerned, it is relevant to note that the PE in India and the GE abroad of which the said PE is part are not independent persons under the domestic law i.e. Indian Income-tax Act and they are not assessed to tax separately in India. The taxable entity is only one i.e. the overseas GE which is the assessee bank in the present case who is a non resident in India and the PE in India is part of that entity which is a taxable entity in India even in respect of income attributable to the PE in India. There is thus only one person assessable to tax i.e. GE and PE is not an independent person who is assessed to tax separately in India. It is a part of the GE and its income is chargeable to tax in the hands of GE which alone is the person assessable to tax in India. Keeping in view the purpose and scope of article 11(4) of the OECD Model Convention, the provisions of which are pari materia to the provisions of article 11(6) of the Indo-Japanese treaty, we are of the view that the same is not applicable to the facts of the present case inasmuch as the situation as contemplated to make it applicable does not exist in the present case. In the present case, the amount is advanced by the head office of the assessee bank to its PE in India and the same represents liability of the PE in India as reflected in the balance sheet of that PE. Interest paid by the PE on such liability, therefore, cannot be regarded as interest paid in respect of debt claims forming part of the assets of the Permanent Establishment. It also cannot be said that the economic ownership of the debt claim is allocated to that Permanent Establishment so as to say that it is effectively connected with the Permanent Establishment. It is no doubt true that article 7 makes inroads in article 11 as a result of the provisions contained in article 11(6) as contended by Shri Girish Dave. However, the situation contemplated in article 11(6) should be found to be in existence in a case to bring the interest to article 7 in order to treat the said income as business profit attributable to the PE indirectly by force of attraction. In the present case, such situation does not exist and article 11(6), therefore, in our opinion, has no application. Although interest paid to the H.O. of the assessee bank by its Indian branch which constitutes its PE in India is not deductible as expenditure under the domestic law being payment to self, the same is deductible while determining the profit attributable to the PE which is taxable in India as per the provisions of article 7(2) & 7(3) of the Indo-Japanese treaty read with paragraph 8 of the protocol which are more beneficial to the assessee. The said interest, however, cannot be taxed in India in the hands of assessee bank, a foreign enterprise being payment to self which cannot give rise to income that is taxable in India as per the domestic law or relevant tax treaty. Accordingly, no liability for deduction of tax at source. Same is held for interest payments made to overseas branches – Decided in favor of assessee. Issues Involved:1. Deductibility of interest payable by the Indian PE of a foreign bank to its Head Office (HO) and other overseas branches.2. Taxability of interest income payable by the Indian PE to its HO and branch offices abroad.Issue-Wise Detailed Analysis:1. Deductibility of Interest Payable by Indian PE to HO and Overseas Branches:Arguments by Assessee:- The assessee, a foreign banking company with branches in India, argued that interest payable by its Indian branches to its HO and other overseas branches should be deductible while computing the profits attributable to the Indian PE. This was based on Article 7(2) and 7(3) of the Indo-Japanese DTAA.- The assessee contended that the PE and HO are not separate entities under Indian tax law and thus, interest payable by the PE to the HO does not constitute income. They relied on the principle that no person can make profit out of oneself, as established in the case of CIT v. Kikabhai Premchand.Arguments by Revenue:- The AO disallowed the interest deduction by invoking Section 40(a)(i) of the Income-tax Act, 1961, due to the failure to deduct tax at source as required by Section 195.- The Revenue argued that the PE should be treated as a separate entity for tax purposes, and interest payable to the HO is taxable in India under Article 11 of the DTAA.- The Revenue relied on the decision of the Hon'ble Supreme Court in the case of Hyundai Heavy Industries, which treated the PE as a separate profit center.Tribunal's Analysis:- The Tribunal noted that under domestic law, the PE and HO are not separate entities, and interest payable by the PE to the HO is a payment to self, which does not give rise to taxable income.- However, under Article 7(2) and 7(3) of the Indo-Japanese DTAA, the PE is treated as a distinct and separate entity for determining the profits attributable to it. Paragraph 8 of the protocol to the DTAA allows deduction of interest payable by a banking institution's PE to its HO.- The Tribunal concluded that the interest payable by the Indian PE to the HO is deductible under the DTAA, even though it is not deductible under domestic law.2. Taxability of Interest Income Payable by Indian PE to HO and Overseas Branches:Arguments by Assessee:- The assessee argued that interest payable by the Indian PE to the HO is not chargeable to tax in India under domestic law, as it is a payment to self.- They contended that Article 11(2) of the DTAA, which allows taxation of interest in the source country, is not applicable because the interest is not taxable under Indian law.- The assessee also relied on Article 11(6) of the DTAA, which states that interest effectively connected with a PE should be taxed under Article 7, not Article 11.Arguments by Revenue:- The Revenue argued that interest payable by the PE to the HO is taxable in India under Article 11(2) of the DTAA at a concessional rate.- They contended that the deeming fiction in Article 7(2) should be extended to Article 11, treating the PE and HO as separate entities for tax purposes.- The Revenue relied on the CBDT Circular No. 740, which treats the branch of a foreign company in India as a separate entity for taxation.Tribunal's Analysis:- The Tribunal held that under domestic law, interest payable by the PE to the HO is not taxable as it is a payment to self.- The Tribunal noted that Article 11(2) of the DTAA allows taxation of interest in the source country only if it is chargeable under the domestic law. Since the interest is not taxable under Indian law, Article 11(2) does not apply.- The Tribunal also rejected the Revenue's argument to extend the deeming fiction of Article 7(2) to Article 11, as the fiction is limited to determining the profits attributable to the PE.- The Tribunal concluded that the interest payable by the Indian PE to the HO is not taxable in India under the DTAA or domestic law.Conclusion:The Tribunal ruled in favor of the assessee on both issues:1. Interest payable by the Indian PE to the HO and overseas branches is deductible under the DTAA.2. Such interest is not taxable in India under the DTAA or domestic law.The decision ensures that the provisions of the DTAA, which are more beneficial to the assessee, override the domestic law. The Tribunal emphasized the principle that no person can make a profit out of oneself, aligning with the legal precedents and the specific provisions of the DTAA.