Foreign bank in UK entitled to deduction under Section 36(1)(viia) due to DTAA non-discrimination clause

The Tribunal held that the bank incorporated in the UK was entitled to the deduction under Section 36(1)(viia) for the assessment years 1985-86 and 1986-87 due to the non-discrimination clause in the DTAA between India and the UK. The Tribunal allowed the deduction for bad and doubtful debts claimed by the assessee, recognizing the previous exclusion of foreign banks from this benefit as unfair discrimination. Ground Nos. 9 and 10 for the assessment year 1985-86 and 8 and 9 for the assessment year 1986-87 were treated as allowed.

---

---

Issues Involved:
1. Deduction under Section 36(1)(viia) of the Income-tax Act for foreign banks.
2. Application of the non-discrimination clause in the Double Taxation Avoidance Agreement (DTAA) between India and the UK.

Issue-wise Detailed Analysis:

1. Deduction under Section 36(1)(viia) of the Income-tax Act for foreign banks:

The assessee claimed a deduction for bad debts under the newly introduced Section 36(1)(viia) of the Income-tax Act for the assessment years 1985-86 and 1986-87. The provision allowed deductions for bad debts for scheduled and non-scheduled banks, but the section explicitly excluded banks incorporated outside India. The Income-tax Appellate Commissioner (IAC) and the Commissioner of Income-tax (Appeals) [CIT(A)] rejected the claim, stating that the section did not apply to foreign banks for the relevant assessment years.

The CIT(A) argued that Section 36(1)(viia) was designed to provide a cushion to rural banks operating in rural sectors of India, which faced unique challenges in recovering advances made to poorer sections of society. Foreign banks, operating primarily in urban areas, did not face the same conditions, and hence, the legislature did not extend this benefit to them before 1-4-1987. The CIT(A) further noted that the non-discrimination clause in the DTAA was not applicable because Indian banks and foreign banks did not operate under the same circumstances or conditions.

2. Application of the non-discrimination clause in the Double Taxation Avoidance Agreement (DTAA) between India and the UK:

The assessee argued that the non-discrimination clause in Article 23 of the DTAA between India and the UK should allow them the same deduction benefits as Indian banks. Article 23 states that nationals of one contracting state should not be subjected to more burdensome taxation than nationals of the other contracting state in similar circumstances.

The assessee's representative, Shri Dastur, referred to Circular No. 333 dated 2-4-1982, which clarified that specific provisions in a DTAA would prevail over the general provisions of the Income-tax Act. He also cited the Supreme Court's decision in State Trading Corporation of India Ltd. v. CTO, which distinguished between 'nationality' and 'citizenship,' arguing that the assessee, being a national of the UK, should not face more burdensome taxation than Indian banks.

The Tribunal examined the legislative history of Section 36(1)(viia) and noted that the section was amended with effect from 1-4-1987 to include foreign banks, indicating a recognition of the previous discrimination. The Tribunal concluded that the non-discrimination clause in the DTAA should apply, and the assessee should be allowed the deduction for bad debts.

Conclusion:

The Tribunal held that the assessee, a bank incorporated in the UK, was entitled to the deduction under Section 36(1)(viia) for the assessment years 1985-86 and 1986-87 by virtue of the non-discrimination clause in the DTAA between India and the UK. The Tribunal directed that the deduction for bad and doubtful debts claimed by the assessee should be allowed, recognizing that the previous exclusion of foreign banks from this benefit constituted unfair discrimination. Ground Nos. 9 and 10 for the assessment year 1985-86 and 8 and 9 for the assessment year 1986-87 were therefore treated as allowed.

---