Treaty deduction for permanent establishment expenses prevails over section 44C for pre-Protocol years, with branch-specific costs fully deductible.

Under the India-UAE tax treaty, Article 7(3) was treated as permitting deduction of all expenses attributable to a permanent establishment, including executive and general administrative expenses, without importing the section 44C ceiling for the relevant pre-Protocol period. The later Protocol, effective from 01.04.2008, was read as a prospective substantive change, confirming that the earlier treaty text did not itself adopt the domestic restriction. Expenses incurred outside India exclusively for Indian branch operations were also held not to be head office expenditure; as branch-specific costs, they were deductible in full and outside section 44C.

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Issues: (i) Whether head office expenses allocated to the Indian permanent establishment were deductible in full under Article 7(3) of the India-UAE tax treaty or were restricted by section 44C of the Income-tax Act, 1961. (ii) Whether expenses specifically incurred outside India exclusively for the Indian branches fell within section 44C or were allowable in full.

Issue (i): Whether head office expenses allocated to the Indian permanent establishment were deductible in full under Article 7(3) of the India-UAE tax treaty or were restricted by section 44C of the Income-tax Act, 1961.

Analysis: Article 25(1) was read as preserving domestic law unless the treaty contained an express contrary provision. Article 7(3), as it stood before the 2007 Protocol, allowed deduction of all expenses incurred for the permanent establishment, including executive and general administrative expenses, without importing any domestic-law ceiling. The later Protocol, made effective from 01.04.2008, was treated as a substantive prospective amendment, which confirmed that the earlier text did not contain a restriction aligned with section 44C. On that construction, the treaty provision prevailed over the domestic limitation for the relevant assessment year.

Conclusion: The head office expenses were allowable in full and were not subject to section 44C.

Issue (ii): Whether expenses specifically incurred outside India exclusively for the Indian branches fell within section 44C or were allowable in full.

Analysis: The disputed items were found to be branch-specific expenditure incurred outside India and not common head office expenditure of the kind contemplated by section 44C. The statutory definition of head office expenditure was confined to executive and general administrative expenditure, while expenses directly attributable to the branch operations were held to stand on a different footing. The material on record showed that the expenses were incurred exclusively for the Indian branches and were therefore deductible without the section 44C restriction.

Conclusion: The expenses were allowable in full and did not fall within section 44C.

Final Conclusion: The assessee succeeded on both substantial issues, and the appeal was allowed.

Ratio Decidendi: Where a pre-amendment tax treaty provision expressly permits deduction of all expenses attributable to a permanent establishment without domestic-law limits, the domestic restriction cannot be imported unless the treaty text itself so provides; separately, expenditure incurred exclusively for branch operations is not head office expenditure.

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