Permanent establishment interest and withholding: internal head-office remittances are not external payments, so deduction and TDS rules differ.

Treaty attribution rules for a permanent establishment treat the branch as a separate enterprise only for computing attributable profits, and that fiction does not by itself create an unconditional deduction for interest credited to the head office. The deduction question still depends on domestic income-computation rules, under which a branch and its head office remain parts of the same enterprise, so the internal interest is not a real outgoing to another person. For withholding, section 195 applies only to payments to a non-resident of sums chargeable under the Act; an internal remittance to the head office is a payment to self, so no tax deduction at source arises and section 40(a)(i) is not attracted.

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Issues: (i) Whether interest credited by an Indian permanent establishment of a foreign bank to its head office or other offshore branches is an allowable deduction in computing the permanent establishment's profits; (ii) whether section 40(a)(i) read with section 195 of the Income-tax Act, 1961 is attracted so as to disallow the interest for want of tax deduction at source.

Issue (i): Whether interest credited by an Indian permanent establishment of a foreign bank to its head office or other offshore branches is an allowable deduction in computing the permanent establishment's profits.

Analysis: Article 7 of the applicable tax treaties permits attribution of profits to a permanent establishment on the footing that it is treated as a distinct and separate enterprise only for the limited purpose of computing profits attributable to it. The treaty language allowing deductions for expenses incurred for the permanent establishment does not, by itself, create an unconditional allowance for interest credited to the head office. The deduction question must still be tested under the domestic law governing computation of business income. On that footing, a branch and its head office are parts of the same enterprise and the interest payment is not a real outgoing to another independent person.

Conclusion: The interest was not allowable as a deduction in the assessee-bank's appeals.

Issue (ii): Whether section 40(a)(i) read with section 195 of the Income-tax Act, 1961 is attracted so as to disallow the interest for want of tax deduction at source.

Analysis: Section 195 applies only where there is a payment to a non-resident of sums chargeable under the Act, and the withholding regime presupposes two distinct persons. The branch and head office are not separate persons for this purpose, and the fiction in the treaty for computing permanent establishment profits cannot be extended to convert an internal allocation into a payment to an outside payee. Since the remittance was in substance a payment to self, no tax was deductible at source and section 40(a)(i) could not be invoked to disallow the claim. This reasoning also supported the order vacating the section 201 demand in the connected matter.

Conclusion: Section 40(a)(i) was not attracted, and no default under section 195 was made out in the connected Bank of Tokyo matter.

Final Conclusion: The interest issue was answered against the assessee in the ABN Amro appeals, while the revenue's appeal in the Bank of Tokyo matter failed because no withholding obligation arose on the internal head-office remittance.

Ratio Decidendi: A treaty fiction treating a permanent establishment as a separate enterprise operates only for attribution of profits and does not extend to create a deductible payment or withholding obligation on internal remittances between a branch and its head office.

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