Treaty non-discrimination clause overrides domestic exclusion, allowing a UK bank the bad debt deduction under tax law.

A UK-incorporated bank was treated as a national of the United Kingdom for the non-discrimination clause in Article 23 of the India-UK DTAA. Section 36(1)(viia), as it then stood, denied deduction for provision for bad and doubtful debts to banks incorporated outside India, creating a discriminatory burden compared with Indian banks in the same circumstances. The later statutory amendment extending the benefit to foreign banks supported that the earlier wording was discriminatory. Because the treaty provision prevailed over the conflicting domestic restriction, the bank could not be denied the deduction solely on the basis of its foreign incorporation, and the disallowance was set aside.

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Issues: Whether the assessee bank, incorporated in the United Kingdom, was entitled to deduction for provision for bad and doubtful debts under section 36(1)(viia) of the Income-tax Act, 1961 for the assessment years in question by invoking the non-discrimination clause in Article 23 of the India-UK double taxation avoidance agreement.

Analysis: Section 36(1)(viia), as it stood prior to 1-4-1987, denied the deduction to banks incorporated outside India. Article 23 of the India-UK agreement prohibited taxation or connected requirements that were more burdensome for nationals of one contracting State in the other State in the same circumstances or under the same conditions. The assessee, being a company incorporated in the United Kingdom, was treated as a national of that contracting State. The later amendment extending the benefit to foreign banks supported the conclusion that the earlier position created a discrimination between Indian banks and foreign banks. Since the treaty provision prevailed over the conflicting domestic restriction, the assessee could not be denied the deduction merely because the domestic provision, as then worded, excluded foreign banks.

Conclusion: The assessee was entitled to the deduction under section 36(1)(viia) by virtue of Article 23 of the double taxation avoidance agreement, and the disallowance was set aside.

Ratio Decidendi: Where a domestic tax provision creates a discriminatory burden contrary to a treaty non-discrimination clause, the treaty prevails and the benefit cannot be denied to a resident of the contracting State solely on the basis of the domestic exclusion.

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