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TMI Blog2012 (10) TMI 134X X X X Extracts X X X X X X X X Extracts X X X X ..... orm 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. ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ing Officer made disallowance for Rs. 42,500. The learned CIT(A) upheld the disallowance. The assessee is aggrieved against the sustenance of this disallowance. 4.2 We have heard the rival submissions and perused the relevant material on record. There is no dispute about the fact that the assessee is a banking company incorporated in Mauritius. The fact that the assessee is entitled to the benefit of Double Taxation Avoidance Agreement between India and Mauritius (hereinafter called "the DTA"), is not in dispute. The authorities below have made and sustained the said disallowance by testing the facts of the case on the touchstone of prescription of section 43B and also the provisions of Article 7 of the DTA. 4.3 The claim of the Revenue is that the provisions of section 43B should be applied for the purpose of confirming disallowance amounting to Rs. 42,500. Any amount of bonus debited to the Profit and loss account which is not paid on or before the due date of filing of the return, is not deductible as per the provisions of section 43B. There is no quarrel on the fact that the assessee failed to pay the aforesaid amount on or before the due date of filing the return of income ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... aim of the assessee as per the DTA and thereafter rejected it as having been not maintainable. 4.6 Article 7 of the DTA provides for the computation of 'Business Profits'. It provides that the profits of an enterprise of a Contracting State shall be taxable only in that State unless the enterprise carries on business in the other Contracting State through a permanent establishment situated therein. If the enterprise carries on business as aforesaid, the profits of the enterprise may be taxed in the other State but only so much of them as are attributable to that permanent establishment. The assessee is admittedly having an Indian branch, which constitutes its permanent establishment as per Article5 of the DTA. As the issue rotates around the computation of business profits, let us have a look at the relevant paras of Article 7 of the DTA, as under : - Article 7 BUSINESS PROFITS "1. The profits of an enterprise of a Contracting State shall be taxable only in that State unless the enterprise carries on business in the other Contracting State through a permanent establishment situated therein. If the enterprise carries on business as aforesaid, the profits of the enterpris ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ose of the business of the permanent establishment including executive and general administrative expenses which are incurred in the State in which the permanent establishment is situated or elsewhere. The crux of para 3 of Article 7 of the DTA is that for the purposes of determining the profits of the permanent establishment in India, all the expenses incurred for the purpose of business of the permanent establishment are to be allowed as deduction. In other words, the deductibility of all the expenses for the purpose of computing the 'business profits' of the permanent establishment, has been sanctioned by para 3 of Article 7. 4.8 It was contended by the ld. AR that since there is no reference to any disallowance as per section 43B in para 3 of Article 7 of the DTA, there can be no question of making any disallowance by considering section 43B. On the other hand, the ld. DR argued that the application of section 43B is implicit in para 3 of Article 7 directly and also by virtue of the provisions of Article 3(2) and Article 23(1) of the DTA. 4.9 From para 3 of Article 7 as extracted above, it is apparent that the business profits imbibe the question of grant of deduction of al ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e extent as provided in such provision. 4.12 This position can be viewed from the stand point of section 44C of the Act. This section puts a ceiling on deduction of head office expenditure, as defined in clause (iv) of Explanation, in the case of non-residents. If any expenditure in the nature of "head office expenditure" is incurred and suppose there is a provision in the treaty that the deductibility of expenses as per Article 7(3) is subject to 'the restrictive clause' of the taxation laws of the concerned State, then such limit as provided u/s 44C to restrict the deduction to 5% of the adjusted total income, shall be presumed as bodily incorporated in the treaty also. In such a case, it will be understood as if section 44C is inbuilt in the treaty also for the purposes of limiting the deductibility of head office expenditure. 4.13 It is manifest that difference between the full or partial deductibility of any expenditure is due to the absence or presence of the restrictive clause in the treaty. But for such restrictive clause, any expenditure incurred by the assessee for the purposes of the business of the permanent establishment becomes deductible in full as per the first ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... therwise incurring of such expenditure and the consequent allowability of deduction is not in dispute. As we are dealing with the Indo-Mauritius DTA, which does not expressly contain any restrictive clause in this regard, contrary to the presence of such clause in certain Conventions including Indo-US DTAA, it becomes perceptible that ex facie restrictive provisions of the Act including section 43B cannot be read into Article 7. 4.15 Now we will espouse the contention of the learned DR that the presence of section 43B of the Act should be inferred by virtue of the Article 3(2) and Article 23(1) of the DTA. It is observed that Article 3 is a definition Article which incorporates definitions of various terms used in the DTA. Para 1 of Article 3 deals with certain specific terms which have been expressly defined for the purpose of DTA. Para 2 of Article 3 provides that: "In the application of the provisions of this Convention by the Contracting State, any term not defined therein shall, unless the context otherwise requires, have the meaning which it has under the laws in force of that Contracting State relating to the areas which are the subject of this Convention". A cursory l ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... h stipulation. The word "except" is the dividing point between the main provision and the qualification part. The portion starting thereafter enumerates the qualification, which is : 'where provisions to the contrary are made in this Convention.' When we read full text of para 1 of Article 23, it is amply borne out that if there is some provision in the DTA contrary to the domestic law, then it is the provision of the DTA which shall prevail. Thus the general rule contained in the first part of para 1 of Article 23, being the applicability of the domestic law, has been eclipsed by any provision to the contrary in the DTA. In case there is no contrary provision in the treaty, then it is the domestic law which shall apply. If however, there is some provision in the DTA contrary to the domestic law then it is such contrary provision of the DTA which shall override the provision in the domestic law in the computation of income as per the DTA. 4.17 With this understanding we will proceed to vet the contention raised by the learned Departmental Representative that since there is a precise provision of section 43B under the Act, which limits the deductibility of the specified expenses ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... siness. Section 43B(d) provides a restriction on the otherwise deductibility of interest u/s 36(1)(iii), if such interest is on any loan or borrowing made from the public financial institutions etc. and such interest is not paid before the due date applicable for filing the return of income u/s 139(1). When we read both these provisions in unison what follows is that it is the question of allowing deduction for interest on borrowings but to the extent it is paid before the due date of filing the return of income. Reverting to our issue, it is found that the deductions of expenses are to be regulated as per the restrictions contained in relevant sections. Thus, if one has to view these sections on a wholesome basis at macro level, what emerges is that these are meant for granting deduction for expenses to the permissible extent. 4.20 The natural corollary which follows from the above discussion is that the Act envisages deductions for expenses with some restrictions. On the other hand, para 3 of Article 7 the DTA is a specific provision governing the deductibility of expenses without any restriction. In both the cases, that is, under the Act as well as the DTA, the subject matter ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... have desisted from dealing with such contradictory orders but decided the extant issue on what we perceive as the simple and plain interpretation of the relevant Articles. 4.22 In view of the foregoing discussion, we hold that no 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. Ex consequenti, the ground raised by the assessee in this regard is allowed. 5.1 The only ground in the Revenue's appeal is against the deletion of disallowance u/s 14A. Factual matrix of this ground is that the assessee invested Rs. 10 crore in tax free bonds and claimed exemption in respect of interest from the same. From the copy of bank account with the Reserve Bank of India, it was observed by the AO that the assessee borrowed funds to the tune of Rs. 15 crore on 12.11.1998 and made investment in tax free bonds from such borrowed amount. As the assessee had not offered any d ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ation to income which does not form part of the total income under the Act. Obviously, if investment is made in tax free securities, interest thereon will be exempt from tax. The provisions of section 14A will squarely apply to make disallowance in respect of expenses incurred in relation to such exempt income as has been held by the Hon'ble jurisdictional High Court in the case of Godrej Boyce Mfg. Co. Ltd. v. DCIT [2010] 328 ITR 81 (Bom)]. This is the position under the Act. 5.5 The learned AR has made out a case for no disallowance u/s 14A in the light of the Aricle 7(3) of the DTA. We have noticed above that section 90(2) of the Act provides that where a DTA has been signed for granting relief of tax then "in relation to the assessee to whom such agreement applies, the provisions of this Act shall apply to the extent they are more beneficial to that assessee". In other words, if the Act charges a particular item of income to tax and the DTAA provides exemption to such item of income, it is the DTAA which shall prevail. To put it in simple words, the DTAA can provide relief only if the Act favours taxability of an item of income or disfavours the deductibility of any expendi ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 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. To put it in simple words, when the exempt income does not enter into the process of determination of 'business profits' of the permanent establishment, the expenses incurred for earning such income also do not equally qualify for deduction. If such expenses have been included in the total business expenses claimed as deduction under Article 7(3), then these are required to be reduced accordingly, as incurred in relation to the income which does not form part of the 'business profits'. 5.8 The ld. AR projected his stand point by contending that it is because of the language of Article 7(3) of the DTA not containing any restrictive clause, that no disallowance can be made u/s 14A as is the case in respect of disallowances under sections 43B and 44C of the Act. In a way, ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ing for disallowance. Further, it is relevant to note the place of residence of section 14A. Unlike the sections providing for disallowances as discussed above falling in Chapter IV-D dealing with the income from business or profession, section 14A has been placed in Chapter IV itself, next to section 14, which classifies income under different heads of income. Because of this basic principle of not allowing deduction of any expense incurred in relation to an exempt income enshrined in section 14A, the distinction between disallowance under this section and other specific sections as discussed above, assumes significance. It is thus patent that the set of specific sections of disallowances stand on a different pedestal from section 14A. 5.10 At this stage, it may be relevant to note para 4 of Article 7 as per which : 'No profits shall be attributed to a permanent establishment by reason of the mere purchase by that permanent establishment of goods or merchandise for the enterprise.' As per this para, no profits can be attributed to a PE in respect of purchase of goods for the general enterprise. The pertinent question which arises is that when no profits can be attributed to th ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ce u/s 14A is warranted as the operation of section 14A does not ceases where the dividend income is only incidental to the shares held as stock in trade. Respectfully following the ratio decidendi of this precedent de hors specific reference to section 14A, we hold that the expenses incurred in relation to the income which does not form part of 'business profits' cannot be allowed as deduction. This contention of the learned AR is also rejected. 5.13 It is worthwhile to note that the AO made a reference to section 14A for the purposes of making disallowance of interest in relation to the exempt interest income from tax free securities. Reference to such section, while considering the disallowance under the Act is fine, but in considering the computation of income under the DTA, the epitome of such reference is to be considered in the light of discussion made in preceding paras, as not allowing any deduction for expenses in relation to exempt income. Similar was the contention of the ld. DR in support to the ground challenging the deletion of disallowance of expenses in relation to exempt income albeit it has been symbolically narrated with reference to the same provision. Be tha ..... X X X X Extracts X X X X X X X X Extracts X X X X
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