2012 (7) TMI 703 - AT - Income Tax

Denial of claim Head office expenses - invoking the provisions of section 44C - DTAA between India and UAE - determining the profits of PE in India - Held that - The insertion of phrase, in accordance with the provisions of and subject to the limitations of the tax laws of that State , the mandate of applicability of the domestic law has been provided, in allowing the deduction of expenses of the PE and determination of profit under the Income Tax Act. Consequently section 44C becomes applicable. Cardinal principle is that when two sovereign nations enter into an agreement and have come to an understanding regarding the terms, views expressed in the agreement, such terms cannot be unilaterally changed. Once the Government of India and Government of UAE had not used the limitation clause of applicability of domestic law in determining the profits and deduction of expenses of PE under Article 7(3), the same cannot be read into even impliedly, that such a provision existed. One has to see the merits of the word and its meaning understood when the two high sovereign nations entered into an agreement. When a particular provisions in the agreement has been brought from a particular date, it has to be, prima facie, taken to be prospective in operation, unless it is expressly or by necessary implication provided or made to have retrospective operation - Here in this case, if any such interpretation is given for retrospective operation of this Article, it creates new obligation and disturbs the assessability of the profit of the PE. Thus, the amendment brought in Article 7(3) w.e.f. 1-4-2008, will not apply retrospectively - that income of the PE of the assessee should be computed as business income after allowing all the expenses attributable to its business in India including the head office expenses - in favour of assessee. Calculation of interest u/s 244A - Held that - CIT (A) has not gone into the question of correctness of method adopted by the AO who has calculated the interest by reducing the refund of tax already granted to the assessee but decided the issue on the ground that the method adopted by the AO is being consistently followed in respect of all assessee. Therefore, the impugned order of the CIT (A) qua this issue is not sustainable in law and liable to be set aside - direct the AO to calculate the interest on the refund due to the assessee without reducing the interest under section 244A which is part of the refund earlier granted from the refund due - in favour of the assessee Exemption u/s 10(15) - Held that - Section 10(15)(iv) are very clear and unambiguous and what is exempt under the said section is interest payable and not the income by way of the interest; and hence, the revenue s grievance is devoid of any substance - in favour of the assessee. Addition in respect of guarantee commission - Held that - If any assessee acquires a right to receive income, the income can be said to accrue to him though it may be received later on. Unless and until there is created in favour of an assessee a debut due by somebody, it cannot be said that income has accrued to him. A mere claim to income without an enforceable right thereto cannot be regarded as accrued income for the purpose of income-tax Act. When the bank gives a guarantee, its obligation extends to the entire period for which guaranty is given. In exchange of this obligation, the bank receives a commission. It is wrong to say that such commission accrues to the full extent the moment when the bank stands as a guarantor. Since the obligation is spread over a period of time, so should be the guarantee commission - in favour of assessee. Addition made in the computation of total income - difference between cost and book value of investment - Held that - As the method of valuation followed by the assessee to value its investment was cost or market value whichever was lower. The assessee had shown a higher value and paid the tax at a higher rate in the assessment year 1996-1997. Such valuation was reversed as per its method of accounting and the differential amount has been claimed as loss. Thus, such a claim is duly allowable deletion of addition is thus warranted - in favour of assessee. Challenge allowability of bad debts without setting of the provision for bad debts - Held that - The total income of the assessee can be computed at the end of the previous year and in computation of such income deduction u/s 36(1)(viia) has to be allowed. If bad debts are written off in the books of account during the course of the previous year, such bad debts must be deducted as admissible u/s 36(1)(viia). Apparently, the deduction allowable under clause (viia) in respect of bad debts will have to be taxed against the opening credit balance in the provision of account to arrive at the quantum of deduction allowable while computing the total income - no infirmity in the reasoning given by the CIT(A) for allowing the assessee s claim - in favour of assessee.

Summary

Issues Involved:
1. Restriction of deduction for head office expenses under Section 44C vis-a-vis Article 7(3) of the India-UAE DTAA.
2. Calculation of interest under Section 244A.
3. Tax rate applicability on business income.
4. Taxation basis for interest on securities.
5. Exemption under Section 10(15) for gross receipts vs. net income.
6. Treatment of guarantee commission.
7. Valuation of investments and treatment of differences between cost and book value.
8. Allowability of bad debts without setting off provisions for bad debts under Section 36(1)(viia).

Detailed Analysis:

1. Restriction of Deduction for Head Office Expenses:
The assessee, a banking company incorporated in UAE with branches in India, argued that the entire head office expenses should be allowed as a deduction under Article 7(3) of the India-UAE DTAA, which overrides domestic law provisions such as Section 44C of the Income Tax Act. The Tribunal noted that prior to the amendment effective from 1st April 2008, Article 7(3) did not include any limitation clause for applying domestic tax laws. It held that the amendment brought by the Protocol was not retrospective and thus, for the assessment years in question, the entire head office expenses should be allowed as per the DTAA without invoking Section 44C.

2. Calculation of Interest under Section 244A:
The assessee challenged the calculation of interest under Section 244A, arguing that the interest should be computed on the tax refund excluding interest already granted. The Tribunal agreed with the assessee, directing the AO to calculate the interest without reducing the interest component already granted from the refund due, following the precedent set in the assessee's own case for earlier years.

3. Tax Rate Applicability on Business Income:
The assessee contested the application of a 48% tax rate instead of 35%. The Tribunal referred to its earlier decisions and upheld the higher tax rate, dismissing the assessee's ground.

4. Taxation Basis for Interest on Securities:
The assessee argued that interest on securities should be taxed on a due basis rather than an accrued basis. The Tribunal, following its earlier decisions, ruled in favor of the assessee, allowing the interest to be taxed on a due basis.

5. Exemption under Section 10(15) for Gross Receipts vs. Net Income:
The Department's appeal contended that exemption under Section 10(15) should apply to net income rather than gross receipts. The Tribunal, following precedent, held that the exemption should be allowed on gross receipts, dismissing the Department's ground.

6. Treatment of Guarantee Commission:
The assessee deferred the recognition of guarantee commission over the period of the guarantee. The Tribunal upheld this method, citing the principle that income accrues over the period of the service provided, aligning with the Supreme Court's decision in Madras Industrial Investment Corporation and the Bombay High Court's decision in Taparia Tools Ltd.

7. Valuation of Investments and Treatment of Differences between Cost and Book Value:
The assessee corrected an earlier overvaluation of bonds, claiming the differential as a loss. The Tribunal upheld the assessee's claim, noting that the method of valuing investments at cost or market value, whichever is lower, was consistent and accepted by the Department in the past.

8. Allowability of Bad Debts without Setting Off Provisions for Bad Debts under Section 36(1)(viia):
The Tribunal ruled in favor of the assessee, allowing the deduction for bad debts without setting off the closing provision for bad debts, following the precedent set in the case of Oman International Bank.

Conclusion:
The Tribunal allowed the assessee's claims regarding the deduction of head office expenses, calculation of interest under Section 244A, taxation basis for interest on securities, and treatment of guarantee commission and valuation of investments. It dismissed the Department's appeals on the exemption under Section 10(15) and upheld the higher tax rate on business income. The assessee's cross objections were dismissed as infructuous following the decisions in the main appeals.