846/CBDT. - Income Tax - 846/CBDT

INSTRUCTION NO. 846/CBDT Dated : June 16, 1975 Section(s) Referred: 37 Statute: Income - Tax Act, 1961 1. In the computation of income of foreign concerns carrying on business in India through branches, expenditure incurred by the head-office on general administration and management (hereinafter referred to as head-office expense) allocable to the Indian branch is admissible as a deduction u/s 37 of the Income-tax Act, 1961. The Reserve Bank of India permits the remittance of such head-office expenses to the extent these have been allowed as a deduction in the relevant income-tax assessments of the foreign concerns. Thus, any excessive claim on account of such expenses not only results in loss of tax revenues but also constitutes a drain on our foreign exchange resources. 1.2 As the rates of tax in some of the foreign countries may be lower than those in India, there is a likelihood of such expenses applicable to the Indian branch being inflated so as to artificially reduce the income taxable in India. A few cases of this type which have come to the notice of the Board show that the scrutiny of the composition of such expenses done by the Income-tax Officers has been superficial and at times perfunctory. Gentificate, no enquiries are made at the time of assessment or a certificate from an auditor in the home country is accepted in support of the claim without making adequate scrutiny. Where disallowances are made in a few cases, they are not upheld in appeal because these disallowances are not well based. Similarly adequate attention is not paid at times to the selection of the appropriate method for the allocation of the head-office expenses to the Indian branch. The Board would, therefore, like to impress upon the Income-tax Officers the need for a proper and careful scrutiny of such claims made by foreign concerns. Some of the points which the Income-tax Officers should keep in mind in this regard are set out in the following paragraphs. 2. It should be clearly understood that the assessee in such cases is the foreign concern and not the Indian branch. The head office alongwith its branches constitute one single entity which cannot make a profit (or loss) out of itself. Hence, any payment made by the Indian branch to the head-office or any of its other officers by way of royalty in return for the use of patents, trade-marks or other rights, or by way of fees for services performed would not be admissible as a deduction in the computation of in come of the Indian branch. Only the actual expenses, if any, incurred by the head-office in procuring such technical know-how, or services, from third parties for supplying the same to the Indian branch may be allowed in the same way and to the same extent as if those expenses had been incurred by the Indian branch. Similarly, any interest paid by the branch to the head-office is not to be allowed as a deduction on the ground that a person cannot pay interest to himself but the cost (including interest paid), if any, to the head-office of obtaining the funds to be lent to the branch in India may be allowed in the same way and to the same extent as if that cost had been incurred by the Indian branch direct. 3. Closely linked with the question of head-office expenses is the question of "transfer pricing" of goods/services, if any, supplied by the head-office to the Indian branch (i.e., the price at which such goods/services are charged to the Indian branch). Such transfer prices comprise (i) direct costs, manufacturing/production costs (ii) indirect costs e.g., the cost of general administration and management; and (iii) profit mark-up. In transactions between a head-office and its branches there is obviously no question of including any element relating to profit mark-up. Where the transfer price includes an element of indirect costs, there will be no justification for a separate charge to the Indian branch on account of head-office expenses. It is, therefore, necessary to ensure before allowing any claim for head-office expenses that the debit to the branch accounts for the goods/services supplied by the head-office is restricted to the bare manufacturing/production, transport and allied costs incurred by the head-office. Breakdown details of the scrutinised for this purpose. It will also be relevant in this connection to compare the basis of billing such costs to the Indian branch as compared to the basis of billing such costs to the Indian branch as compared to the basis adopted for billing similar goods/services supplies to the other branches of the foreign concern. 4. The head-office expenses clamed as a deduction in such cases fall into three broad categories:- (i) Expenses incurred by the head-office which are directly identifiable with the activities of the Indian branch, e.g., travelling expenses of employees in the Indian branch going on official work to the head-office where such expenses are met by the head-office. (ii) Expenses incurred by the head-office not specifically for the Indian branch alone but conjointly for the Indian branch and some other foreign branches. (iii) Expenses incurred by the head-office which are not directly identifiable with any one or more branches, but which are incurred for the over-all management and administration of the head-office. Expenses falling in the first category will be deductible in full provided the usual conditions under the Income-tax Act are satisfied. In respect of the expenses falling in the second and third categories, only a suitable proportion of the otherwise admissible expenses will be allowable as a deduction in the computation of income taxable in India. 5. It is true that the verification of these expenses presents some difficulties in actual practice but this only underlines the importance of devoting adequate attention to this matter. There is no reason, however, why the claims should not be put to strict proof and the assessees asked to furnish all the necessary information. If any assessee does not produce the relevant information, the Income-tax Officer will be justified in drawing suitable adverse inferences. 6. Composition of Expenses. 6.1. First, it is necessary to examine the nature of the various items comprised in the head-office expenses to ascertain their admissibility under the provisions of the Income-tax Act. 1961. For this purpose, full details of the expenses should be obtained and items of expenditure not admissible under the provisions of the Income-tax law should be excluded. 6.2. Further, such part of the head-office expenses as can reasonably be held as not related to the activities of the Indian branch should also be excluded exclusively for the business carried on in the home country or in the countries where other branches are situated. 6.3. The nature of business/activities carried on or the sources of income in India should be compared with the nature of business/activities carried on or the source of income in the home country and in the other foreign branches. It may be that the business/activities on or the sources of income in the home to the business in the home country or in other foreign branches, or certain sources of income do not exist at all in India (e.g., where a foreign concern derives investment income from dividends or interest outside India whereas the activity in India is limited to carrying on business). In such cases, a suitable part of the overall expenses incurred by the head-office allocable to such additional business/activities/sources of income should be excluded from the total head-office expenses as not being relevant to the business/activities/sources of income of the Indian branch. The rationale is that the overheads must be pro-rated over all the gross income of the foreign concern. 7. Basis of opportionment. 7.1. After the composition of the head-office expenses has been scrutinised as above, the Income-tax Officer has to select a suitable basis of opportionment for determining the part thereof which is appropriately debatable as a charge against the profits of the Indian branch. Various criteria are possible for this purpose, e.g., gross income/receipts/turn-over/working capital/expenses/assets. 7.2. The criterion to be adopted in a particular case will depend upon the nature of the business/activities/sources of income in India. This should be done carefully after taking into account all the relevant facts and the Income-tax Officer should seek guidance from his Inspecting Asst. Commissioner in this behalf. However, once a particular criterion of apportionment is selected, it should be followed from year to year provided there is no change in the criterion adopted for apportionment is considered necessary owing to a change in the relevant factors or circumstances or because such a change is claimed by the assessee, the Income-tax Officer should seek guidance from the Inspecting Asst. Commissioner. Further, a uniform criterion should be adopted, as far as possible in cases having the same or similar mature of business/activities/sources of income in India. 7.3. Wide variations in the claims for head-office expenses in the cases of assessees in the same line of business have already come to notice and this aspect needs to be carefully looked into by the Inspecting Asst. Commissioners. 7.4. After the criterion has been selected, the amount actually admissible as a deduction from the profits of the Indian branch will be computed by applying the fraction constituted by the Indian figure of the selected criterion as the numerator and the corresponding global figure as the denominator, to the total admissible head-office expenses. Care should be taken to see that the numerator of the fraction is not artificially increased nor is the denominator reduced because otherwise it would result in inflating the amount allocable to the Indian branch. 8.1. In order to satisfy himself about the admissible composition of the head-office expenses and apportionment thereof to the Indian branch, the Income-tax Officer should ask the assessee concerned to, inter alia, (i) furnish copies of the global Profit and Loss Account and Balance-sheet, and (ii) indicate the basis of apportionment adopted in respect of the other branches in countries out-side India. 8.2. Further, the assessee may also be asked to explain as to how this matter has been dealt with for the purpose of the income-tax assessment in the home country. The quantum of income arising in a foreign country (such as India) is material in the assessment in the home country for the purpose of determining the income on which double taxation relief may be admissible in the home country or for determining the amount of foreign income which is not taxable in the home country if, under the law of that country, the income arising abroad is not subjected to tax. In all these cases, it will thus be relevant to find out (i) how the head-office expenses have been apportioned between the head-office and the various branches in the foreign countries, for the purpose of the income-tax assessment in the home country, and (ii) how the reimbursement of such expenses by the Indian branch has been accounted for in the books of the head-office. 8.3. The assessee may be requested to furnish relevant information on these points as also a copy each of the account of the branch in the books of the head-office and the account of the head-office in the books of the branch. If any variations are noticed in the claim made in India and the basis adopted in this behalf for the apportionment of head-office expenses to other branches or for the purpose of the assessment in the home country, or any discrepancy is noticed in the branch/head-office accounts, the matter may be examined further in depth. 9. The general administration and management expenses may be styled variously as home office expenses, area office expenses, regional office expenses or service charge, etc. Whatever the nomenclature, the approach to be adopted will be the same as indicated above as regards the admissible composition of the expenses as well as the basis of apportionment. 10. In some cases, the Profit Loss Account of the Indian branch may include some expenditure which is connected not merely with the Indian branch but the benefit of which goes also to the business carried on by the head-office or the other foreign branches. In such cases, it will be necessary to disallow that part of the expenditure which is attributable to the services rendered or benefits accruing to either the head-office or the other branches.. 11. Where the percentage of head-office expenses to (a) the expenditure incurred in India by the branch, or (b) the Indian profits, or (c) the Indian receipts, is unduly high, or where there are large variations in the amount of head-office expenses claimed from year to year, there will be all the more reason for greater care being exercised by the Income-tax Officers in the scrutiny of these claims. 12. The Board desire that the Income-tax Officers should seek the advice of their IACs in cases where the claim towards head-office expenses in any year exceeds Rs. 1 lakh. 13. Where it is desired to obtained some information or material (e.g., regarding activities of the foreign concern in India or the need for any supervisory role by the head-office in any particular case) from the Reserve Bank of India or Ministries/Departments of the Government of India, which could assist the Income-tax Officers in properly determining the amount of expenditure appropriately debitable to the India branch, such information, etc., it may be called for by the Income-tax Officers direct from the authorities concerned. It may be mentioned particularly in the case of foreign banks. However, should there be any difficulty or delay in obtaining the necessary information in any particular case from the R.B.I or any Ministry/Department of the Government of India, or where some significant information is required which can be obtained at higher levels, the matter may be referred to the Board. 14. A distinction has to be made in the case of head-office expenses paid by an Indian subsidiary to a foreign company. According to our law, a foreign parent and a domestic subsidiary are two distinct and separate legal entities. All their inter se transactions are subject to the test of arm's length standard. In view of this position, there is no justification for allowing head-office expenses in the case of an Indian subsidiary and as such the question of proportionate allocation of general and administrative expenses to the Indian subsidiary does not arise. Any expenditure incurred by a parent company towards supervision of its investments in a subsidiary is not admissible as a deduction in the computation of income of the subsidiary. 15. These instructions may kindly be brought to the notice of the Income-tax Officers in your Charge for careful compliance. The detailed scrutiny of head-office expenses may be taken up in pending assessments. If in scrutiny, it is found in any case that excessive claims have been made, suitable action in respect of the past assessments may also be taken after making such enquiries as may be necessary.