TaxTMI 
TaxTMI 
2026 (6) TMI 781
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....n partly upholding the order of Assistant Commissioner of Incometax, Circle 1(2), Mumbai, thereby disposing the appeal of the Appellant on the following grounds. 1. In taxing the interest received from overseas branches amounting to Rs 48,878,457. 2. In disallowing a deduction for hub expenses to Rs. 51,769, 989/-" The Revenue has raised the following grounds of appeal:- "1. On the facts and in the circumstances of the case and in law, the Id. CIT(A) erred in directing the AO to allow broken period interest paid on securities purchased amounting to Rs. 1,40,63,711/-. 2. On the facts and in the circumstances of the case and in law, the Ld. CIT(A) erred in directing the AO to delete the salary paid to expatriate employee amounting to Rs. 1,62,95,395/-. 3. On the facts and in the circumstances of the case the Id. CIT(A) erred in directing the AO to allow loss on revaluation of unmatured foreign exchange contracts amounting to Rs. 39,97,207/-. 4. On the facts and in the circumstances of the case and in law, the Ld. CIT(A) erred in directing the AO to allow the loss incurred on depreciation in value of investments amounting to Rs.....
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....ble Supreme Court in the case of Vijaya Bank Ltd. Vs. CIT (187 ITR 541). The Ld. CIT(A) further upheld the action of the Ld.AO in taxing the interest received from Head Office/overseas branches by holding that for the purpose of taxation, the Indian branch and the Head Office are to be treated as distinct entities and such interest income had nexus with the Indian operations. The Ld.CIT(A) confirmed the disallowance of hub expenses on the ground that the assessee failed to substantiate that such expenses were incurred wholly and exclusively for the purposes of its business in India. 3.3. However, the Ld.CIT(A) granted relief to the assessee on certain issues. The disallowance of salary paid to expatriate employee was deleted by holding that the expenditure was incurred wholly and exclusively for the purposes of the Indian branch and was allowable u/s 37(1) of the Act, and could not be treated as head office expenditure u/s 44C. The Ld. CIT(A) allowed the loss on revaluation of unmatured foreign exchange contracts by following judicial precedents and accepted accounting principles. Similarly, the claim of depreciation in value of investments was allowed by holding that valuation ....
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....the provisions of the India-USA DTAA, the Ld. Sr. Counsel submitted that Article 7 incorporates the principle that the profits attributable to a Permanent Establishment are to be computed as if the Permanent Establishment were a distinct and separate enterprise dealing wholly independently with the enterprise of which it forms a part. However, it was argued that this is only a legal fiction created for the limited purpose of determining the profits attributable to the Permanent Establishment. Such fiction cannot be extended beyond its legitimate field to create a charge of tax on notional income arising from internal transactions between different parts of the same entity. 4.4. The Ld.Sr.Counsel further submitted that the Ld.AO/CIT(A) incorrectly relied on the concept of separate entity under the DTAA to hold that the interest has accrued to the Indian branch. According to him, while the fiction may permit attribution of profits to a Permanent Establishment, it does not alter the fundamental legal character of the transaction. He submitted that a branch cannot lend money to itself and cannot earn income from itself. Consequently, the so-called interest credited by the Head Offic....
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....easury deployment into a taxable lending transaction. The test is whether any real income has arisen to the assessee from a source external to itself. Since the entire transaction is confined within the same legal entity, no real income can be said to have accrued. 4.9. In support the Ld.Sr.Counsel placed reliance the decision of the Hon'ble Bombay High Court in the case of Credit Agricole Indosuez reported in (2010) 377 ITR 102 and the decision of the Hon'ble Special Bench of Mumbai Tribunal in the case of Sumitomo Mitsui Banking Corporation vs.DCIT reported in (2012) 19 taxmann.com 364, wherein it has been consistently held that interest arising on transactions between a foreign bank and its branches constitutes a payment to self and does not give rise to taxable income. The Ld.Sr.Counsel accordingly submitted that the addition sustained by the Ld.CIT(A deserves to be deleted in its entirety. 4.10. Per contra, the Ld. DR strongly relied upon the orders of the Assessing Officer and the learned CIT(A). It was submitted that the interest income in question has arisen out of funds generated by the Indian branch in the course of its banking operations in India and, therefore, be....
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....d by both sides in light of the records placed before this Tribunal. 5. The issue for consideration is whether the interest received by the Indian branches from assessee (Head Office) and/or overseas branches is liable to tax in India. 5.1. It is an undisputed position that the Head Office and the Indian branch constitute the same legal entity during the year under consideration. It is also an admitted position that the Indian branch had placed surplus funds with its Head Office and/or overseas branches in the ordinary course of its banking operations and earned interest thereon. The Revenue has not disputed that the transactions are purely inter se between different establishments of the same legal entity. The mere fact that, for the limited purpose of attribution of profits under the DTAA, a Permanent Establishment is treated as a distinct and separate enterprise does not alter the fundamental legal position that the Head Office and the branch continue to constitute one and the same juridical person. 5.2. We also find considerable merit in the contention of the assessee that the impugned interest cannot be brought to tax by resorting to the general provisions contained i....
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....ave any shareholder who is a citizen of India or who is resident in India, no income shall be deemed to accrue or arise in India through or from operations which are confined to the shooting of any cinematograph film in India."** 5.3. It is a settled principle of statutory interpretation that where a specific provision deals with a particular category of income, the taxability thereof has to be examined with reference to such specific provision and not under a more general provision. Interest income is specifically governed by section 9(1)(v) of the Act, which lays down the circumstances in which interest shall be deemed to accrue or arise in India. Therefore, the taxability of the impugned interest has necessarily to be tested on the touchstone of section 9(1)(v), and recourse cannot be taken to the more general provisions of section 9(1)(i) dealing with business connection. Section 9(1)(v)(c) - Income-tax Act, 1961:- "(c) by a person who is a non-resident, where the interest is payable in respect of any debt incurred, or moneys borrowed and used, for the purposes of a business or profession carried on by such person in India." 5.4. A perusal of the above s....
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....uthorities that the impugned interest constitutes taxable income in the hands of the Indian branch. The foundation of the Revenue's case is that, by virtue of Article 7 of the India-USA DTAA, the Permanent Establishment is required to be treated as a distinct and separate enterprise and, therefore, the interest credited by the Head Office and overseas branches must be regarded as taxable income of the Indian branch. In our considered opinion, such an interpretation overlooks the limited purpose for which the legal fiction has been enacted. 6.1. The fiction of treating a Permanent Establishment as a distinct and separate enterprise is incorporated in the DTAA solely for the purpose of determining the quantum of profits attributable to the Permanent Establishment. The object of the fiction is to facilitate a fair allocation of business profits between different taxing jurisdictions by assuming that the Permanent Establishment deals independently with the enterprise of which it forms a part. However, it is a settled principle that a legal fiction must be confined strictly to the purpose for which it is created and cannot be extended beyond its legitimate field. 6.2. The deeming ....
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....any real income, no tax liability can arise therefrom. 7. There is yet another significant aspect of the matter. A careful reading of Explanation 1(a) to section 9(1)(v), inserted with effect from 01.04.2016, shows that the deeming fiction is confined to a specific category of transactions, namely, interest payable by a Permanent Establishment in India to its Head Office or any other branch or Permanent Establishment outside India. The Legislature has consciously brought within the tax net only the outbound payment of interest by the Indian Permanent Establishment to the foreign Head Office or overseas branches and has provided that such interest shall be deemed to accrue or arise in India and shall be chargeable to tax in addition to the profits attributable to the Permanent Establishment. 7.1. In the present case, however, the factual situation is exactly the converse. The impugned amount represents interest payable by the Head Office and/or overseas branches to the Indian Permanent Establishment on temporary placement of surplus funds by the Indian branch. Thus, the transaction under consideration is not one where the Indian Permanent Establishment is the payer of interest....
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.... raised by the assessee stands allowed. 8. Ground No. 2: Disallowance of deduction of Hub Expenses - Rs. 5,17,69,989/- 8.1. Brief facts apropos this issue is that during the year under consideration, the assessee claimed deduction of hub expenses amounting to Rs. 5,17,69,989/-. These expenses pertained to centralized banking support services rendered by the assessee's overseas offices, primarily located at Hong Kong and Bournemouth. The said services included data processing, transaction monitoring, and other essential operational and control functions necessary for the day-to-day functioning of the Indian branch of the assessee. 8.1.1. The Ld.AO disallowed the claim of hub expenses on the ground that the assessee failed to establish that the expenditure was incurred wholly and exclusively for the purposes of business in India. The Ld.AO further observed that the assessee did not furnish proper and reasonable basis for allocation of such centralized costs to the Indian branch, and therefore, the claim was not substantiated with adequate supporting evidence. 8.1.2. The Ld.CIT(A) confirmed the disallowance made by the Ld.AO. The Ld.CIT(A) held that the assessee had not pr....
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....ies failed to properly appreciate the evidentiary material and the role of such services in the assessee's banking operations. 8.6. The Ld.Sr.Counsel contended that the hub expenses are intrinsically and inextricably linked to the carrying on of banking operations by the Indian branch and constitute an integral part of the cost of doing business. Without such centralized support functions, it would not be possible for the Indian branch to operate in a regulated and compliant banking environment. Accordingly, the expenditure satisfies the test of being laid out wholly and exclusively for the purposes of business. 8.7. It was therefore submitted that the disallowance made by the Ld.AO and confirmed by the Ld.CIT(A) proceeds on an erroneous appreciation of facts and law, ignoring the commercial reality of global banking operations and the documentary evidence placed on record. The Ld.Sr.Counsel accordingly prayed that the expenditure be allowed as a deduction under section 37(1) of the Act. 8.8. Per contra, the Ld.DR strongly relied upon the orders of the Ld.AO and the Ld.CIT(A). It was submitted that the assessee has failed to discharge the onus cast upon it to establish tha....
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....ntiate the allocation methodology with sufficient reliability. 9.3. From the material placed on record, including the nature of services rendered and regulatory framework governing banking operations, it is evident that the hub functions are not in the nature of general administrative overheads but constitute operational support services directly linked to the core banking activities of the Indian branch. In modern banking structures, such centralization of critical functions is a business necessity to ensure uniformity of processes, risk control, and real-time transaction monitoring across jurisdictions. 9.4. The assessee has also placed on record RBI approvals and supporting documentation to demonstrate that such outsourcing/centralization of functions is an accepted feature of banking operations. The allocation mechanism, as demonstrated from the record, is based on identifiable business parameters and is not shown to be arbitrary or ad hoc. 9.5. It is also not disputed that similar expenditure under identical arrangements has been allowed in earlier assessment years. No material has been brought on record by the Revenue to show any change in facts or to demonstrate tha....
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....ads which are incapable of precise identification with any specific branch. 9.9. Hon'ble Supreme Court in Director of Income Tax (IT)-I, Mumbai v. American Express Bank Ltd. (supra), considered the submission of the assessee and analysed the same in the light of the section 44C. Hon'ble Court explained that section 44C is a special provision intended to deal with the difficulty of apportionment of such common head office expenditure and to substitute subjective allocation with a statutory formula ensuring a reasonable restriction on deduction of such overheads attributable to Indian operations. The ratio of the said decision makes it clear that section 44C operates in a limited field of allocation of general and indivisible head office expenses. 9.9.1. The ratio laid down by Hon'ble Supreme Court in Director of Income Tax (IT)-I, Mumbai v. American Express Bank Ltd. (supra). on the scope and applicability of section 44C, as well as the principles governing allocation of head office expenditure to Indian operations, has been succinctly summarized in paragraphs 83 to 85 of the judgment, which read as under: "83. The pivotal question involved in these appeals has been a....
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....eir deduction will be governed by the limits set out therein." Thus, the provision governs only common administrative and executive expenditure which is incapable of direct attribution to specific services or functions. 9.10. In the present case, however, the hub expenses pertain to identifiable and specific operational services such as data processing, transaction monitoring, risk management support, system control functions and other banking support services rendered by designated hubs at Hong Kong and Bournemouth are at pages 53 to 82 of the paper book filed. These services rendered by Honkong and Bournemoth as per the agreement between Chase Manhattan Bank Honkong and The Chase Manhattan bank Mumbai placed at pages 47 to 52 of the paper book. On perusal of the same it is noted that the services are function-specific, operational in nature, and directly utilized for carrying on banking activities of the Indian branch. They are not in the nature of general head office administrative overheads contemplated under section 44C. 9.10.1. Accordingly, while section 44C deals with allocation of common and indivisible head office expenditure as explained by the Hon'ble Supreme Co....
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....fixed stipulation for payment of interest at periodic intervals, generally six months. It was explained that where such securities are acquired during the interregnum between two interest payment dates, the purchase consideration is bifurcated into (i) the cost of the security and (ii) the interest accrued from the last interest payment date up to the date of acquisition, commonly referred to as "broken period interest". 11.2. It was further submitted that upon receipt of the next interest payment, the purchaser bank receives interest for the entire coupon period, which necessarily includes the component relatable to the period prior to acquisition. In substance, therefore, the assessee, being the purchaser, effectively earns interest from a date anterior to the date of purchase up to the date on which the first post-acquisition interest becomes due. Accordingly, the broken period interest paid at the time of acquisition, amounting to Rs. 1,40,63,711/-, having been debited to the Profit and Loss Account, represents a revenue expenditure incurred in the ordinary course of banking operations and is not in the nature of capital cost of securities. 11.3. It was thus contended tha....
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....st paid as expenditure and the selling banker treats the Broken Period Interest received as income. The purchasing bank becomes the owner of security from the date of purchase only and therefore it is natural that interest relatable to the period before purchase is treated as income of the selling bank. These securities are fixed income earning assets, where earnings accrue in direct proportion with time. 12.3. The issue regarding allowability of Broken Period Interest was considered in great detail by Hon'ble Bombay High Court in the case of American Express(supra). Hon'ble Court inter alia factually distinguished the decision of Hon'ble Supreme Court in the case of Vijaya Bank (supra), the relevant portion of which is reproduced below: "In that case (Vijaya Bank's case) the facts were as follows. During the assessment year under consideration, Vijaya Bank entered into an agreement with Jayalakshmi Bank Limited, whereby Vijaya Bank took over the liabilities of Jayalakshmi Bank. They also took over assets belonging to Jayalakshmi Bank. These assets consisted of two items viz. Rs. 58,568 and Rs. 11,630. The said amount of Rs. 58,568 represented Interest, whic....
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.... on the judgment of the Hon'ble Bombay High Court in American Express International Banking Corporation (258 ITR 601), which has been approved by the Hon'ble Supreme Court. Further, reliance was placed on the decision of the Hon'ble Supreme Court in the case of Bank of Rajasthan reported in (2024) 167 taxmann.com 430, wherein, erstwhile State Bank of Mysore now merged with State Bank of India is a party, where it has been clarified that where securities are held as stock-in-trade, broken period interest is to be allowed. 12.6. Hon'ble Supreme Court in Bank of Rajasthan Ltd. v. CIT reported in (2024) 167 taxmann.com 430, has clarified that the characterization of securities in the hands of a banking company is a fact-dependent exercise and that RBI classification is not determinative for tax purposes. However, for the limited purpose of allowability of Broken Period Interest, such distinction is not decisive. 12.7. In the present case, the Revenue has admittedly brought to tax the Broken Period Interest received as business income. In such circumstances, the corresponding Broken Period Interest paid cannot be disallowed, as doing so would result in taxing notional income and w....
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....(A) allowed the claim of the assessee by following binding judicial precedents. The Revenue has not brought any material on record to controvert the findings of the Ld. CIT(A) or to demonstrate that the issue is covered in its favour. 12.10. In view of the above settled legal position, particularly in the case of banking entities, we find no infirmity in the order of the Ld.CIT(A) in allowing the claim. The disallowance made by the Ld.AO is accordingly directed to be deleted. Accordingly, ground no.1 raised by the Revenue is dismissed. 13. Ground No.2: Disallowance of salary paid to expatriate employee - Rs. 1,62,95,395/- During the year under consideration, the assessee claimed deduction of salary paid to an expatriate employee amounting to Rs. 1,62,95,395/-. The said employee was an expatriate engaged in rendering services in connection with the assessee's operations in India, and the salary expenditure was claimed as deduction in the computation of income. 13.1. The Ld.AO disallowed the claim by invoking the provisions of section 44C of the Act. The Ld.AO treated the expenditure as "head office expenditure" on the reasoning that the salary was paid outside India a....
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.... decision of the Hon'ble jurisdictional High Court in case of CIT v. Emirates Commercial Bank Ltd. reported in 262 ITR 55, and also on the decision of the Hon'ble Bombay High Court in case of CIT v. American Express Bank Ltd. reported in 258 ITR 601, wherein it has been held that section 44C does not apply to specific expenditure incurred for the purposes of Indian operations and that such expenditure is allowable as business expenditure under section 37(1) of the Act. We have perused the submissions advanced by both sides in light of the records placed before this Tribunal. 15. Section 44C of the Act is a specific computational provision intended to place a restriction on deduction of "head office expenditure" in the nature of general administrative and executive expenses incurred outside India. The applicability of the said provision presupposes that the expenditure in question is in the nature of common head office overheads which are not directly identifiable with the operations of the Indian branch. 15.1 In the present case, however, the factual position emerging from the record clearly indicates that the impugned expenditure does not represent any independent head of....
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....ny infirmity in the view taken by Ld.CIT(A) and the same is upheld. Accordingly, this Ground No. 2 raised by the Revenue is dismissed. 16. Ground No.3: Allowance of loss on revaluation of unmatured foreign exchange forward contracts - Rs. 39,97,207/- During the year under consideration, the assessee had entered into forward contracts in foreign exchange which was mark to market as on 31/03/ 1999. This resulted in a loss of Rs. 39,97,207/- on account of revaluation of unmatured foreign exchange forward contracts as on the balance sheet date. Such loss was debited to the profit and loss account of the Indian PE and consequently claimed as deduction while computing the total income. 16.1. The Ld.AO disallowed the said loss on the ground that the same was notional in nature and had not crystallized during the year. 16.2. The Ld. CIT(A), however, allowed the claim of the assessee by holding that such loss is allowable in accordance with the mercantile system of accounting and consistent accounting practices followed by banking institutions. Reliance was placed by the Ld.CIT(A) on the decision of Hon'ble Mumbai Special Bench in case of DCIT vs. Bank of Bahrain and Kuwait r....
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.... 17.2. We further find that the view taken by the Ld.CIT(A) stands fortified by the decision of Hon'ble Bombay High Court in CIT vs. Citibank N.A. reported in (2016) 66 taxmann.com 373, wherein Hon'ble Court, dealing with a similar issue of valuation of outstanding derivative/foreign exchange contracts on mark-tomarket basis, upheld the allowability of such loss as a permissible deduction under the mercantile system of accounting. 17.3. In the said decision, the Hon'ble High Court, inter alia, approved the principle that where the assessee is consistently following a recognised accounting method and values its outstanding foreign exchange contracts in accordance with prescribed accounting standards / RBI guidelines, the resultant loss arising on revaluation as at the balance sheet date cannot be characterised as merely notional or contingent. It was further held that such valuation reflects a real and present obligation which has accrued as on the closing date and therefore is allowable as a business loss. 17.3. We note that the ratio laid down by the Hon'ble High Court in Citibank N.A. (supra) is in consonance with the Special Bench decision in DCIT vs. Bank of Bahrain & Ku....
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....ll-settled principle of commercial accounting, i.e., "cost or market value, whichever is lower". It was further held that any diminution in the value of such stock-in-trade, determined on a scientific and consistently followed valuation method, results in a real and ascertained business loss, which cannot be brushed aside merely on the basis of a change in characterisation sought to be made by the Assessing Officer. 18.3. The Ld.CIT(A) placed reliance on the judgment of the Hon'ble Supreme Court in case of United Commercial Bank v. CIT reported in (1999) 240 ITR 355, wherein it has been unequivocally held that an assessee is entitled to value its stock-in-trade in accordance with recognised accounting principles and that the Revenue cannot disregard such consistent method of accounting if it reflects true and correct profits. The said principle has been upheld by Hon'ble Bombay High Court in case of CIT v. Bank of Baroda reported in (2003) 262 ITR 334, wherein it has been affirmed that securities held by banks as trading assets form part of stock-in-trade and the valuation thereof on a prudential basis, even if resulting in a loss, is allowable in computing business income. 1....
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....19.4. We further find that the Ld.CIT(A) rightly applied the settled principle of valuation of stock-in-trade at "cost or market value, whichever is lower". Hon'ble Supreme Court in United Commercial Bank v. CIT (supra) clearly held that assessee is entitled to value its stock-in-trade in accordance with recognised commercial accounting principles and that the Revenue cannot disregard such consistent method if it reflects true profits. The said principle has been affirmed by Hon'ble jurisdictional High Court in CIT v. Bank of Baroda (supra), wherein it has been held that securities held by banks as trading assets constitute stock-in-trade and the resultant loss on valuation is allowable. 19.5. In view of the above binding judicial precedents, we find no merit in the stand of the Revenue that the diminution in value is merely notional or that the securities partake the character of capital investments. The finding recorded by the Ld.CIT(A) that the loss is real, ascertained and allowable in accordance with the mercantile system of accounting is well-reasoned and calls for no interference. We therefore find no infirmity in the order of the Ld. CIT(A) in allowing the claim of the a....