2025 (2) TMI 332 - AT - Income Tax

Under pre-amendment Article 7(3) DTAA, full PE-related deductions override domestic Section 44C restrictions; foreign branch expenses deductible

Mashreq Bank Psc Versus DCIT (IT) -3 (2), Mumbai

ITAT MUMBAI held that, under the pre-amendment Article 7(3) of the DTAA, all deductions and expenses attributable to a permanent establishment (PE) in ... Disallowance of deduction claimed of head office expenses allocated to the Indian branches - Scope of amended Article 7(3) - assessee is a non-resident banking company incorporated in United Arab Emirates (UAE) and operates in India through its branches in Mumbai and New Delhi - whether head office expenses allocated to the PE in India is allowable u/Article 7(3) of the treaty without any limit or subject to the restrictions imposed under section 44C of the Act ? HELD THAT:- On a careful reading of Article 7(3) of the Treaty, as it existed prior to its amendment, it becomes very much clear that while determining the profit of a PE, all deductions and expenses attributable to the PE have to be allowed. There are no restrictions/conditions imposed in Article 7(3) of the Treaty to limit the expenditure to a particular percentage. Therefore, in absence of any restrictions/conditions expressly provided in Article 7(3), no such restrictions/conditions can either be imported or read between the lines. As in the amended Article 7(3) of the Treaty, specific restriction/condition was imposed providing that the deduction of expenses relating to the PE has to be allowed in accordance with the provisions of and subject to limitations of the tax laws of the particular State where the PE is situated. A reading of the amended Article 7(3) would make it clear that there were no restrictions/conditions imposed with regard to the limit of deduction of expenses earlier to the Protocol. If Revenue’s contention that even without the Protocol amending Article 7(3), Article 25(1) provided for computation of deduction under Article 7(3) as per the provisions of domestic law is accepted, then there was no need for amending Article 7(3) by the Protocol. The language used in Article 7(3) of the treaty prior to and post amendment demonstrates that at the time of entering into the DTAA, the treaty partners, initially, never intended to put any restriction of the domestic laws on allowability of expenses in computing the business profits of the PE. Subsequently, the treaty partners having felt that the benefits provided under Article 7(3) needs to be withdrawn or restricted, agreed to amend the provision. Thus, in our view, prior to amendment of Article 7(3), the understanding between treaty partners is to allow all expenses attributable to the PE, without applying the limitation/restriction imposed under the domestic laws. Thus, we hold that Article 7(3) of the Treaty, being an express provision contrary to the domestic law will, override the domestic law. As per the language of pre-amended Article 7(3) of the Treaty, the disallowance of expenditure attributable to the PE has to be allowed in full without applying the restriction imposed under section 44C of the Act. Thus, we agree with the view expressed in case of Dalma Energy LLC [2012 (5) TMI 10 - ITAT, AHMEDABAD] Abu Dhabi Commercial Bank [2012 (7) TMI 703 - ITAT MUMBAI] State Bank of Mauritius Ltd [2012 (10) TMI 134 - ITAT, MUMBAI] . Having gone through the decision we are of the view that it was decided upon different set of facts, hence, not applicable. Firstly, in the case before us, there is no allegation by the Departmental Authorities that the non-resident assessee is getting a more favorable treatment than the resident assessee’s. Secondly, while computing profit of business and profession, business expenses are allowed to a resident assessee under the Indian Income Tax Act. Accordingly, ground no.1 is decided in favour of the assessee. Disallowance of deduction claimed being expenses specifically incurred outside India for the Indian branches - whether the provisions of section 44C would apply to such expenditure ? - HELD THAT:- Looking at the nature of expenditure incurred, there cannot be any doubt that they are exclusively related to the operations of Indian branches. The expenditure covered under section 44C is of common nature, which is incurred for various branches or which is incurred for the head office and branches. In case of DIT Vs Credit Agricole Indosuez [2015 (6) TMI 974 - BOMBAY HIGH COURT] as held that expenses incurred by head office on behalf of Indian branch are deductible u/s 37(1) of the Act without applying the restrictions of section 44C of the Act. Same view was expressed in case of American Express Bank Ltd. [2015 (4) TMI 1041 - BOMBAY HIGH COURT] The ratio that can be deduced from these decisions are, the expenditure specifically incurred for the branches has to be allowed without the restrictions of section 44C. Thus, keeping in view the definition of head office expenditure under section 44C and the ratio laid down in the judicial precedents, discussed above, we hold that the expenditure incurred outside India exclusively for the Indian branches does not fall within the ambit of section 44C. Hence, would be allowable in full. This ground is allowed. ISSUES PRESENTED and CONSIDEREDThe primary issues considered in this judgment are:1. Whether the head office expenses allocated to the Permanent Establishment (PE) in India are fully deductible under Article 7(3) of the India-UAE Double Taxation Avoidance Agreement (DTAA) without being subject to the limitations imposed by Section 44C of the Income Tax Act.2. Whether specific expenses incurred outside India for the Indian branches, such as SWIFT and Globus Accounting Software expenses, are deductible under Section 37 of the Income Tax Act without being subjected to the restrictions of Section 44C.ISSUE-WISE DETAILED ANALYSIS1. Deductibility of Head Office Expenses under Article 7(3) of the India-UAE DTAARelevant legal framework and precedents:The legal framework involves Article 7(3) and Article 25(1) of the India-UAE DTAA, Section 44C of the Income Tax Act, and the Vienna Convention on the Law of Treaties. The judgment also references various decisions, including those from the Mumbai Tribunal in the assessee's own cases for prior years and other relevant cases.Court's interpretation and reasoning:The Tribunal examined whether Article 7(3) allows for the deduction of all expenses incurred for the PE without domestic law restrictions. It considered the language of Article 7(3) prior to its amendment, which did not reference domestic law restrictions, and contrasted it with the amended Article 7(3), which explicitly incorporated such limitations.Key evidence and findings:The Tribunal noted conflicting views in prior decisions and emphasized the need to interpret treaties in good faith, considering the context and purpose. It highlighted that the original Article 7(3) did not impose domestic law limitations, suggesting that the treaty partners did not initially intend for such restrictions.Application of law to facts:The Tribunal concluded that prior to the amendment effective from April 1, 2008, Article 7(3) allowed for full deduction of expenses attributable to the PE without the limitations of Section 44C.Treatment of competing arguments:The Tribunal addressed the Revenue's argument that Article 25(1) implied domestic law restrictions, rejecting this interpretation based on the treaty's language and purpose. It also dismissed the argument that the protocol amendment was merely clarificatory.Conclusions:The Tribunal held that for the relevant assessment year, the head office expenses were fully deductible under Article 7(3) without the restrictions of Section 44C.2. Deductibility of Specific Expenses Incurred Outside IndiaRelevant legal framework and precedents:The legal framework includes Section 37 and Section 44C of the Income Tax Act, along with judicial precedents such as CIT Vs. Emirates Commercial Bank Ltd. and DIT Vs. Credit Agricole Indosuez.Court's interpretation and reasoning:The Tribunal considered whether expenses like SWIFT and Globus Accounting Software, incurred exclusively for the Indian branches, fall under the definition of 'head office expenditure' as per Section 44C.Key evidence and findings:The Tribunal found that these expenses were directly related to the operations of the Indian branches and did not fit the definition of general administrative expenses under Section 44C.Application of law to facts:The Tribunal determined that these expenses should be allowed under Section 37 without the restrictions of Section 44C, as they were specifically incurred for the Indian branches.Treatment of competing arguments:The Tribunal relied on judicial precedents that supported the deduction of such specific expenses without applying Section 44C limitations.Conclusions:The Tribunal allowed the deduction of these expenses in full under Section 37.SIGNIFICANT HOLDINGSCore principles established:The Tribunal reinforced the principle that treaty provisions should be interpreted in good faith, prioritizing the treaty's language and purpose over domestic law restrictions unless explicitly stated. It emphasized that amendments to treaties are prospective unless clearly stated otherwise.Final determinations on each issue:The Tribunal concluded that the head office expenses were fully deductible under Article 7(3) for the relevant assessment year, and specific expenses incurred for the Indian branches were deductible under Section 37 without Section 44C restrictions.