TaxTMI 
TaxTMI 
2005 (8) TMI 294
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....t to its Head office or other Branches under section 195 and thereby made itself liable for payment under section 201 of the Act. 3. We shall first take the case of ABN Amro Bank. The assessee-bank in this case is incorporated in Netherlands with a limited liability having its original office at Singapore. It had a branch in India registered in terms of Schedule II of the Reserve Bank of India (RBI) Act, 1934. It carries on banking business in India comprising of accepting deposits, giving loans, discounting/collection of bills issue of letter of credit/guarantees, executing forward transactions in foreign currencies for importers and exporters, money market lending borrowings, etc. in terms of the existing rules and regulations governing such transactions. As per the Double Taxation Avoidance Agreement between India and Netherlands (DTAA in short), the assessee-company is having a Permanent Establishment (PE for short) in India and consequently, it is liable to tax in respect of its income attributable to such PE. It had been paying interest to the head office and/or other branches from year to year and in the two years under consideration, it paid a sum of Rs. 55,03,000 (in as....
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....rofit and loss account does not arise. 6. The CIT(A) did not accept the contention of the assessee. He observed that admittedly, the branches of the bank in India constitute a separate taxable entity and head office and other branches located abroad are different entities as far as taxation is concerned. As such, according to him, payment of interest by the bank's branches in India to its head office and other branches located outside India cannot be treated as payment to self. According to him, interest paid to the head office, etc., constitutes income chargeable to tax under section 9 of the Act and since no deduction of tax at source on the interest so paid as required under section 195 has been made, no deduction can be allowed in respect of such interest payment in computing the total income of the assessee in view of the express provisions of section 40(a)(i) of the Act. The assessee is in appeal. 7. The matter came up for hearing before the Division Bench wherein an order of the Tribunal in the case of Bank of Tokyo Mitsubishi Ltd. [IT Appeal No. 899 (Kol.) of 2002] was relied upon wherein it was held that interest debited to Indian permanent establishment of a for....
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....roviso and exception carved out of article 7.3(a) specifically providing for a deduction of interest paid by a PE to head office without imposing any condition or restriction thereon. According to him, the words, "in accordance with the provisions of and subject to the limitations of the taxation laws of that State" as appearing in article 7.3(a) are absent in article 7.3(b) and, therefore, the interest is allowable without any restriction provided under article 7.3(a) of the DTAA. It is further submitted that section 195 has no application to interest paid by PE to head office because such interest is not 'chargeable under the provisions of this Act' which is a condition precedent for invoking the provisions of section 195. This is because there is no provision in the Act providing for taxation of interest received by the head office of a bank from its branches, in the hands of the head office. It is further submitted that there is also no provision in the DTAA providing for taxation of interest received by head office of a bank from its branches in the hands of the head office. The provisions dealing with deduction of tax at source, it is submitted, presupposes the existe....
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....ia constitute a separate taxable entity and head office and other branches located abroad are different entities as far as taxation is concerned. Therefore, payment of interest by the bank's branches in India to its head office and other branches located outside India cannot be considered as payment to self. The interest paid to the head office etc. constitute income chargeable to tax under section 9 of the Income-tax Act, 1961 and that since deduction of tax at source on the interest so paid as required under section 195 has not been made, hence in view of the express provisions of section 40(a)(i) of Income-tax Act, no deduction can be allowed in respect of 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 the instant case, assessee has claimed payment of interest to non-resident 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 Non-resident for the purpose of assessee which is its permanent establishment carrying on banking business in India. Th....
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.... loss account and offered for taxation. The assessee also makes payment of interest to its head office and other branches located outside India and claims such payment of interest as allowable deduction as such interest has been charged to its profit and loss account. Therefore, payment of interest to head office etc. is not merely a transfer entry because in addition to transfer of income, the assessee has also claimed it as its business expenditure which is not merely a transfer entry; (b) Admittedly, the branches of the assessee in India constitute a separate taxable entity and head office and other branches located abroad are different entities as far as taxation is concerned. Therefore, the payee in this case is a non-resident and thus the amounts remitted are subject to income-tax in its hands in India; (c) It is also well settled law that in the absence of any express provisions in the Treaty, contrary to the general provisions of the Act, the general provisions of the Act will prevail; (d) Moreover, the assessee by its own conduct has established that payment was not to self. By claiming the deduction in respect of interest paid to head office, etc. situated abroad the asse....
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....evious year if (a) it is an Indian company or (b) building that year, the control and management of its affairs is situated wholly in India. ABN Amro Bank is a non-resident company. Section 9 provides for the situations in which income is deemed to accrue or arise in India. Clause (v) of sub-section (1) of section 9 deems all income accruing or arising, whether directly or indirectly, to or from any business connection in India, or through or from any property in India, or through or from any asset or source of income in India, or through the transfer of a capital asset situate in India. Explanation 1 provides for the purposes of this clause that in a case of a business of which all the operations are not carried out in India, the income of the business is deemed under this clause to accrue or arise in India shall be the only such part of the income as is reasonably attributable to the operations carried out in India. Explanation 2 declares that the business connection shall include any business activity carried out through a person who, acting on behalf of the non-resident, - (a) has and habitually exercises in India, an authority to conclude contracts on behalf of the non-residen....
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....f the DTAA between the two countries reads as under:- "Article 7.- Business profits. 1. The profits of an enterprise of one of the States shall be taxable only in that State unless the enterprise carries on business in the other State through a permanent establishment situated therein. If the enterprise carries on business as aforesaid, the profits of the enterprise may be taxed in the other State but only so much of them as is attributable to that permanent establishment. 2. Subject to the provisions of paragraph 3 where an enterprise of one of the State carries on business in the other State through a permanent establishment situated therein, 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. In any case, where the correct amount of profits attributable to a permanent establishment is incapable of determination or the determination thereof presents exceptional difficulties....
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....hts, or by way of commission for specific services performed or for management, or except in the case of a banking enterprise, by way of interest on moneys lent to the head office of the enterprise, or any of its other offices. 4. No profits shall be attributed to a permanent establishment by reason of the mere purchase by that permanent establishment of goods or merchandise for the enterprise. 5. For the purposes of the preceding paragraphs, the profits to be attributed to the permanent establishment shall be determined by the same method year by year unless there is good and sufficient reason to the contrary. 6. Where the profits include items of income which are dealt with separately in other Articles of this Convention, then the provisions of those Articles shall not be affected by the provisions of this Article." 14. The DTAA also contains an article dealing with interest income and it states that interest arising in one of the States and paid to the residents of the other State may be taxed in that other State. Article 11 deals with interest income and it reads as under:- "Article 11. Interest. (1) Interest arising in one of the....
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....ing a right to participate in the debtor's profits and in particular, income from the Government securities and income from bonds or debentures, including premiums and prizes attaching to such securities, bonds or debentures. Penalty charges for late payment shall not be regarded as interest for the purpose of this Article. (7) The provisions of paragraphs 1, 2 and 3 shall not apply if the beneficial owner of the interest, being a resident of one of the States, carries on business in the other State in which the interest arises, through a permanent establishment situated therein, or performs in that other State independent personal services from a fixed base situated therein, and the debt-claim in respect of which the interest is paid is effectively connected with such permanent establishment or fixed base, in such a case the provisions of Article 7 or Article 14, as the case may be, shall apply. (8) Interest shall be deemed to arise in one of the States when the payer is that State itself, a political sub-division, a local authority or a resident of that State. Where, however, the person paying the interest, whether he is a resident of one of the States or no....
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....N Amro Bank, a corporate body is the assessee and carrying on banking business in India and therefore, it is liable to be taxed in India in respect of the profit it earns in India by virtue of section 5(2) read with sections 28 to 44BA of the Act. Since it carries on the business through a branch which is a PE it has to be assessed only in respect of that profit which is relatable to the activities and attributable to the PE both by virtue of section 5 as well as section 9 of I.T. Act. In view the existence of DTAA the taxability is to judged with reference to the provisions thereof as well. Article 7 of DTAA deals with Business profits. By clause 1 of the Article the profits of an enterprise of one of the States are to be taxable only in that State unless the enterprise carries on business in the other State through a permanent establishment situated therein. If the enterprise carries on business as aforesaid, the profits of the enterprise may be taxed, in the other State but only so much of them as is attributable to that permanent establishment. The assessee ABN Amro Bank is an enterprise of Netherlands and carries on business in India through a PE situated herein. Therefore so ....
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....rrying a right to participate in the debtor's profits, and in particular income from the Government securities and income from bonds or debentures, including premiums and prizes attaching to such securities, bonds or debentures. This provision does not apply if the beneficial owner of the interest, carries on business in the other country in which the interest arises, through a permanent establishment situated therein, or performs in that other country independent personal services from a fixed base situated therein and the interest earning debt-claim is effectively connected with such PE or fixed base. In such a case the provisions of Article 7 dealing with business profits or as the case may be. Article 14 dealing with personal services, are to apply. Where the-person paying the interest, has in one of the country a PE or a fixed base in connection with which the indebtedness on which the interest is paid was incurred, and such interest is borne by such PE or fixed base, then such interest shall be deemed to arise in the country in which the PE or fixed base is situated. 18. The proposition of law is well settled that nobody can make profit out of self nor can trade with s....
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....t be taxed however much the market rises; nor can he be taxed on what he gives away from his own personal stock, nor, so far as his shop is concerned, can he be compelled to sell at a profit. If he keeps two sets of books and enters in one all the bags which go into his personal godown and in the other the rice which is withdrawn from the godown into his shop, rice just sufficient to meet the day-to-day demands of his customers so that only a negligible quantity is left over in the shop after each day's sales, his private and personal dealings with the bags in his personal godown could not be taxed unless he sells them at a profit. What he chooses to do with the rice in his godown is no concern of the Income-tax department provided always that he does not sell it or otherwise make a profit out of it. He can consume it, or give it away, or just let it rot. Why should it make a difference if instead of keeping two sets of books he keeps only one? How can he be said to have made an income personally or his business a profit, because he uses ten bags out of his godown for a feast for the marriage of his daughter? How can it make any difference whether the bags are shifted directly ....
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..... During the year the branch had purchased certain goods, which were transferred to head office in India. The branch had included a profit margin at the time of transfer of goods. The head office was supposed to sell the goods to third parties. The said goods formed part of closing stock for the concerned year. The tax authorities taxed the profit margin of the branch office. The assessee contended that there was no sale to third party and the profit taxed was notional. 22. The Allahabad High Court held in favour of the assessee on the ground that no one can make profits out of himself. The following observations of the High Court are interesting: "We put a question to learned counsel for the department to the effect that, if the assessee had spent Rs. 10,000 on the purchase of cloth at Bhadohi (branch) and had mentioned the invoice price as Rs. 15,000 when sending the cloth from Bhadohi to Semohi (head office) and had then sold it at Semohi for Rs. 43,000 could he be said to have made a profit of Rs. 3,000 or was he to be said to-have incurred a loss of Rs. 2,000. The answer of course was that he had made a profit of Rs. 3,000." 23. In the case Mitsui Bank Ltd. v. I....
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....way of commission, for specific services performed or for management, or, except in the case of a banking enterprise, by way of interest on moneys lent to the permanent establishment. Likewise, no account shall be taken, in the determination of the profits of a permanent establishment, for amounts charged (otherwise than towards reimbursement of actual expenses), by the permanent establishment to the head office of the enterprise or any of its other offices, by way of royalties, fees or other similar payments in return for the use of patents or other rights, or by way of commission for specific services performed or for management, or, except in the case of a banking enterprise, by way of interest on moneys lent to the head office of the enterprise, or any of its other offices." By the mere fact that a particular expenditure is excluded from list of disallowable items, it does not ipso facto mean that it would be allowable. The deductibility of interest paid by the Branch in India to the head office is to be seen by looking to other provisions of the treaty or the local law. The payment of such interest may be included in the expenses allowable including executive and general expen....
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....m PE. 27. Therefore, the first part of the question as to whether the interest payment is allowable deduction or not is to be held against the assessee and in favour of the revenue. 28. The second part of the question as to whether the provisions of section 40(a)(i) are attracted in respect of such payment of interest would not really survive in view of our finding that the interest payment by the Branch/PE to Head Office or other offshore branches is not allowable as payment being to self. Since however detailed arguments are raised from both the sides and the question is referred for consideration of the Special Bench we would deal with the same. 29. Section 40(a)(i) reads as under:- "40. Notwithstanding anything to the contrary in sections 30 to 38, the following amounts shall not be deducted in computing the income chargeable under the head 'Profits and gains of business or profession',- (a) in the case of any assessee- (i) any interest (not being interest on a loan issued for public subscription before the 1st day of April, 1938), royalty, fees for technical services or other sum chargeable under this Act, which is payable,- ....
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....IT v. Premier Tyres Ltd. [1982] 134 ITR 17 and before Calcutta High Court in the case of Bunge & Co. Ltd. v. ITO [1971] 79 ITR 93 it is held that if the assessee is agent of the non-resident, provisions of section 195 are not applicable. In the first case of Bunge & Co. Ltd. a foreign company having an office at Calcutta carried on the business of exporting jute goods from India. It had agents some of whom were also buyers in various foreign countries who were non-residents. During the accounting year 1961-62, it remitted a sum of money to the foreign agents. The Income-tax Officer sent notices to the company proposing to treat the company as agents of the non-residents under section 163 of the Act "for the limited purpose of recovery of tax under section 201 of the Act" in respect of the sum of money remitted to the foreign agents. The Calcutta High Court held that the same person cannot be treated as an agent under section 163 of the Act and proceeded with under section 201 at the same time. It was held that the group of sections from sections 160 to 163 and the group of sections from sections 195 to 201 of the Act are mutually exclusive and operate on different fields. 32. Th....
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....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. 35. In the case of CIT v. Ajax Products Ltd. [1965] 55 ITR 741, the Supreme Court dealt with a case under section 10(2)(vii) of the Income-tax Act, 1922 whereby under the second proviso to the section, whenever a sale takes place after the cessation of the business, the surplus must be deemed to be the profits of the year previous to the year i....
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....he carry forward of unabsorbed depreciation, observed that the avowed purpose of the legal fiction created by the deeming provision contained in proviso (b) to section 10(2)(vi) of the Indian Income-tax Act, 1922, and in section 32(2) of the Income-tax Act, 1961 is to make the unabsorbed carried forward depreciation partake of the same character as the current depreciation in the following year so that it is available, unlike unabsorbed carried forward business loss, for being set off against other heads of income of that year. Such being the purpose for which the legal fiction is created, the fiction cannot be extended beyond its legitimate field and will have to be confined to that purpose. It cannot be said that because of the legal fiction, the unabsorbed carried forward losses should be given preference not merely over the unabsorbed carried forward depreciation but also over the current year's depreciation. The court held that it is well settled that legal fictions are created only for some definite purpose and these must be limited to that purpose and should not be extended beyond that legitimate field. 37. In the case of CIT v. Vadilal Lallubhai [1972] 86 ITR 2, the ....
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....cannot be treated as a separate entity for the purpose of deduction of tax at source. The fiction created under Article 7 of the DTAA is for a specific purpose and cannot be extended beyond the fixed area and in this connection Transfer Pricing provisions introduced in IT Act with effect from April 2002 require transactions between two associated enterprises at arm's length price and in that connection. Section 92F(iii) defines the term "enterprise" as follows: "enterprise means a person (including a Permanent Establishment of such person) who is, or has been, or proposed to be engaged in any activity, relating to the production, storage...." 41. The bracket in the definition intends to state is that, even a PE is to be treated as an enterprise. Though one of the interpretation could be that a PE is to be included in person as its part i.e., the PE and the person are to be treated as one enterprise. However, that is not the case. Hence the law itself suggest that person can trade with himself and earn profits out of it. 42. In the instant case, assessee has claimed payment of interest to non-resident ABN Amro Bank, NV situated in Netherlands and being a company i....
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....cond part of the question therefore is to be held in favour of the assessee. 45. In the appeal in the case of Bank of Tokyo Mitsubishi Ltd. appearing in IT Appeal No. 899 (Kol.) of 2002 the assessee, made payment of Rs. 5,40,29,702 to their head office in Tokyo and other foreign branches without deduction of tax at source under section 195 of the Act for the default of which the assessee was held liable under; section 201 and was directed to make payment by the Assessing Officer. In this case also, the assessee's contention has been that the payment was made to head office and, therefore, there was no obligation of TDS and this contention has been rejected by the Assessing Officer by stating that once it has been claimed and allowed as deduction for arriving at the total income, the assessee cannot escape from the liability of not deducting TDS under section 195. It was also pleaded by the assessee that interest paid by Indian Offices to their head office and foreign branches are not chargeable to income-tax in India and, therefore, there is no liability TDS does not arise and this contention was also rejected by the Assessing Officer by stating that the argument is misconce....
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.... from the Indian branch of the enterprise is chargeable to tax in the hands of Japanese Enterprise or any of its overseas branches. Stipulation in section 40(a)(i) thus has no application on the facts and in the circumstances of the case. I am, therefore, inclined to hold that Assessing Officer was not justified in denying deduction in respect of the payment to non-residents of amounts aggregating to Rs. 5,13,09,654. Addition is accordingly deleted and ground 10, fully allowed." 46. In this case, the revenue is in appeal. The revenue has raised a similar argument as in the case of ABN Amro Bank NV. The ld. counsel of the assessee submitted that payment of interest to the head office in case of a banking company is an allowable deduction in view of Article 7.3 of the DTAA between India and Japan. It is further submitted that to attract the provisions of section 195 there must exist two persons namely, the payer and payee where the payee should be a non-resident for the purposes of the Act and further the amount remitted to the non-resident payee should be subject to income-tax in its hands in India. He submitted that the assessee is assessed in India in the status of non-resident....
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....me cannot be given effect to. It is further submitted that Japanese treaty provides for deduction without being subject to the limitations provided in the domestic tax laws of India except the one relating to the deductibility of general administrative or head office expenses as provided in the protocol to the said Indo-Japan treaty. Section 40(a)(i) of the Act, being a limiting or restrictive provision contained in the domestic tax laws of India, but not relating to general administrative or head office expenses for which there is a specific limiting provision in the Act in the form of section 44C, would accordingly not have any application in the case of the assessee in view of the favourable provisions of the Indo-Japan tax treaty as contrary to the Indo-Netherlands treaty appearing in the case of ABN Amro Bank NV. 47. Article 7 of the Convention between India and Government of Japan for avoidance of double taxation and prevention of fiscal evasion with respect of taxes on income (hereinafter referred to as "Japanese DTAA") is differently drafted and it reads as under:- "Article 7 - Business Profits 1. The profits of an enterprise of a Contracting State shal....
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....ions of those articles shall not be affected by the provisions of this Article." 48. The Article dealing with interest in this Japanese DTAA reads as under:- "Article - 11 - Interest - 1. Interest arising in a Contracting State and paid to a resident of the other Contracting State may be taxed in that other Contracting State. 2. However, such interest may also be taxed in the Contracting State in which it arises, and according to laws of that Contracting State, but if the recipient is the beneficial owner of the interest, the tax so charged shall not exceed: (a) 10 per cent of gross amount of the interest if the beneficial owner is a bank; and (b) 15 per cent of the gross amount of the interest in all other cases. 3. Notwithstanding the provisions of paragraph 2, interest arising in a Contracting State and derived by the Government of the other Contracting State, a political submission-division or a local authority thereof, the Central Bank of that other Contracting State or any financial institution wholly owned by that Government, or by any resident of the other Contracting State with respect to debt-claims guaranteed or in....
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....ty thereof or a resident of that Contracting State. Where, however, the person paying the interest, whether he is a resident of a Contracting State or not, has in a Contracting State a permanent establishment or a fixed base in connection with which the indebtedness on which the interest is paid was incurred, and such interest is borne by such permanent establishment or fixed base, then such interest shall be deemed to arise in the Contracting State in which the permanent establishment or fixed base is situated. 8. Where, by reason of a special relationship between the payer and the beneficial owner or between both of them and some other person, the amount of the interest, having regard to the debt-claim for which it is paid, exceeds the amount which would have been agreed upon by the payer and the beneficial owner in the absence of such relationship, the provisions of this Article shall apply only to the last-mentioned amount. In such a case, the excess part of the payments shall remain taxable according to the laws of each Contracting State, due regard being had to the other provisions of this Convention." 49. Article 14 of the Japanese DTAA reads as under:- ....