2006 (10) TMI 175 - AT - Income Tax

Accrual Of Income - non-resident enterprise or its branches outside India - banking company incorporated in Germany - taxation of profits earned by the branch offices of non-resident companies - profit attributable to the PE - Interest receivable from Head Office/Overseas Branches of the bank - DTAA between India and Germany - CIT(A) held that the interest receivable by the Indian branch of your appellant from its head office/overseas branches is 'income' of your appellant taxable as such - HELD THAT - The very concept of computation of PE profits is created as a fiction of tax law in order to demarcate tax jurisdiction over the operations of a company in a country of which it is not a tax resident. Unless the PE is treated as a separate profit centre, it is not possible to ascertain the profits of the permanent establishment which, in turn, constitute profits accruing or arising to the foreign GE in India. On a conceptual note, it is also important to bear in mind that based on a substance-over-form approach, the tax treatment applicable to these fictitious entities, such as a PE, should be the same as in the cases where non-residents establish separate legal entities in the form of subsidiaries. If both entitles carry out similar economic activities, the choice of legal form should not lead to different tax results. The income of subsidiaries is determined separately based on the subsidiary's revenues and deductible costs and expenses taking into account all incurred items the taxation of PEs should be designed along the same lines. Therefore, while incomes of the PE should include all revenues, including revenues earned from other intra organization entities outside the respective tax jurisdiction, the expenses allowed as deductions from the profits of a PE should also be those that are actually borne by such a PE (i.e., that are incurred in the interest of the PE and not of another part/parts of the company) irrespective of whether or not the deductible amount should actually be reimbursed by the PE. As rightly observed by the co-ordinate Bench of this Tribunal, in the case of Banque Indosuez, dealing with materially identical remarks made by the Hon'ble Calcutta High Court in the case of Betts Hartley Huett Co. Ltd., 1978 (4) TMI 58 - CALCUTTA HIGH COURT remarks are in a different context, that is an assessee whose operations comprehend both - a head office and a branch, and so, to our mind, are not applicable to the case like that of the present assessee in respect of whom the income of the permanent establishment, as a separate unit, has to be determined . We are in most respectful agreement with the views so expressed by the co-ordinate Bench. Although these observations were in the context of determination of profits of the PE in accordance with the provisions of the applicable tax treaty, we are of the considered view that these observations are applicable with equal force on the question of determination 'accrued or arisen in India' u/s 5(2)(b) of the Act, which is nothing but the profits of the Indian PE as an independent unit. Learned representatives have also agreed that it is an acceptable method to determine the profits accruing or arising in India, to the foreign bank, that the Indian PE is taken a profit centre. As a matter of fact, as we have discussed earlier in this order, there is no other way in accountancy or, for that purpose, even in commercial practices or in law in which the profits accruing or arising in India, in the hands of a tax entity not domiciled in India, can be determined. We have no treat the branches as hypothetically independent, and that is the underlying presumption in branch accounting methods in accountancy as well. The assessee has admittedly lent monies to the head office, in consideration of which interest credits are received. These funds are acquired by the assessee by incurring certain costs, such as interest paid to the depositors as also establishment costs. The use of these funds, however, is outside Indian tax jurisdiction and the income earned from these funds, therefore, is exigible to tax outside Indian tax jurisdiction. When the revenues generated are not taxable in India, the expenditure incurred for earning these revenues also cannot be allowed as deduction of income exigible to tax in India. The entire costs of acquiring these funds should then cease to be deductible as an expense for the purposes of business in India. In our considered opinion, expenditure can be allowed as deduction only in the tax jurisdiction in which the corresponding income is taxed, or, by the same logic, income is to be taxed in the same tax jurisdiction in which corresponding deduction is to be allowed. Where economic activities to earn an income are spread over two tax jurisdictions, the income can be suitably appropriated in those two jurisdictions, and the provision for intra organization interest charge does precisely that. If, however, we are to uphold the contention of the assessee, it will result in manifest absurdity. The taxability of income will be in the GE country, i.e., Germany, while allowability of expense will be in PE country, i.e., India. That is clearly an unintended absurdity, and an interpretation which leads to such incongruous results cannot meet any judicial approval. It is not the assessee's case that the interest income from the head office is without any consideration or without sufficient consideration. In other words, fact of or correctness of interest earnings from head office are not in dispute. Therefore, in our considered view, the interest earnings from the head office are to be taken into account for the purposes of computing profits arising in or accruing in India. We, therefore, reject the contentions of the assessee. Since the case of the assessee fails on the scope of the main chargeability section of income 'accruing or arising in India' u/s 5(2)(b) of the Act, there is no need to deal with the scope of the deeming fiction of income deemed to accrue or arise in India under section 9 of the Act. We have held the income to be 'accruing or arising in India' and therefore, it is not really relevant whether the income can be treated as 'deemed to accrue or arise in India'. While we, therefore, approve the conclusions arrived at by the CIT(A), we do not even see the need to deal with the reasoning adopted by the CIT(A). Our reasoning may be different, but conclusion is the same as arrived at by the CIT(A). We approve the conclusion arrived at by the CIT(A), so far as this grievance of the assessee is concerned, and decline to interfere in the matter. Ground No.2 is, accordingly, dismissed.

Summary

Issues Involved:
1. Interest on foreign currency deposits.
2. Interest receivable from Head Office/Overseas Branches.
3. Applicability of Minimum Alternate Tax (MAT) under Section 115JA.
4. Treatment of provision for bad debts while computing book profit under Section 115JA.

Issue-wise Detailed Analysis:

1. Interest on Foreign Currency Deposits:
The primary grievance was whether the exemption under Section 10(15)(iv)(fa) of the IT Act should be on the gross or net interest. The AO contended that only net interest should be exempt, citing the need to avoid double deductions. The CIT(A) upheld this view, invoking Section 14A, which disallows expenses related to exempt income. The Tribunal, however, disagreed, stating that the language of Section 10(15)(iv)(fa) explicitly exempts gross interest. It remitted the matter back to the AO to identify any specific expenses incurred to earn the exempt income, emphasizing that a clear identification of such expenses is necessary for disallowance under Section 14A.

2. Interest Receivable from Head Office/Overseas Branches:
The issue was whether the interest received by the Indian branch from its head office/overseas branches is taxable in India. The AO and CIT(A) held it taxable, arguing that intra-organization transactions should be treated as independent for tax purposes. The Tribunal supported this view, stating that for computing profits of a PE (Permanent Establishment), intra-organization transactions must be considered at arm's length prices. It rejected the argument that such transactions are profit-neutral, emphasizing the need to treat the Indian branch as a separate profit center. The Tribunal also noted that ignoring such transactions would lead to absurd results, such as shifting taxability of income and allowability of expenses between jurisdictions.

3. Applicability of Minimum Alternate Tax (MAT) under Section 115JA:
The question was whether MAT provisions apply to foreign companies. The CIT(A) affirmed its applicability, and the Tribunal upheld this, agreeing with the AAR's ruling that Section 115JA applies to foreign companies. The Tribunal dismissed the argument that the legislature did not intend to include foreign companies, stating that it is not the role of the judiciary to supply omissions in the statute. The Tribunal also rejected the selective application of treaty provisions, asserting that once an assessee opts to be assessed under the IT Act, they cannot seek treaty protection for specific aspects like MAT applicability.

4. Treatment of Provision for Bad Debts while Computing Book Profit under Section 115JA:
The AO added back the provision for bad debts to the book profit, treating it as a provision for unascertained liabilities. The CIT(A) upheld this, but the Tribunal reversed it, following precedents that classify such provisions as diminution in asset value rather than liabilities. The Tribunal directed the AO to exclude the provision for bad debts from the book profit computation under Section 115JA, granting relief to the assessee.

Conclusion:
The appeal was partly allowed. The Tribunal provided relief on the issue of provision for bad debts and remitted the matter regarding interest on foreign currency deposits back to the AO for further examination. It upheld the taxability of interest from head office/overseas branches and the applicability of MAT under Section 115JA to foreign companies.