Treaty deduction and exempt-income interest rules shape PE profit computation under the India-Mauritius tax framework.

Article 7(3) of the India-Mauritius tax treaty allows deduction of expenses incurred for the business of a permanent establishment without importing domestic-law limits where the treaty text contains no restrictive clause, so section 43B could not be used to disallow unpaid bonus expenditure. By contrast, expenditure directly referable to income outside business profits remains non-deductible in computing treaty profits; the same principle reflected in section 14A was applied to interest linked to tax-free bond income. On the facts, the borrowing had a direct nexus with the exempt investment, but the adjustment was confined to interest for the short period the loan remained outstanding.

---

---

Issues: (i) Whether bonus expenditure unpaid before the due date of filing the return could be disallowed under section 43B when Article 7(3) of the India-Mauritius Double Taxation Avoidance Agreement permits deduction of expenses incurred for the business of a permanent establishment; (ii) Whether interest expenditure relatable to tax-free bond income could be disallowed in computing business profits under Article 7 of the India-Mauritius Double Taxation Avoidance Agreement, notwithstanding the assessee's reliance on treaty provisions and the claim of stock-in-trade.

Issue (i): Whether bonus expenditure unpaid before the due date of filing the return could be disallowed under section 43B when Article 7(3) of the India-Mauritius Double Taxation Avoidance Agreement permits deduction of expenses incurred for the business of a permanent establishment.

Analysis: Section 43B restricts deduction of certain liabilities unless actually paid within the stipulated time. However, the applicable treaty provision, Article 7(3), contains no restrictive clause tying deductibility to domestic law limitations. The treaty therefore allows deduction of expenses incurred for the business of the permanent establishment in full. Article 3(2) does not assist in importing section 43B because that provision does not define a treaty term, and Article 23(1) cannot override the express allowance in Article 7(3).

Conclusion: The disallowance under section 43B was not sustainable. The assessee succeeded on this issue.

Issue (ii): Whether interest expenditure relatable to tax-free bond income could be disallowed in computing business profits under Article 7 of the India-Mauritius Double Taxation Avoidance Agreement, notwithstanding the assessee's reliance on treaty provisions and the claim of stock-in-trade.

Analysis: Expenses incurred in relation to income that does not form part of business profits cannot be allowed as deduction in computing those profits. Section 14A reflects that principle under the Act, and the same principle operates in treaty computation when the exempt income itself is outside the business profits of the permanent establishment. The absence of a restrictive clause in Article 7(3) does not permit deduction of expenditure referable to exempt income. On the facts, the borrowing had a direct nexus with the tax-free bond investment, but the loan was repaid the next day and the disallowance had to be confined to the actual interest for that limited period.

Conclusion: Disallowance was justified in principle, but it was required to be restricted to interest for one day only. The Revenue succeeded only to that limited extent.

Final Conclusion: The assessee obtained relief on the bonus disallowance issue, while the Revenue obtained only a restricted allowance on the exempt-income interest issue. The order was modified accordingly and the cross appeals were disposed of partly in each side's favour.

Ratio Decidendi: Where a treaty provision for deduction of business-expense attribution to a permanent establishment contains no domestic-law restrictive clause, a disallowance under the Income-tax Act cannot be imported to curtail that treaty deduction; but no deduction can be allowed for expenditure directly referable to income excluded from business profits.

---