Treaty treatment of branch-head office transactions limits disallowance, MAT exposure, and transfer pricing segregation for a foreign bank.

A note on a foreign bank branch's Indian tax position under the India-Japan DTAA explains that expatriate salary costs borne by head office for staff working exclusively in India, intra-entity interest flows between head office, overseas branches and the Indian branch, and deferred bank guarantee commission were treated in line with earlier treaty-based rulings, while section 115JB was considered inapplicable to the foreign banking company's statutory accounts framework. It also notes that external commercial borrowing interest was not to be taxed beyond the Indian branch's actual role and that a transfer pricing adjustment on guarantee commission was rejected because the transaction had already been benchmarked on an aggregated basis and could not be carved out for a separate CUP analysis. The higher branch tax rate issue remained adverse to the assessee.

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Issues: (i) Whether salary paid overseas to expatriates working in India by the head office and the Indian taxes paid thereon were disallowable under section 44C or allowable under Article 7(3) of the India-Japan DTAA; (ii) Whether interest paid to the head office and overseas branches, and the corresponding interest received from Indian branches, were taxable or required tax deduction at source; (iii) Whether section 115JB applied to a foreign banking company computing income under the treaty; (iv) Whether interest on external commercial borrowings was taxable in India in the manner adopted by the Assessing Officer; (v) Whether deferred bank guarantee commission was taxable on receipt basis; (vi) Whether the rate of tax applicable to the permanent establishment could exceed the domestic company rate; (vii) Whether the transfer pricing adjustment on guarantee commission was sustainable.

Issue (i): Whether salary paid overseas to expatriates working in India by the head office and the Indian taxes paid thereon were disallowable under section 44C or allowable under Article 7(3) of the India-Japan DTAA.

Analysis: The expatriates were found to be working exclusively for the Indian permanent establishment, and the issue had already been decided in earlier years in the assessee's favour. The Tribunal also noted the supporting High Court view that such expenditure was incurred wholly and exclusively for the Indian branch and was not hit by section 44C.

Conclusion: The disallowance was not sustainable and the claim was allowed in favour of the assessee.

Issue (ii): Whether interest paid to the head office and overseas branches, and the corresponding interest received from Indian branches, were taxable or required tax deduction at source.

Analysis: The interest payment to the head office and overseas branches was treated as governed by the treaty and the earlier Special Bench and High Court rulings had held that the branch and head office were not separate taxable persons for this purpose. On the corresponding receipt side, the interest received by the Indian branch from its own head office and overseas branches was treated as a receipt from self and was held not chargeable in the hands of the assessee.

Conclusion: Both additions were deleted and the issue was decided in favour of the assessee.

Issue (iii): Whether section 115JB applied to a foreign banking company computing income under the treaty.

Analysis: The assessee was a banking company governed by the Banking Regulation Act, and its accounts were not prepared under Parts II and III of Schedule VI of the Companies Act. The Tribunal followed the binding High Court view that section 115JB could not be applied in such circumstances and that the treaty computation governed the taxability.

Conclusion: Section 115JB was held inapplicable and the issue was decided in favour of the assessee.

Issue (iv): Whether interest on external commercial borrowings was taxable in India in the manner adopted by the Assessing Officer.

Analysis: The Tribunal held that the borrowings were connected only to the extent of the role played by the Indian permanent establishment in arranging the funds, and the balance could not be brought to tax again. The issue was treated as covered by earlier year decisions in the assessee's own case.

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

Issue (v): Whether deferred bank guarantee commission was taxable on receipt basis.

Analysis: The commission related to a multi-year guarantee, but the Revenue sought taxation on receipt basis. The Tribunal followed the High Court view in the assessee's own case and held that the commission could not be assessed merely on receipt basis in the manner adopted by the Assessing Officer.

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

Issue (vi): Whether the rate of tax applicable to the permanent establishment could exceed the domestic company rate.

Analysis: The Tribunal noted the competing treaty and domestic law positions and the later statutory amendment, but also noted that the issue had already been decided in earlier years and was pending in higher forum. No relief was granted on this ground.

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

Issue (vii): Whether the transfer pricing adjustment on guarantee commission was sustainable.

Analysis: The assessee's overall international transactions had been benchmarked under a combined TNMM approach and the margins had been accepted. The Tribunal held that the guarantee commission transaction could not be artificially segregated and benchmarked separately on an external CUP basis using comparables that were functionally different and risk-bearing.

Conclusion: The transfer pricing adjustment was deleted and the issue was decided in favour of the assessee.

Final Conclusion: The appeal succeeded on all substantial grounds except the challenge to the rate of tax, and the impugned additions and transfer pricing adjustment were substantially deleted.

Ratio Decidendi: Where a foreign bank's Indian branch and head office are treated as one taxable enterprise for treaty purposes, internal branch-head office interest and branch-related expatriate costs cannot be brought to tax or disallowed in a manner inconsistent with the treaty, and MAT provisions cannot be applied where the statutory computation framework does not fit the foreign banking company.

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