2019 (8) TMI 895 - HC - Income Tax

Rate of tax applicable to PE of foreign entity - rate @65% OR rate applicable to a domestic company - DTAA between India and Japan - HELD THAT - By virtue of Section 90(2), since there is a double taxation avoidance agreement between India and Japan, the provisions of the Act shall apply to a permanent establishment of a Japanese entity in India to the extent they are more beneficial to that assessee'. Also, in terms of the mandate of clause 24(2) of the agreement, the taxation on a permanent establishment - - in the other Contracting State shall not be less favourably levied - - than the taxation levied on enterprise carrying on the same activities. By virtue of Clause 24(2) of the said agreement and the statutory recognition thereof in Section 90(2), the permanent establishment of a Japanese entity in India could not have been charged tax at a rate higher than comparable Indian assessees carrying on the same activities. The stand taken in the Tribunal s order cannot be appreciated or accepted since a similar clause in the double taxation avoidance agreement between India and the Netherlands was interpreted by the Central Board for Direct Taxes and a circular issued thereupon. The Tribunal held, in the present case, that since there was no similar circular, the benefit as available to a permanent establishment of ABN Amro Bank in India could not be extended to this assessee. When there is no dispute that there is a double taxation avoidance agreement in place between India and the country of origin of the assessee in the present case and when such agreement contains a lucid clause as apparent from Article 24(2) thereof quoted above and when Section 90 recognises such an agreement and creates a special status for the relevant permanent establishments, there was no room for either the Commissioner to wait for any dictat from the high command of the CBDT or for the Tribunal to demonstrate similar servile conduct in not appropriately interpreting and giving effect to the clear words of the agreement between the two countries. Tribunal was incorrect in holding that the rate of tax applicable to the assessee was 65%. The Tribunal ought to have held that the rate applicable to the assessee was such rate as applicable to a domestic company carrying on similar activities. In the light of such answer, the two other questions need not be addressed since paragraph 8 of the order admitting the reference recognised that the answer to the first question would cover the entire matter.

Summary

Issues:
1. Applicability of tax rate to a permanent establishment of a foreign State under a double taxation avoidance agreement.
2. Allowability of deductions for expenses in computing profits attributable to the permanent establishment.
3. Interpretation of provisions related to expenses in the Income Tax Act for executive and general administrative nature expenditures.

Issue 1: Applicability of Tax Rate:
The case involved determining the tax rate applicable to a permanent establishment of a foreign State under a double taxation avoidance agreement. Section 90 of the Income Tax Act, 1961 deals with double taxation relief. The agreement between India and Japan, under Article 24(2), states that the taxation on a permanent establishment in one contracting State should not be less favorably levied than on enterprises carrying out similar activities in that State. This implies that the permanent establishment should be taxed at a rate not less favorable than entities conducting the same activities in the host country. Therefore, the permanent establishment of a Japanese entity in India could not be taxed at a rate higher than comparable Indian entities. The Tribunal erred in applying a 65% tax rate instead of the rate applicable to domestic companies carrying out similar activities.

Issue 2: Deductions for Expenses:
The Tribunal also had to decide on the allowability of deductions for expenses in computing profits attributable to the permanent establishment. The agreement between India and Japan, along with Section 90(2) of the Act, ensures that the Act's provisions apply to the permanent establishment to the extent they are more beneficial. The Tribunal's decision to disallow certain deductions for expenses based on the Income Tax Act provisions was not in line with the agreement's intent. The permanent establishment should be treated similarly to domestic companies in terms of deductions for expenses, as per the agreement's provisions.

Issue 3: Interpretation of Provisions for Expenses:
Furthermore, the case raised questions about the interpretation of Income Tax Act provisions related to expenses for executive and general administrative nature expenditures. The Tribunal's decision not to extend benefits similar to those granted to another entity under a different agreement was deemed incorrect. The Tribunal should have interpreted the agreement between India and the relevant country without waiting for additional directives. The clear language of the agreement and the Act's recognition of such agreements should guide the treatment of permanent establishments regarding expenses and taxation.

In conclusion, the High Court held that the Tribunal's decision to apply a 65% tax rate to the assessee was incorrect. The rate applicable should have been the same as that for domestic companies carrying out similar activities. The Tribunal's interpretation of the double taxation avoidance agreement and the Income Tax Act provisions regarding deductions and expenses was deemed flawed. The Court's decision clarified the application of tax rates and deductions for expenses to permanent establishments under double taxation avoidance agreements, emphasizing the need to adhere to the agreement's provisions without waiting for additional directives.