1. This is a departmental appeal. The issue raised by the department turns on the interpretation of a provision in the Agreement for Avoidance of Double Taxation between India and France ('the Agreement'). The assessee is a non-resident company incorporated in France. The company had entered into a contract with Bombay Municipal Corporation for execution and erection of water filtration plant at Bhandup. The accounting year followed in the company is the year ended 30-9-1977. For the assessment year 1978-79, the company claimed in their return a deduction of Rs. 43,695 by way of bead office expenditure. There is no dispute on this figure. The ITO felt that the provisions of Section 44C of the Income-tax Act, 1961 ('the Act') would be applicable. This provision allows deduction to be computed on three alternative basis. The statute provides for the amount to be deducted which is the least of the three alternatives. According to the ITO, one of the alternatives provided is to average out the expenditure in the prior years and allow an amount equal to it. Now, the assessment year 1978-79 is the first assessment for the assessee in India. Therefore, there was no expenditure under the head 'head office expenditure' for any of the prior assessment years. Therefore, nothing is allowable as per this alternative. In the result, he held that nothing is allowable at all under Section 44C.2. The Commissioner (Appeals) found that the provisions of the Agreement are applicable in computing the income of the assessee. As per the Agreement, the expenditure to be allowed as per commercial principles. He, therefore, held that the assessee is entitled to the claim made in the return. In the alternative, he held that one of the alternative computations under Section 44C would entitle the assessee to a deduction of Rs. 18,755. He held that in the alternative at least this amount is allowable.
3. Against this finding, the department has come on appeal. We have heard Shri Ruhela for the department and Shri Puri for the assessee, we are of the opinion that the finding of the Commissioner (Appeals) is to be upheld. There is no dispute that the assessee, being a company incorporated in France, is assessable on this income in France also.
There is also no dispute that since the work is done in India, a part of the income accrues in India and is assessable in India. So since the income accruing to the assessee-company comes for assessment in both the countries, we have to consider the provisions of the Agreement.
Now, Clause (1) of article III provides that the industrial or commercial profits of an enterprise of one of the Contracting States shall not be subjected to tax in the other Contracting State unless the enterprise has a permanent establishment situated in the other Contracting State. The proceedings have been taken on the footing that the assessee-company has a permanent establishment in India. Now, Clause (2) of Article III provides that where an enterprise of one of the Contracting States has a permanent establishment situated in the other Contracting State, there shall be attributed to such permanent establishment the industrial or commercial profits which it might be expected to derive in that other Contracting State, if it were an independent enterprise. Now, Clause (3) of Article III is crucial to the issue before us, This clause reads as follows : (3) In determining the industrial or commercial profits of a permanent establishment, there shall be allowed as deductions all expenses, wherever incurred, reasonably allocable to such permanent establishment, including executive and general administrative expenses so allocable.
As per the above clause, expenses incurred, whether in France or in India, which are reasonably allocable to the permanent establishment in India would be allowable. Since the proceedings are on the assumption that the assessee-company has a permanent establishment in India, then, as per this clause, the expenses incurred in head office, although incurred in France, would be allowable if they are reasonably allocable. Now, there is no dispute that the expenditure claimed by the assessee is reasonable and allocable in determining the Indian income.
Now, it will be clear that but for the provisions of Section 44C, the assessee would be entitled to what has been claimed by them.
4. The ITO has assumed that the provisions of Section 44C override the provisions of the articles in the Agreement. This assumption is contrary to a circular issued by the CBDT, i.e., Circular No. 333 [F.No. 506/42/81-FTD], dated 2-4-1982 9 Taxman 264 (Sec. IV).
Paragraphs 2 and 3 of the circular read as follows : 2. The correct legal position is that where a specific provision is made in the double taxation avoidance agreement, that provision will prevail over the general provisions contained in the Income-tax Act.
In fact the double taxation avoidance agreements which have been entered into by the Central Government under Section 90 of the Income-tax Act, also provide that the laws in force in either country will continue to govern the assessment and taxation of income in the respective country except where provisions to the contrary have been made in the agreement.
3. Thus, where a double taxation avoidance agreement provides for a particular mode of computation of income, the same should be followed, irrespective of the provisions in the Income-tax Act.
Where there is no specific provision in the agreement, it is the basic law, i.e., the Income-tax Act, that will govern the taxation of income.
Now, it will be seen from the above that the ITO have been directed to compute the income according to the Agreement unless the Agreement clearly provides otherwise. The provisions of the Agreement will override the provisions of the Act.
5. That being the position, we have to see whether any contrary provision is found in the Agreement. On going through the Agreement, we do find contrary provision. Clause (3) of article III clearly provides that whatever is reasonably allocable out of the expenditure incurred in both the countries, should be allocated and allowed as a deduction, We consider this as a very specific provision in computing the income of a non-resident having activities in India and France. Therefore, the provisions of Section 44C will not be applicable. The Commissioner (Appeals) is justified in his findings.
6. In view of our finding, we think it unnecessary to go into the issue whether any of the three alternatives of computation of the amount deductible under Section 44C has to be considered. In our opinion, that exercise would be completely academic.