Gross interest taxation under treaty permits domestic loss set-off and supports concessional ECB-linked interest rate eligibility.

A treaty provision taxing interest at the gross amount does not displace domestic computation rules; the term "gross" excludes deduction of expenditure, but current-year business loss of an Indian permanent establishment may still be set off under the Income-tax Act, so the set-off was treated as allowable. Concessional taxation of non-resident interest at 5% was also held available where the borrowing complied with RBI-governed ECB conditions, and case-specific loan approval was not required merely because the loan was an external commercial borrowing. The commentary also notes that refund adjustment was remitted for verification and the penalty ground was considered premature.

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Issues: (i) Whether business loss of the Indian permanent establishment could be set off against interest on external commercial borrowing loans taxable under Article 11(2) of the India-UAE treaty. (ii) Whether the interest income was eligible for concessional taxation at 5% under section 115A(1)(a)(iiaa) read with section 194LC of the Income-tax Act, 1961.

Issue (i): Whether business loss of the Indian permanent establishment could be set off against interest on external commercial borrowing loans taxable under Article 11(2) of the India-UAE treaty.

Analysis: Article 11(2) contemplates first computing the income under the domestic law of the source State and then applying the treaty cap on tax at the gross amount of interest. The expression "gross" was read as excluding deduction of expenditure, not as barring statutory computation provisions or set off of current year loss. Since the interest was assessed as income from other sources and no expenditure deduction was claimed, the computation provisions of the Income-tax Act, including section 71, remained applicable.

Conclusion: The set off of the permanent establishment's business loss against the interest income was allowable, and this issue was decided in favour of the assessee.

Issue (ii): Whether the interest income was eligible for concessional taxation at 5% under section 115A(1)(a)(iiaa) read with section 194LC of the Income-tax Act, 1961.

Analysis: The CBDT clarification on approval of loan agreements showed that specific case-by-case approval was not required where the borrowing complied with RBI-administered ECB regulations. As the borrowing was not shown to be in violation of those regulations, the concessional regime for non-resident interest income was held applicable.

Conclusion: The interest income was held taxable at 5% under section 115A(1)(a)(iiaa), and this issue was decided in favour of the assessee.

Final Conclusion: The assessment was interfered with on the substantive tax issues, while the refund-adjustment matter was sent back for verification and the penalty ground was rejected as premature.

Ratio Decidendi: Where a treaty requires taxation of interest at the gross amount, the term "gross" excludes deduction for expenditure but does not exclude statutory set off of current year business loss under the domestic computation provisions; and a concessional non-resident interest rate applies where the borrowing satisfies the prescribed ECB regulatory conditions.

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