Interest to head office treated as self-payment, so no TDS obligation and no disallowance for non-deduction.

Interest paid by an Indian branch of a foreign bank to its head office and overseas branches was treated as a payment to self under domestic law, so the amount was not chargeable to tax in India in the hands of the foreign enterprise. On that basis, no obligation to deduct tax at source under section 195 arose, and disallowance under section 40(a)(i) could not be made. The analysis also followed the Special Bench view that, for a banking enterprise, such interest is allowable in computing profits attributable to the permanent establishment under the treaty while remaining non-taxable as a self-payment under domestic law.

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Issues: Whether interest paid by the Indian branch of a foreign bank to its head office and overseas branches is deductible or taxable, and whether disallowance under section 40(a)(i) could be made for non-deduction of tax at source.

Analysis: The payment by the Indian branch to the head office and overseas branches was treated as a payment to self under domestic law. On that basis, the interest was not chargeable to tax in India in the hands of the foreign enterprise, and the obligation to deduct tax at source under section 195 did not arise. Consequently, the disallowance provision in section 40(a)(i) could not be invoked. The conclusion followed the binding Special Bench view that, for a banking enterprise, such interest is allowable in computing profits attributable to the permanent establishment under the treaty, while remaining non-taxable as a self-payment under domestic law.

Conclusion: No disallowance under section 40(a)(i) was permissible on the interest paid to the head office and overseas branches, and the assessee succeeded on this ground.

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