2012 (10) TMI 134 - AT - Income Tax

India Mauritius DTAA - disallowance of bonus expense u/s 43B - Held that - Disallowance u/s 43B can be made in respect of the bonus unpaid before the due date of filing of return u/s 139(1) because Article 7(3) expressly provides for the deduction of all expenses incurred for the purpose of the business of permanent establishment. Further Article 3(2) and Article 23(1) do not impliedly sanction the invoking of section 43B in Article 7(3) of the DTA. When there is a specific provision as per Article 7(3) of the DTA providing for the deductibility of all expenses incurred for the purpose of permanent establishment, we fail to comprehend as to how Article 23(1) can be applied to invoke disallowance u/s 43B. This contention of the DR, being devoid of any merit - in favour of assessee. Disallowance u/s 14A - CIT(A) deleted the addition - Held that - DTAA can only cure the rigor of the Act and not convert an exempt income under the Act into a taxable one. If a particular amount of income is exempt under the Act, it will cease to form part of Business profits of the enterprise under Article 7. Once a particular item of income does not itself constitute business profit as per Article 7 because of its exemption under the Act, there can be no question of allowing any deduction for an expenditure incurred in relation to such income against the other taxable business income - This factual scenario brings to a stage where the assessee did borrow interest bearing funds for making investment in tax free bonds and repaid such loan out of its own interest free funds on the next day. There is obviously a direct nexus between the borrowing of interest bearing funds and making of investment in tax free bonds. There can be no dispute on the fact that only such part of interest can be disallowed which has been incurred in relation to the income not forming part of the business profits of the assessee as per Article 7 of the DTA. The disallowance of interest is definitely called for but it cannot exceed the actual amount of interest paid in respect of borrowed funds used for the purposes of making investment in tax free bonds, which in the present case is only one day. The AO is directed to calculate disallowance on Rs. 10 crore for one day at the rate which was charged by the RBI on the loan advanced to the assessee on 12.11.1998. This will be the amount of interest paid by the assessee in relation to tax free interest income which is not included in the business profits as per Article 7 of the DTA, warranting disallowance in the computation of business profits - partly in favour of revenue.

Summary

Issues Involved:
1. Tax rate applicable to non-resident companies.
2. Disallowance of expenditure on purchase of fixed assets.
3. Disallowance of bonus expense under Section 43B.
4. Disallowance under Section 14A for interest on borrowed funds used for investment in tax-free bonds.

Issue-wise Detailed Analysis:

1. Tax Rate Applicable to Non-Resident Companies:
The first ground of the assessee's appeal concerned the direction of the CIT(A) to levy tax at the rate of 48% applicable to normal non-resident companies. The learned Counsel for the assessee conceded that a similar issue had been decided against the assessee in the appeal for the assessment year 1997-98. Since the circumstances and legal position remained unchanged, the Tribunal upheld the impugned order, and this ground was not allowed.

2. Disallowance of Expenditure on Purchase of Fixed Assets:
The second ground involved the confirmation of disallowance of expenditure on the purchase of fixed assets amounting to Rs. 3,43,28,114. The learned AR admitted that a similar issue had been decided against the assessee in the order for the assessment year 1997-98. Following the precedent, the Tribunal upheld the impugned order, and this ground was not allowed.

3. Disallowance of Bonus Expense Under Section 43B:
The third ground was against the sustenance of disallowance out of bonus expense. The assessee claimed a deduction of Rs. 66,500 as bonus, but the Assessing Officer found that only Rs. 24,000 was paid before the due date of filing the return. Invoking Section 43B, the Assessing Officer disallowed Rs. 42,500, which was upheld by the CIT(A). The Tribunal examined the provisions of the Double Taxation Avoidance Agreement (DTA) between India and Mauritius, specifically Article 7, which deals with the computation of 'Business Profits'. The Tribunal noted that Article 7(3) of the DTA allows deductions for expenses incurred for the business of the permanent establishment without any restrictive clause. Therefore, the Tribunal concluded that Section 43B could not be applied to disallow the unpaid bonus, and the ground raised by the assessee was allowed.

4. Disallowance Under Section 14A for Interest on Borrowed Funds Used for Investment in Tax-Free Bonds:
The only ground in the Revenue's appeal was against the deletion of disallowance under Section 14A. The assessee had invested Rs. 10 crore in tax-free bonds using borrowed funds and claimed exemption on the interest income. The Assessing Officer disallowed Rs. 34,76,712 as interest expenditure under Section 14A. The CIT(A) deleted this disallowance, considering the assessee had sufficient interest-free funds. The Tribunal examined the provisions of Article 7(3) of the DTA, which does not limit the deductibility of expenses as per the Act. It concluded that Section 14A, which disallows expenses incurred in relation to exempt income, could not be applied under the DTA. However, the Tribunal noted that only the interest for one day should be disallowed, as the borrowed funds were repaid the next day. The Assessing Officer was directed to calculate the disallowance accordingly. The Revenue's appeal was partly allowed for statistical purposes.

Conclusion:
In the result, the assessee's appeal was partly allowed, and the Revenue's appeal was partly allowed for statistical purposes.