2005 (8) TMI 294 - AT - Income Tax

Interest Payments by PE to Head Office Not Deductible in India, Section 40(a)(i) & 195 Not Applicable.

The Tribunal determined that interest payments by a permanent establishment (PE) to its head office are not deductible under Indian tax laws, as they are ... Business Expenditure - Whether, the provision of interest by a permanent establishment of a foreign enterprise payable to head office and/or other branches outside India is allowable deduction and if so, whether the provision of section 40(a)(i) is attracted in respect of such payment/provision? - default in not deducting tax from the payment of interest to its Head office or other Branches u/s 195 - liable for payment u/s 201 - HELD THAT:- The assessee in this case is the corporate body and its branches are paying interest to its Head office and other offshore Branches i.e., the payment is by one wing of the assessee to its other wing or so to say by one hand to another. The tax is to be deductible under Chapter XVII-B of the Act and in case of a payment to non-resident it is section 195 of the IT Act. The Branch/PE of the assessee in India is not a person in legal terminology. The person is the Corporate Body-ABN Amro Bank NV and not its Branch or the PE. This is also evident from the fact that assessment in this case is made on the Corporate Body ABN Amro Bank NV and not on its Branch or PE. We, therefore, find force in the assessee's contention that the provisions dealing with deduction of tax at source u/s 195 presupposes the existence of two distinct and separate entities which is absent in the present case. On both the grounds therefore section 40(a)(i) does not come into play. Disallowance of interest on this by invoking the provisions of this section would not be justified. We also find force in the submission of the assessee that the interest paid being not the income of the assessee on the ground that no income does arise from self and consequently interest paid by PE to head office is not 'chargeable under the provisions of this Act' which is a condition precedent for invoking the provisions of section 195 and also on the ground that payment by PE is cancelled by the receipt by the Head office of the assessee-enterprise, in case if the PE is considered as a separate entity than the Head Office of the assessee-enterprise. It is true that the branches of the assessee are taxable but not as a separate entities. The Branch/PE are so deemed as independent and separate entities for determination of the extent of the income subjected to tax in either country and in that connection, the payment of interest by the bank's branches in India to its head office and other branches located outside India is considered allowable and from that point of view it may not be considered as payment to self. It is by fiction created in Article 7.2 of DTAA when it states that 'there shall in each State be attributed to that permanent establishment the profits which it might be expected to make if it were a distinct and separate enterprise engaged in the same or similar activities under the same or similar conditions and dealing wholly independently with the enterprise of which it is permanent establishment'. This fiction is only for computing the profits of the PE for levying tax in India. It is not as if a PE is taken as an independent assessee in India or for all other purposes. Whenever a fiction is created it has to be restricted to the specified object for which it was created and should not be extended beyond that field. This is well settled proposition of law as we find from the following decisions of various courts discussed hereunder. In the instant case, assessee has claimed payment of interest to nonresident ABN Amro Bank, NV situated in Netherlands and being a company incorporated in Netherlands, is a resident of Netherlands for the purpose of income-tax and, therefore, comes under the category of Nonresident for the purpose of assessee which is its PE carrying on banking business in India. Therefore, the payee in this case is a non-resident and the amounts remitted are subject to income-tax in its hands in India. The interest paid to the head office etc. may constitute income chargeable to tax u/s 5(2)/9 of the Income-tax Act, 1961 but no deduction of tax at source on the interest so paid is required u/s 195 as PE of the assessee and head office being same person and hence, the provisions of section 40(a)(i) of I.T. Act cannot be invoked for disallowing such interest of Rs. 55,03,300 in assessment year 1997-98 and of Rs. 62,73,106 in assessment year 1998-99 in computing the total income. In our opinion, it is a payment to self the same does not require any deduction of tax at source u/s 195 of the Act. Consequently, section 40(a)(i) shall not apply entailing no disallowance of interest allowable under Article 7 of DTAA. In case interest is allowable deduction, the second part of the question therefore is to be held in favour of the assessee. We find that clauses 1,2,5,6 and 7 of Article 7 of the Japanese DTAA are similarly worded as clauses 1, 2, 4, 5 and 6 of Netherlands DTAA. Clause 3 of the Japanese DTAA merely incorporates the first part of clause 3(a) of Netherlands DTAA and the proviso placing a restriction by the law of the State in which PE is situate are not incorporated. Again, clause 3(b) of Netherlands DTAA which prohibits allowance of certain expenditure is also missing in Japanese DTAA. There is no other material difference between the two treaties. As pointed out by the learned counsel of the assessee, there are no restrictive covenants in Article 7 for allowance of expenses incurred for the purposes of PE either by the prefix of the words 'in accordance with the provisions of the law of that State' or by the suffix words 'and subject to limitations of taxation laws of that State'. This may be one of the other alternate reasons for not invoking the provisions of section 40(a)(i) of the Income-tax Act for disallowing the payment of interest in computing the income of the assessee through the PE. However, here also, the deeming fiction of treating the PE as a different and separate entity dealing wholly independently with the enterprise in clause 2 of the Article 7 of Japanese DTAA or for the specific purpose of computing the income attributable to the PE and not for any other purposes. Therefore, for the reasons stated above, while dealing with the Netherlands DTAA we hold that no tax was required to be deducted u/s 195 of the Act from the payment of interest by the PE to its head office or other offshore branches of the assessee-enterprise, Bank of Tokyo. We, therefore, uphold the order of the CIT(A) in vacating the order u/s 201 of the Act by holding that the assessee was not in default in deducting the tax at source. In the result, the question referred to Special Bench in 2 appeals filed by the assessee in the case of ABN Amro Bank Ltd. are decided against the assessee and one appeal filed by the revenue in the case of Bank of Tokyo is dismissed. Issues Involved:1. Whether the provision of interest by a permanent establishment (PE) of a foreign enterprise payable to the head office and/or other branches outside India is an allowable deduction.2. Whether the provision of section 40(a)(i) is attracted in respect of such payment/provision.3. Whether the assessee has committed any default in not deducting tax from the payment of interest to its head office or other branches under section 195 and thereby made itself liable for payment under section 201 of the Act.Detailed Analysis:Issue 1: Allowability of Interest DeductionThe assessee, ABN Amro Bank, incorporated in the Netherlands, operates in India through a branch (PE). It claimed a deduction for interest paid to its head office and other branches. The Assessing Officer disallowed this deduction, arguing that the branch in India is a separate taxable entity from the head office and other branches abroad, thus requiring tax deduction at source (TDS) under section 40(a)(i). The CIT(A) upheld this view, stating that the payment to the head office constitutes income chargeable under section 9, and since no TDS was made, the interest payment is not deductible.The Tribunal held that the deeming fiction in Article 7.3(b) of the DTAA between India and the Netherlands, which allows deduction of interest paid by a PE to the head office in the case of a banking enterprise, does not automatically make such interest deductible under Indian tax laws. The deductibility must be in accordance with local laws, which do not allow deductions for payments to self. Therefore, the interest payment is not an allowable deduction.Issue 2: Applicability of Section 40(a)(i)Section 40(a)(i) disallows deductions for certain payments to non-residents unless tax is deducted at source. The Tribunal noted that the PE and the head office are not separate entities for tax purposes. The provisions of section 195, which require TDS on payments to non-residents, presuppose the existence of two distinct entities, which is not the case here. Thus, section 40(a)(i) does not apply, and disallowance under this section is not justified.Issue 3: Default in Deducting Tax under Section 195In the case of the Bank of Tokyo, the Assessing Officer held the assessee liable under section 201 for not deducting tax on interest payments to the head office and other branches. The CIT(A) canceled this order, stating that the interest paid to the head office does not constitute income chargeable to tax in India, and thus section 195 does not apply. The Tribunal upheld this view, noting that the PE and the head office are not separate entities, and no tax deduction is required under section 195.Conclusion:The Tribunal concluded that the interest payment by the PE to the head office is not an allowable deduction under Indian tax laws, as it constitutes a payment to self. Consequently, the provisions of section 40(a)(i) are not attracted. In the case of the Bank of Tokyo, the Tribunal upheld the CIT(A)'s order, confirming that no default was committed in not deducting tax under section 195, as the interest payment does not constitute income chargeable to tax in India. The appeals by the assessee in the case of ABN Amro Bank were decided against the assessee, and the appeal by the revenue in the case of the Bank of Tokyo was dismissed.