Permanent establishment attribution under treaty does not extend to taxing branch-to-branch interest payments in India

Under the India-Switzerland treaty, the hypothetical independence of a permanent establishment under Article 7 applies only to attribution of business profits and cannot be extended to treat the overseas branches or head office as independent recipients of interest for Indian tax purposes. The discussion notes that the amendment to section 9(1)(v) by the Finance Act, 2015 does not override the treaty position where Article 11, read with Article 7, governs the tax treatment. It also notes that a penalty challenge based only on initiation of proceedings is premature where no crystallised levy has arisen.

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Issues: (i) Whether interest paid by the Indian branch office to the assessee's overseas branches was taxable in India under section 9(1)(v) of the Income-tax Act, 1961 despite the India-Switzerland tax treaty; (ii) whether initiation of penalty proceedings was premature.

Issue (i): Whether interest paid by the Indian branch office to the assessee's overseas branches was taxable in India under section 9(1)(v) of the Income-tax Act, 1961 despite the India-Switzerland tax treaty.

Analysis: The assessee's Indian branch constituted a permanent establishment in India, and the interest was claimed as a deduction in computing branch profits under Article 7 of the treaty. The decisive question was whether the fiction of hypothetical independence under Article 7 could be extended beyond attribution of profits to the permanent establishment and used to tax the overseas branches as recipients of interest. The Tribunal followed the view that the separate entity fiction operates only for computation of profits attributable to the permanent establishment and does not extend to taxation of the head office or other overseas branches as if they were independent recipients in India. The amendment to section 9(1)(v) by the Finance Act, 2015 did not alter the treaty position where Article 11, read with Article 7, governed the matter.

Conclusion: The interest paid by the Indian branch office to the overseas branches was held not taxable in India, and the addition was deleted.

Issue (ii): Whether initiation of penalty proceedings was premature.

Analysis: The penalty ground related only to proposed proceedings and did not arise from any crystallised levy at the stage of appeal.

Conclusion: The ground challenging initiation of penalty proceedings was dismissed as premature.

Final Conclusion: The appeals were allowed on the principal taxability issue, while the penalty-related ground did not succeed, leaving the assessee with only partial relief.

Ratio Decidendi: For a banking enterprise covered by a tax treaty, the fiction of a permanent establishment's hypothetical independence applies only to attribution of business profits and cannot be extended to tax interest paid by the Indian branch to overseas branches as income of the head office or those branches.

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