Head office interest and permanent establishment profits: treaty deduction allowed, while the related income issue was remanded.

Interest paid by an Indian branch of a foreign bank to its head office was treated as a payment to self under domestic law, but it remained deductible in computing profits attributable to the permanent establishment under the relevant treaty, and was not taxable in India in the foreign enterprise's hands. On that basis, the interest disallowance was deleted. A separately raised ground on the taxability of the corresponding interest income in the head office's hands was admitted as arising from the record, but was remanded to the first appellate authority for fresh adjudication after hearing the assessee.

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Issues: (i) whether interest paid by the Indian branch of a foreign bank to its head office was deductible in computing the profit attributable to the permanent establishment and whether such interest could be taxed in India in the hands of the foreign bank; (ii) whether the additional ground regarding taxability of the corresponding interest income in the hands of the head office should be decided on merits or remanded.

Issue (i): whether interest paid by the Indian branch of a foreign bank to its head office was deductible in computing the profit attributable to the permanent establishment and whether such interest could be taxed in India in the hands of the foreign bank.

Analysis: The issue was covered by the Larger Bench decision in Sumitomo Mitsui Banking Corporation, which held that interest paid by an Indian branch to its head office is not deductible under domestic law as a payment to self, but is deductible in determining the profit attributable to the permanent establishment under the relevant treaty provisions. The same decision further held that such interest is not taxable in India in the hands of the foreign enterprise and that the provisions relating to deduction of tax at source and disallowance for non-deduction do not apply to such payment.

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

Issue (ii): whether the additional ground regarding taxability of the corresponding interest income in the hands of the head office should be decided on merits or remanded.

Analysis: The additional ground was admitted as it arose from the assessment order, but the Tribunal considered that it should not decide the matter on merits for the first time. Following the rule that such newly raised legal grounds should be examined by the first appellate authority, the Tribunal remanded the additional ground for fresh adjudication in accordance with law after giving an opportunity of hearing.

Conclusion: The issue was remanded to the Commissioner of Income Tax (Appeals) for fresh decision.

Final Conclusion: The appeal succeeded on the core disallowance of head office interest, while the additional ground was sent back for reconsideration, resulting in only partial relief to the assessee.

Ratio Decidendi: Interest paid by an Indian branch of a foreign bank to its head office is a payment to self under domestic law, but may still be deducted in computing treaty-based profits attributable to the permanent establishment where the applicable treaty so permits; a separately raised legal ground arising from the record may be admitted but can be remitted for decision by the appellate authority.

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