Branch taxation under treaty and accounting principles: unrealised gains, FX losses, head-office interest, and expatriate salary treatment clarified.

The article discusses tax treatment of a foreign bank's Indian branch under the India-Korea DTAA and domestic accounting principles. It notes that the non-discrimination clause did not support a lower tax rate for the foreign company, while unrealised appreciation on revalued securities was excluded from income where the securities were treated as current investments and valued on a recognised cost-or-market basis. It also states that guarantee commission accrued on issuance of the guarantee, interest between branch and head office was deductible and not separately taxable in India, foreign-exchange contract losses were allowable when crystallised, and expatriate salary paid for the Indian branch was not restricted by section 44C.

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Issues: (i) Whether the assessee was entitled to the lower resident tax rate by invoking the non-discrimination clause under Article 25 of the India Korea DTAA; (ii) whether unrealised appreciation on revaluation of securities was taxable as income; (iii) whether upfront guarantee commission accrued in the relevant year; (iv) whether interest paid by the Indian branch to its head office was deductible and whether corresponding interest could be taxed in India; (v) whether loss on revaluation of foreign-exchange contracts was allowable; and (vi) whether salary paid to expatriate employees deputed from the head office was hit by section 44C.

Issue (i): Whether the assessee was entitled to the lower resident tax rate by invoking the non-discrimination clause under Article 25 of the India Korea DTAA.

Analysis: The claim for parity with resident taxpayers was held to be covered against the assessee by the earlier decision in its own case. The treaty and the domestic law were read together, and the higher rate on a foreign company was held not to attract the non-discrimination clause on the facts considered.

Conclusion: The issue was decided against the assessee and the higher tax rate was sustained.

Issue (ii): Whether unrealised appreciation on revaluation of securities was taxable as income.

Analysis: The securities were treated as current investments and valued on the recognised method of cost or market price whichever is less. Consistent accounting practice, the RBI framework, and earlier orders in the assessee's own case supported exclusion of mere appreciation that had not been realised.

Conclusion: The addition was deleted and the issue was decided in favour of the assessee.

Issue (iii): Whether upfront guarantee commission accrued in the relevant year.

Analysis: The commission was held to accrue on issuance of the guarantee, following the earlier view in the assessee's own case. The alternative safeguard was that any amount already taxed in a later year should be excluded to avoid double taxation.

Conclusion: The addition was sustained subject to exclusion in the later year if already offered to tax there, so the issue was substantially against the assessee.

Issue (iv): Whether interest paid by the Indian branch to its head office was deductible and whether corresponding interest could be taxed in India.

Analysis: Following the Special Bench view, such interest was treated as deductible in computing profits attributable to the permanent establishment under the applicable treaty provisions, while the corresponding receipt could not be taxed in India as payment to self under domestic law or the treaty.

Conclusion: The disallowance was deleted and the revenue's attempt to tax the corresponding receipt failed, both in favour of the assessee.

Issue (v): Whether loss on revaluation of foreign-exchange contracts was allowable.

Analysis: The loss was held to have crystallised on the basis of binding obligations under the contracts and consistent accounting treatment. The recognised accounting principle and the Special Bench ruling supported allowance of the loss.

Conclusion: The claim was allowed in favour of the assessee.

Issue (vi): Whether salary paid to expatriate employees deputed from the head office was hit by section 44C.

Analysis: The salary expenditure was treated as incurred exclusively for the Indian branch, and not as common head office expenditure. It therefore did not fall within the restriction in section 44C.

Conclusion: The revenue's challenge failed and the allowance was sustained in favour of the assessee.

Final Conclusion: The appeals of the assessee succeeded on the securities revaluation, head-office interest, foreign-exchange loss, and expatriate salary issues, while the tax-rate claim and the upfront guarantee commission issue were rejected, and the revenue's appeals were dismissed.

Ratio Decidendi: Consistent accounting treatment and the applicable treaty provisions govern the taxability of bank income attributable to a permanent establishment, and unrealised gains or contract losses are to be recognised only in accordance with settled commercial principles unless the statute or treaty requires otherwise.

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