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Abn Amro Bank Nv Vs. Assistant Director of Income-tax - Court Judgment

LegalCrystal Citation
CourtIncome Tax Appellate Tribunal ITAT Kolkata
Decided On
Judge
Reported in(2006)280ITR117(Kol.)
AppellantAbn Amro Bank Nv
RespondentAssistant Director of Income-tax
Excerpt:
1. the president, tribunal, has constituted this special bench to decide the following question (in the cases of abn amro bank nv) : "whether the provision of interest by a permanent establishment of a foreign enterprise payable to head office and/or other branches outside india is allowable deduction and if so, whether the provision of section 40(a)(i) is attracted in respect of such payment/provision ?" 2. the question in the case of bank of tokyo is whether assessee has committed any default in not deducting tax from the payment of interest to its head office or other branches under section 195 and thereby made itself liable for payment under section 201 of the act.3. we shall first take the case of abn amro bank. the assessee-bank in this case is incorporated in netherlands with a.....
Judgment:
1. The President, Tribunal, has constituted this Special Bench to decide the following question (in the cases of ABN Amro Bank NV) : "Whether the provision of interest by a permanent establishment of a foreign enterprise payable to head office and/or other branches outside India is allowable deduction and if so, whether the provision of Section 40(a)(i) is attracted in respect of such payment/provision ?" 2. The question in the case of Bank of Tokyo is whether assessee has committed any default in not deducting tax from the payment of interest to its head office or other branches under Section 195 and thereby made itself liable for payment under Section 201 of the Act.

3. We shall first take the case of ABN Amro Bank. The assessee-bank in this case is incorporated in Netherlands with a limited liability having its original office at Singapore. It had a branch in India registered in terms of Schedule II of the Reserve Bank of India (RBI) Act, 1934. It carries on banking business in India comprising of accepting deposits, giving loans, discounting/collection of bills, issue of letter of credit/guarantees, executing forward transactions in foreign currencies for importers and exporters, money market lending/borrowings, etc. in terms of the existing rules and regulations governing such transactions. As per the Double Taxation Avoidance Agreement between India and Netherlands (DTAA in short), the assessee-company is having a permanent establishment (PE for short) in India and consequently, it is liable to tax in respect of its income attributable to such PE. It had been paying interest to the head office and/or other branches from year to year and in the two years under consideration, it paid a sum of Rs. 55,03,000 (in asst. yr. 1997-98) and Rs. 62,73,106 (in asst, yr. 1998-99). The payment of interest to head office was claimed as a deduction. The assessee has also been receiving interest from head office and other branches located outside India and that was credited to P&L a/c and was offered to tax.

4. In the assessment proceedings, the AO formed an opinion that the assessee has not made any tax deducted at source as per provisions of Section 40(a)(i) on such payment of interest, it is not allowable. The assessee claimed to be under the impression that it being the same person, was not required to deduct any tax on the payment of interest to head office and offshore branches. According to AO, however, the branch of the bank in India constitutes a separate taxable entity different from head office and other branches located abroad as far as taxation is concerned and, therefore, any payment of interest to head office and other branches located abroad, the tax was deductible and having failed to do so deduction of interest is not allowable. He, therefore, disallowed such interest payment and added the same to the income of the assessee for the two years under consideration.

5. Before the CIT(A), the assessee submitted that the payment of interest having been made to self could not constitute income subject to deduction at source, that the assessee has a running account with head office and other branches outside India which debit the assessee's account in their books for interest due on overdraft balances and the assessee accordingly credits the account of the head office and other branches in its own books as a mode of payment of such accounts; that Section 195 of the Act requiring tax to be deducted at source on payment made to non-resident is applicable only in respect of those sums as were chargeable to tax under the provisions of the Act; that in view of the decision of Calcutta High Court in the case of Betts Hartley Huett & Co. Ltd. v. CIT one cannot earn income from one's own self and that interest charged made by head office/other branches outside India to the assessee does not result in any income chargeable to tax under the Act in the head office or the branches; Section 195 does not apply and consequently, the question of disallowance of interest debited by the assessee to its P&L a/c does not arise.

6. The CIT(A) did not accept the contention of the assessee. He observed that admittedly the branches of the bank in India constitute a separate taxable entity and head office and other branches located abroad are different entities as far as taxation is concerned. As such, according to him, payment of interest by the bank's branches in India to its head office and other branches located outside India cannot be treated as payment to self. According to him, interest paid to the head office, etc. constitutes income chargeable to tax under Section 9 of the Act and since no deduction of tax at source on the interest so paid as required under Section 195 has been made, no deduction can be allowed in respect of such interest payment in computing the total income of the assessee in view of the express provisions of Section 40(a)(i) of the Act. The assessee is in appeal.

7. The matter came up for hearing before the Division Bench wherein an order of the Tribunal in the case of Bank of Tokyo Mitsubishi Ltd. in ITA No. 899/Kol/2002 was relied upon wherein it was held that interest debited to Indian PE of a foreign bank by way of corresponding credit of their head office account was not an allowable deduction unless tax is deducted at source from the same. There was also a difference of opinion between the two members who heard the impugned appeals and, therefore, the matter was referred to the Special Bench to resolve the controversy.

8. The contention of the learned Counsel of the assessee Sh. F.V. Irani is that the question referred to has two limbs, namely, (i) interest paid by the branch in India is an allowable deduction, and (ii) whether it is not to (be) allowed because no tax has been deducted in respect of this payment. By virtue of deeming fiction provided by Article 7.3(b) of DTAA, the interest paid by the PE to the head office in case of a banking enterprise, he submitted, is an allowable deduction and interest received by the PE from head office is included in the income of the PE. Therefore, the first part of the question as to whether the interest payment is allowable deduction or not is to be held in favour of the assessee. As regards the second part, the contention of the assessee is that the provisions of Section 40(a)(i) of the IT Act, 1961, are not attracted as by virtue of Article 7 such interest paid by the PE to head office would have to be allowed as a deduction without any restriction or condition. The words "in accordance with the provisions of the IT Act and subject to the limitation of the taxation laws of that State" in Article 7.3(a) cannot be invoked for disallowing the interest payment because these words qualify only "the executive and general administrative expenses so incurred" and not to other expenses. In any case, it is submitted that taxation laws in India nowhere envisage a deduction of tax at source from payments made by a branch to a head office because such payments under the domestic law are regarded as payment to self and domestic law does not treat the payments made by a branch to head office as payment between two independent parties. The deeming fiction of DTAA cannot be extended to the local laws. Without prejudice to above, it is submitted that a non-resident cannot be made worse off than a resident by making applicable to him the disallowing provisions of domestic law which would never have been attracted to a similarly situated resident. It is further submitted that Article 7.3(b) is a proviso and exception carved out of Article 7.3(a) specifically providing for a deduction of interest paid by a PE to head office without imposing any condition or restriction thereon. According to him, the words, "in accordance with the provisions of and subject to the limitations of the taxation laws of that State" as appearing in Article 7.3(a) are absent in Article 7.3(b) and, therefore, the interest is allowable without any restriction provided under Article 7.3(a) of the DTAA. It is further submitted that Section 195 has no application to interest paid by PE t6 head office because such interest is not "chargeable under the provisions of this Act" which is a condition precedent for invoking the provisions of Section 195. This is because there is no provision in the Act providing for taxation of interest received by the head office of a bank from its branches, in the hands of the head office. It is further submitted that there is also no provision in the DTAA providing for taxation of interest received by head office of a bank from its branches in the hands of the head office. The provisions dealing with deduction of tax at source, it is submitted, presupposes the existence of two distinct and separate entities which is absent in the present case and that is also the requirement of Section 40(a)(i) of the Act.

Reliance is placed on the decision of Bombay High Court in the case of CIT v. Premier Tyres Ltd. and of Calcutta High Court in the case of Bunge & Co. Ltd. v. ITO and Ors.

wherein it is held that if the assessee is agent of the non-resident, provisions of Section 195 are not applicable. It is also submitted that wherever the legislature wanted to deem the branch as a separate entity, it has provided so specifically as in Section 92A, 92B, 92F, etc. and having not made any specific provision in Section 40(a)(i), the branch of the assessee cannot be treated as a separate identity for the purpose of deduction of tax at source. It is further submitted that the fiction created under Article 7 of the DTAA is for a specific purpose and cannot be extended beyond the fixed area and in this connection, reliance is placed on the decision of CIT v. Ajax Products Ltd. , CIT v. Mother India Refrigeration Industries (P) Ltd. Reference is also made to the decision of Bombay High Court in the case of CIT v. Hindustan Petroleum Corporation Ltd. (1991) 187 ITR 1 (Bom) and of Allahabad High Court in the case of CIT v. Nathimal Gaya Lal (FB). Reference is also invited to the Tribunal decision in the case of Citi Bank in ITA No. 1487/Bom/1981 for asst.

yr. 1976-77 and others dt. 28th Aug., 1982, and in the case of British Bank of Middle East in ITA No. 4514/Bom/1985, dt. 21st July, 1989, and a reference thereagainst was rejected vide order in RA No.2057/Bom/1989, dt. 7th Aug., 1990. The decisions in the case of British Bank of Middle East in ITA No. 8031/Bom/1992, dt. 28th July, 2003. in the case of Societe Generale in ITA No. 4099/M/2000, dt. 24th May, 2004. and in the case of Bank of Nova Scotia in ITA No. 298/Bom/1995 for asst. yr. 1991-92, dt. 28th Jan., 2004, were relied on.

9. The learned Departmental Representative, on the other hand, submitted that in accordance with the provisions of DTAA, the assessee is subject to tax in India on the profits and other income attributable to such PE in India. The branches of the assessee in India constitute a separate taxable entity and head office and other branches located abroad are different entities as far as taxation is concerned.

Therefore, payment of interest by the bank's branches in India to its head office and other branches located outside India cannot be considered as payment to self. The interest paid to the head office, etc. constitute income chargeable to tax under Section 9 of the IT Act, 1961, and that since deduction of tax at source on the interest so paid as required under Section 195 has not been made, hence in view of the express provisions of Section 40(a)(i) of IT Act, no deduction can be allowed in respect of such interest of Rs. 55,03,300 in asst. yr.

1997-98 and of Rs. 62,73,106 in asst. yr. 1998-99 in computing the total income. In the instant case, assessee has claimed payment of interest to non-resident ABN Amro Bank NV situated in Netherlands and being a company incorporated in Netherlands, is a resident of Netherlands for the purpose of income-tax and, therefore, comes under the category of non-resident for the purpose of assessee which is its PE carrying on banking business in India. Therefore, the payee in this case is a nonresident and the amounts remitted are subject to income-tax in its hands in India. It is further submitted that the Central Board of Direct Taxes vide its Circular No. 740 (F. No.500/99/94-FTD), dt. 17th Aug., 1996 has also clarified the position in this regard. The said circular reads as under : "Subject: Taxability of interest remitted by branches of banks to the head office abroad, under the Foreign Currency Packing Credit Scheme of Reserve Bank of India.

The Reserve Bank of India has introduced a Foreign Currency Packing Credit Scheme (FCPCS) for Indian exporters. Under this scheme, the authorised dealers in India can arrange for lines of credit from abroad for providing pre-shipment credit to Indian exporters at internationally competitive rates of interest. Such credit can also be arranged by Indian branches of foreign banks from their head offices or any other branch abroad.

2. References have been received seeking clarification as to whether interest remitted by a branch in India to its head office or a branch abroad on the lines of credit arranged under this scheme would be chargeable to tax in India and whether tax would have to be deducted at source in terms of Section 195 of the IT Act, 1961.

3. It is clarified that the branch of a foreign company/concern in India is a separate entity for the purposes of taxation. Interest paid/payable by such branch to its head office or any branch located abroad would be liable to tax in India and would be governed by the provisions of Section 115A of the Act. If the Double Taxation Avoidance Agreement with the country where the parent company is assessed to tax provides for a lower rate of taxation, the same would be applicable. Consequently, tax would have to be deducted accordingly on the interest remitted as per the provisions of Section 195 of the IT Act, 1961." 10. Reliance was placed on the decision of Tribunal, Kolkata, dt. 13th Jan., 2003 in MA No. 218/Kol/2002 in the case of Bank of Tokyo Mitsubishi wherein the same view is taken. It is further submitted that as regards the assessee's claim that it is a payment to self, the same also does not hold true because--(a) The assessee is receiving interest from its head office and other branches outside India which the assessee has credited to its P&L a/c and offered for taxation. The assessee also makes payment of interest to its head office and other branches located outside India and claims such payment of interest as allowable deduction as such interest has been charged to its P&L a/c.

Therefore, payment of interest to head office, etc. is not merely a transfer entry because in addition to transfer of income, the assessee has also claimed it as its business expenditure which is not merely a transfer entry; (b) Admittedly, the branches of the assessee in India constitute a separate taxable entity and head office and other branches located abroad are different entities as far as taxation is concerned.

Therefore, the payee in this case is a non-resident and thus the amounts remitted are subject to income-tax in its hands in India; (c) it is also well settled law that in the absence of any express provisions in the Treaty, contrary to the general provisions of the Act, the general provisions of the Act will prevail; (d) Moreover, the assessee by its own conduct has established that payment was not to self. By claiming the deduction in respect of interest paid to head office, etc. situated abroad, the assessee has established that it was not simply payment to self i.e., transfer of funds from branch, i.e., assessee to head office, etc. but was a business expenditure of assessee PE which was necessarily incurred for earning income. The payment of interest by assessee will certainly form part of income in the hands of ABN Amro Bank NV and not merely receipt of payment on capital account; and (e) Since all the conditions of Section 40(a)(i) being met, the assessee having not deducted tax at source under Section 195, under Chapter XVII-B on payments of interest to non-resident, the assessee's claim for deduction of said payment of interest as business expenditure while computing its income chargeable to tax under the head "Income from business and profession" is not at all justified. It is further submitted that even if the payment of interest by PE is to self and it is not an independent or separate entity as claimed by the assessee, in that case also it would be not an allowable deduction in absence of any express provision in the DTAA for allowance thereof, as the payment to self is not an allowable deduction even as per decisions relied upon by the assessee itself.

11. We have heard the parties and considered their rival submissions.

Sec. 4 of the IT Act provides for the charge of income-tax in respect of total income of the previous year of every person. Section 5 defines the scope of total income. Sub-section (2) of Section 5 provides that the total income of any previous year of a person who is a non-resident includes all income from whatever source is derived which--(a) is received or is deemed to be received in India in such ' year by or on behalf of such person; or (b) accrues or arises or is deemed to accrue or arise to him in India during such year. Expln. 1 to Section 5 carves out an exception stating that the income accruing or arising outside India shall not be deemed to be received in India within the meaning of the section by reason only of the fact that it is taken into account in a balance sheet prepared in India. Section 2(30) defines a non-resident to mean a person who is not a resident and for the purposes of Section 92, 93 and 168, includes a person who is not ordinarily resident within the meaning of Sub-section (6) of Section 6. Sub-section (6) of Section 6 defines a company to be a resident in India in any previous year if (1) it is an Indian company or (b) during that year, the control and management of its affairs is situated wholly in India. ABN Amro Bank is a non-resident company. Sec. 9 provides for the situations in which income is deemed to accrue or arise in India. Clause (i) of Sub-section (1) of Section 9 deems all income accruing or arising, whether directly or indirectly, to or from any business connection in India, or through or from any property in India, or through or from any asset or source of income in India, or through the transfer of a capital asset situate in India. Expln. 1 provides for the purposes of this clause that in a case of a business of which all the operations are not carried out in India, the income of the business is deemed under this clause to accrue or arise in India shall be the only such part of the income as is reasonably attributable to the operations carried out in India. Expln.

2 declares that the business connection shall include any business activity carried out through a person who, acting on behalf of the non-resident,--(a) has and habitually exercises in India, an authority to conclude contracts on behalf of the nonresident, unless these activities are limited to the purchase of goods or merchandise for the non-resident; or (b) has no such authority, but habitually maintains in India a stock of goods or merchandise from which he regularly delivers goods or merchandise on behalf of the non-resident; or (c) habitually secures order in India, mainly or wholly for the non-resident for that nonresident and other non-residents controlling, controlled by, or subject to same common control, as that non-resident. Clause (v) of Section 9(1) provides for deeming income by way of interest payable by a person who is non-resident, when the interest is payable in respect of any debt incurred, or money borrowed and used, for the purposes of the business or profession carried on by such person in India.

12. By virtue of provisions of Section 90 of the IT Act, the Central Government may enter into an agreement with the Government of any other country outside India for granting relief in respect of income on which have been paid both income-tax in India and income-tax in that country, or to income-tax chargeable under IT Act and under the corresponding law in force in that country to promote mutual economic relations, trade and investment or for the avoidance of double taxation of income under this Act and under the corresponding law in force in that country. Sub-sectiom (2) of Section 90 provides that in relation to the assessees to whom such agreement applies, the provisions of this Act shall apply to the extent they are more beneficial to that assessee.

Sub-section (3) of Section 90 provides that any term used but not defined in the Act or in the agreement referred to in Sub-section (1) shall, unless the context otherwise requires, and is not inconsistent, with the provisions of the Act or the agreement, have the same meaning as assigned to it in the notification issued by the Central Government in the Official Gazette in that behalf. The Explanation for the removal of doubt declares that the charge of tax in respect of foreign company at a higher rate at which domestic companies are chargeable, shall not be regarded as less favourable charge or levy of tax in respect of such foreign companies.

13. It may be stated here that there is a Double Taxation Avoidance Agreement between Netherlands and India (DTAA for short) wherein the assessee-bank is incorporated in India, wherein it has a branch office.

Article 7 of the DTAA between the two countries reads as under : 1. The profits of an enterprise of one of the States shall be taxable only in that State unless the enterprise carries on business in the other 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 is attributable to that permanent establishment.

2. Subject to the provisions of para 3, where an enterprise of one of the States carries on business in the other State through a permanent establishment situated therein, there shall in each State be attributed to that permanent establishment the profits which it might be expected to make if it were a distinct and separate enterprise engaged in the same or similar activities under the same or similar conditions and dealing wholly independently with the enterprise of which it is permanent establishment. In any case, where the correct amount of profits attributable to a permanent establishment is incapable of determination or the determination thereof presents exceptional difficulties, the profits attributable to the permanent establishment may be estimated on the basis of an apportionment of the total profits of the enterprise to its various parts, provided, however, that the result shall be in accordance with the principles contained in this article.

3(a) In determining the profits of a permanent establishment there shall be allowed as deductions, expenses which are incurred for the purposes of the permanent establishment, including executive and general administrative expenses so incurred, whether in the State in which the permanent establishment is situated or elsewhere, in accordance with the provisions of and subject to the limitations of the taxation laws of that State. Provided that where the law of the State in which the permanent establishment is situated imposes a restriction on the amount of the executive and general administrative expenses which may be allowed, and that restriction is relaxed or overridden by any Convention between that State and a third State which enters into force after the date of entry into force of the Convention, the competent authority of that State shall notify the competent authority of the other State of the terms of the corresponding paragraph in the Convention with that third State immediately after the entry into force of that Convention and, if the competent authority of the other State or requests, the provisions of this sub-paragraph shall be amended by protocol to reflect such terms.

(b) However, no such deduction shall be allowed in respect of amounts, if any, paid (otherwise than towards reimbursement of actual expenses) by the permanent establishment to the head office of the enterprise or any of its other offices, by way of royalties, fees or other similar payments in return for the use of patents or other rights, or by way of commission, for specific services performed or for management, or, except in the case of a banking enterprise, by way of interest on moneys lent to the permanent establishment. Likewise, no account shall be taken, in the determination of the profits of a permanent establishment, for amounts charged (otherwise than towards reimbursement of actual expenses), by the permanent establishment to the head office of the enterprise or any of its other offices, by way of royalties, fees or other similar payments in return for the use of patents or other rights, or by way of commission for specific services performed or for management, or except in the case of a banking enterprise, by way of interest on moneys lent to the head office of the enterprise, or any of its other offices.

4. 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.

5. For the purposes of the preceding paragraphs, the profits to be attributed to the permanent establishment shall be determined by the same method year by year unless there is good and sufficient reason to the contrary.

6. Where the profits include items of income which are dealt with separately in other articles of this Convention, then the provisions of those articles shall not be affected by the provisions of this article." 14. The DTAA also contains an article dealing with interest income and it states that interest arising in one of the States and paid to the residents of the other State may be taxed in that other State. Article 11 deals with interest income and it reads as under : 1. Interest arising in one of the States and paid to a resident of the other State may be taxed in that other State.

2. However, such interest may also be taxed in the Contracting State in which it arises and according to laws of that State, but if the recipient is the beneficial owner of the interest the tax so charged shall not exceed 10 per cent of gross amount of the interest.

(a) the Government of one of the States shall be exempt from tax in the other State in respect of interest derived directly or indirectly by that Government from that other State; (b) interest arising in one of the States and paid in respect of a loan guaranteed or insured by the Government of the other State shall be exempted from tax in the first-mentioned State.

(a) in the case of the Netherlands, the Government of the Kingdom of the Netherlands and shall include : such institutions, the capital of which is wholly owned by the Government of the Kingdom of the Netherlands or the local authorities; the Netherlands Financierings Maatshappji voor Ontwikkelings landen N.V. (Netherlands Finance company for developing countries) and the Netherlands Investerings bank voor Ontwikkelingslanden N.V. (Netherlands investment bank for developing countries) : all other institutions as may be agreed from time to time between the competent authorities of the States.

(b) in the case of India, the Government of India and shall include : a political sub-division; - such institutions, the capital of which is wholly owned by the Government of India or a political sub-division or a local authority; - all other institutions as may be agreed from time to time between the competent authorities of the States.

5. The competent authorities of the States shall by mutual agreement settle the mode of application of para 2.

6. The term "interest" as used in this article means income from debt-claims of every kind whether or not secured by mortgage, but not carrying a right to participate in the debtor's profits and in particular, income from the Government securities and income from bonds or debentures, including premiums and prizes attaching to such securities, bonds or debentures. Penalty charges for late payment shall not be regarded as interest for the purpose of this article.

7. The provisions of paras 1, 2 and 3 shall not apply if the beneficial owner of the interest, being a resident of one of the States, carries on business in the other State in which the interest arises, through a permanent establishment situated therein, or performs in that other State independent personal services from a fixed base situated therein, and the debt-claim in respect of which the interest is paid is effectively connected with such permanent establishment or fixed base. In such a case the provisions of Article 7 or Article 14, as the case may be, shall apply.

8. Interest shall be deemed to arise in one of the States when the payer is that State itself, a political sub division, a local authority or a resident of that State. Where, however, the person paying the interest, whether he is a resident of one of the States or not, has in one of the States a permanent establishment or a fixed base in connection with which the indebtedness on which the interest is paid was incurred, and such interest is borne by such permanent establishment or fixed base, then such interest shall be deemed to arise in the State in which the permanent establishment or fixed base is situated.

9. Where, by reason of a special relationship between the payer and the beneficial owner or between both of them and some other person, the amount of the interest, having regard to the debt-claim for which it is paid, exceeds the amount which would have been agreed upon by the payer and the beneficial owner in the absence of such relationship, the provisions of this article shall apply only to the last-mentioned amount. In such a case, the excess part of the payments shall remain taxable according to the laws of each State, due regard being had to the other provisions of this Convention." 15. Article 14 deals with only independent personal services. It reads: Article 14 referred to in Clause 7 of Article 11 reads as under: 1. Income derived by a resident of one of the States in respect of professional services or other activities of an independent character shall be taxable only in that State except in the following circumstances, when such income may also be taxed in the other State : (a) if he has a fixed base regularly available to him in the other State for the purpose of performing his activities; in that case, only so much of the income as is attributable to that fixed base may be taxed in that other State, or.

(b) if his stay in the other State is for a period or periods amounting to or exceeding in the aggregate 183 days in the fiscal year concerned; in that case, only so much of the income as is derived from his activities performed in that other State may be taxed in that other State.

2. The term "professional services" includes especially independent scientific, literary, artistic, educational or teaching activities as well as the independent activities of physicians, lawyers engineers, architects, dentists and accountants." 16. The income of an assessee carrying on business in India is to be taxed as per the provisions of Chapter IV-D consisting of Section 28 to 43 and 43 and Section 44BA of the Act. ABN Amro Bank, a corporate body is the assessee and carrying on banking business in India and, therefore, it is liable to be taxed in India in respect of the profit it earns in India by virtue of Section 5(2) r/w Section 28 to 44BA of the Act. Since it carries on the business through a branch which is a PE, it has to be assessed only in respect of that profit which is relatable to the activities and attributable to the PE both by virtue of Section 5 as well as Section 9 of IT Act. In view the existence of- DTAA the taxability is to be judged with reference to the provisions thereof as well. Article 7 of DTAA deals with business profits. By Clause 1 of the article the profits of an enterprise of one of the States are to be taxable only in that State unless the enterprise carries on business in the other State through a PE 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 is attributable to that PE. The assessee ABN Amro Bank is an enterprise of Netherlands and carries on business in India through a PE situated herein. Therefore so much of profit as is attributable to the PE is to be taxed in India. By Clause 2 the profit in each State is to be attributed to that PE which it might be expected to make as if it were a distinct and separate enterprise engaged in the same or similar activities under the same or similar conditions and dealing wholly independently with the enterprise of which it is PE. In computing profits of a PE, Clause 3 of Article 7 provides for allowance of deduction of expenses which are incurred for the purposes of the PE.Such expenses to be deductible are including executive and general administrative expenses whether incurred, in the country in which the PE situates or elsewhere. This deduction is, however, in accordance with the provisions of and subject to the limitations of the taxation laws of that country. Sub-clause (b) of Clause 3 however, denies any such deduction for the amounts, if any, paid by the PE to the head office of the enterprise or any of its other offices, by way of royalties, fees or other similar payments, or by way of commission, or, by way of interest on moneys lent to the PE. In the case of a banking enterprise this prohibition for disallowance of interest on money lent by head office to PE is spared. Likewise, it provides that no account is to be taken, in the determination of the profits of a PE, for amounts charged by the PE to the head office of the enterprise or any of its other offices, by way of royalties, fees or other similar payments or by way of commission, or, except in the case of a banking enterprise, by way of interest on moneys lent to the head office of the enterprise, or any of its other offices. Clause 6 of Article 7 clarifies that where the profits include items of income which are dealt with separately in other article of this Convention, then the provisions of those articles shall not be attracted by the provisions of this article.

17. By Article 11 interest arising in one of the countries and paid to the residents of the other country may be taxed in that other country.

Such interest may also be taxed in the contracting country in which it arises and according to laws of that country, but the tax is not to exceed 10 per cent if the recipient is the beneficial owner of the interest. The term "interest" is defined to mean income from debt-claims of every kind, whether or not secured by mortgage, but not carrying a right to participate in the debtor's profits, and in particular, income from the Government securities and income from bonds or debentures, including premiums and prizes attaching to such securities, bonds or debentures. This provision does not apply if the beneficial owner of the interest, carries on business in the other country in which the interest arises, through a PE situated therein, or performs in that other country independent personal services from a fixed base situated therein, and the interest earning debt-claim is effectively connected with such PE or fixed base. In such a case the provisions of Article 7 dealing with business profits or as the case may be, Article 14 dealing with personal services, are to apply. Where the person paying the interest, has in one of the countries a PE or a fixed base in connection with which the indebtedness on which the interest is paid was incurred, and such interest is borne by such PE or fixed base, then such interest shall be deemed to arise in the country in which the PE or fixed base is situated.

18. The proposition of law is well settled that nobody can make profit out of self nor can trade with self nor earn from self. In 1953, the issue came up before the Supreme court in the case of Sir Kikabhai Premchand v. CIT where the assessee, a dealer in silver and shares, withdrew some silver bars and shares from the business and settled them on certain trusts in which he was the managing trustee. In his books, the assessee credited the business with cost price of the bars and shares so withdrawn. The IT authorities held that the assessee derived income from the stock-in-trade thus transferred and assessed him on a certain sum being the difference between the cost price of the silver bars and shares and their market value at the date of their withdrawal from the business. The Supreme Court by majority decision held that no income arose to the assessee as a result of withdrawal of shares and silver bars. It observed at p. 509 of the report as under : "It is well recognised that in revenue cases regard must be had to the substance of the transaction rather than to its mere form. In the present case disregarding technicalities it is impossible to get away from the fact that the business is owned and run by the assessee himself. In such circumstances we are of opinion that it is wholly unreal and artificial to separate the business from its owner and treat them as if they were separate entities trading with each other and then by means of a fictional sale introduce a fictional profit which in truth and in fact is non-existent. Cut away the fictions and you reach the position that the man is supposed to be selling to himself and thereby making a profit out of himself which on the lace of it is not only absurd but against all canons of mercantile, and income-tax law. And worse. He may keep it and not show a profit. He may sell it to another at a loss and cannot be taxed because he cannot be compelled to sell at a profit. But in this purely fictional sale to himself he is compelled to sell at a fictional profit when the market rises in order that he may be compelled to pay to Government a tax which is anything but fictional.

Consider this simple illustration. A man trades in rice and also uses rice for his family consumption. The bags are all stored in one godown and he draws upon his stock as and when he finds it necessary to do so, now for his business, now for his own use. What he keeps for his own personal use cannot be taxed however much the market rises nor can he be taxed on what he gives away from his own personal stock, nor, so far as his shop is concerned, can he be compelled to sell at a profit. If he keeps two sets of books and enters in one all the bags which go into his personal godown and in the other the rice which is withdrawn from the godown into his shop, rice just sufficient to meet the day-to-day demands of his customers so that only a negligible quantity is left over in the shop after each day's sales, his private and personal dealings with the bags in his personal godown could not be taxed unless he sells them at a profit. What he chooses to do with the rice in his godown is no concern of the IT Department provided always that he does not sell it or otherwise make a profit out of it. He can consume it, or give it away, or just let it rot. Why should it make a difference if instead of keeping two sets of books he keeps only one? How can he be said to have made an income personally or his business a profit, because he uses ten bags out of his godown for a feast for the marriage of his daughter? How can it make any difference whether the bags are shifted directly from the godown to the kitchen or from the godown to the shop and from the shop to the kitchen, or from the shop back to the godown and from there, to the kitchen And yet, when the reasoning of the learned Attorney-General is pushed to its logical conclusion, the form of the transaction is of its essence and it is taxable or not according to the route the rice takes from the godown to the wedding feast. In our opinion, it would make no difference if the man instead of giving the feast himself hands over the rice to his daughter as a gift for the marriage festivities of her son." 19. This was the case where the person was in India and the transactions were within India. There are also cases where transactions by a non-resident were beyond Indian territory but with a PE within India and in those cases also the Courts have held that neither the income from self can be assessed nor any expenditure for the payment to self can be allowed as a deduction. These are discussed in subsequent paragraphs.

20. In Betts Hartley Huett & Company Ltd. v. CIT (supra) the Calcutta High Court, the assessee was a non-resident company. It had its head office at London and a branch in India. It was purchasing tea from India for the head office and other customers and in turn recovering expenses incurred for supply of tea as well as commission from the other customers. No commission for the supplies made to the head office was charged or recovered from the head office. The Revenue took a stand that the assessee was liable to pay tax on commission not charged or commission forgone as this resulted in profits for the head office. The High Court did not agree with the stand of the Revenue and it held : "We note, however, that the parties did all along proceed under a misconception. In law there cannot be a valid transaction of sale between the branch office of the assessee in India and its head office in London. It is an elementary proposition that no person can enter into contract with oneself. Debiting or crediting one's account cannot alter this legal position. If one unit of business does not debit any" commission to other unit of the same business then it is difficult to follow how any saving has been effected by the business."Ram Lal Bechairam v. CIT (1946) 14 ITR 1 (All). In this case, the assessee had a branch office outside India. During the year the branch had purchased certain goods, which were transferred to head office in India. The branch had included a profit margin at the time of transfer of goods. The head office was supposed to sell the goods to third parties. The said goods formed part of closing stock for the concerned year. The tax authorities taxed the profit margin of the branch office. The assessee contended that there was no sale to third party and the profit taxed was notional.

22. The Allahabad High Court held in favour of the assessee on the ground that no one can make profits out of himself. The following observations of the High Court are interesting : "We put a question to learned Counsel for the Department to the effect that, if the assessee had spent Rs. 10,000 on the purchase of cloth at Bhadohi (branch) and had mentioned the invoice price as Rs. 15,000 when sending the cloth from Bhadohi to Semohi (head office) and had then sold it at Semohi for Rs. 43,000 could he be said to have made a profit of Rs. 3,000 or was he to be said to have incurred a loss of Rs. 2,000. The answer of course was that he had made a profit of Rs. 3,000." 23. In the case Mitusai Bank Ltd. v. IAC (1989) 35 TTJ (Bom) 426, the assessee, a Japanese bank, had established a branch office in India.

The Indian PE had to pay certain funds to the head office. The assessee had claimed a deduction, for interest on such balance payable to the head office. The Tribunal rejected the claim of the assessee on the basis that the Indian branch and the head office in Japan cannot be treated as separate legal entities and deduction cannot be allowed to the branch in India for such notional interest.

24. The Tribunal decision in the case of Citibank in ITA No.1487/Bom/1981 for asst. yr. 1976-77 and others dt. 28th Aug., 1982, and in the case of British Bank of Middle East in ITA No. 4514/Bom/1985, dt. 21st July, 1989, and a reference thereagainst was rejected vide order in RA No. 2057/Bom/1989, dt. 7th Aug., 1990, the decisions in the case of British Bank of Middle East in ITA No. 8031/Bom/1992, dt. 28th July, 2003, in the case of Societe Generale in ITA No. 4099/M/2000, dt.

24th May, 2004, and in the case of Bank of Nova Scotia in ITA No.298/Bom/1995 for asst. yr. 1991-92, dt. 28th Jan., 2004, are cases where payment or receipt by head office to branch has not been allowed or assessed in the hands of same entity.

25. The contention of the learned Counsel of the assessee Sh. F.V.Irani on the first limb of the question, i.e., by virtue of deeming fiction provided by Article 7.3(b) of DTAA, the interest paid by the PE to the head office in case of a banking enterprise is an allowable deduction, in our opinion, has no force. Article 7.3(b) prohibits the allowance of certain expenses. It, however, specifically excludes interest paid by PE from disallowable list. It thus only makes it evident that interest is not disallowable under Article 7.3(b) of DTAA and nothing more. The deductibility of the interest payment by PE/branch to head office or other branches outside India is not dealt with by Clause (b) of Article 7.3 of DTAA. The highlighted portion of Article 7.3(b) demonstrates this position very clearly. "However, no such deduction shall be allowed in respect of amounts, if any, paid (otherwise than towards reimbursement of actual expenses) by the PE to the head office of the enterprise or any of its other offices, by way of royalties, fees or other similar payments in return for the use of patents or other rights, or by way of commission, for specific services performed or for management, or, except in the case of a banking enterprise, by way of interest on moneys lent to the PE. Likewise, no account shall be taken, in the determination of the profits of a PE, for amounts charged (otherwise than towards reimbursement of actual expenses), by the PE to the head office of the enterprise or any of its other offices, by way of royalties, fees or other similar payments in return for the use of patents or other rights, or by way of commission for specific services performed or for management, or, except in the case of a banking enterprise, by way of interest on moneys lent to the head office of the enterprise, or any of its other offices." By the mere fact that a particular expenditure is excluded from the list of disallowable items, it does not ipso facto mean that it would be allowable. The deductibility of interest paid by the branch in India to the head office is to be seen by looking to other provisions of the treaty or the local law. The payment of such interest may be included in the expenses allowable including executive and general expenses by virtue of provisions contained in Article 7.3(a) of DTAA. The Article 7.3(a) provides that in determining the profits of a PE there shall be allowed as deductions expenses which are incurred for the purposes of the PE, including executive and general administrative expenses so incurred whether in the State in which the PE is situated or elsewhere, in accordance with the provisions of and subject to the limitations of the taxation laws of that State. Interest is not specifically, included in the expenses to be allowed in determining the income of the PE. Even if it is included within its purview, then the deductibility has to be in accordance with the provisions of local laws and subject to the limitations provided therein, like as provided in Section 44C, etc. It has to be judged from the point of view of local laws. Looked at from that point of view, we are of the opinion that law and even as per the learned Counsel of the assessee the local law does not allow any deduction of the payment of expenditure to self. Nor it assumes the interest receipt from self through a branch or PE as its income and charges it to tax.

26. We can look at the issue from a different angle and on the assumption that the contention of the parties that PE is a different entity than its head office and the interest payment by the PE to head office is an allowable deduction, on the parity of reasoning, the receipt by the head office of the interest paid by the PE would be chargeable to tax in India under Section 5(2) of the Act r/w Article 11 of the DTAA. As there is only one assessment in the case of the assessee-bank both for the profit earned by the PE as well as the income earned by the head office in India, the result would be that on one hand, an expenditure by way of payment of interest by PE to head office would be allowable as a deduction and on the other, the receipt by the head office from PE would have to be charged to tax because the interest has been earned by and arisen and accrued to the head office in India. Result would be same in both cases, i.e., the income or expense is nil, in the first case because no profit is earned from self and, therefore, nothing accrued and in the second case again nil by allowing deduction of payment of interest by PE to head office and assessing the receipt of interest in the head office being receipt of income by head office from PE.27. Therefore, the first part of the question as to whether the interest payment is allowable deduction or not is to be held against the assessee and in favour of the Revenue.

28. The second part of the question as to whether the provisions of Section 40(a)(i) are attracted in respect of such payment of interest would not really survive in view of our finding that the interest payment by the branch/PE to head office or other offshore branches is not allowable as payment being to self. Since, however, detailed arguments are raised from both the sides and the question is referred for consideration of the Special Bench, we would deal with the same.

"40. Notwithstanding anything to the contrary in Sections 30 to 38, the following amounts shall not be deducted in computing the income chargeable under the head "Profits and gains of business or profession"-- (i) any interest (not being interest on a loan issued for public subscription before the 1st day of April, 1938), royalty, fees for technical services or other sum chargeable under this Act, which is payable,-- (B) in India to a non-resident not being a company or to a foreign company, on which tax is deductible at source under Chapter XVII-B and such tax has not been deducted or, after deduction, has not been paid during the previous year, or in the subsequent year before the expiry of the time prescribed under Sub-section (l) of Section 200: Provided that where in respect of any such sum, tax has been deducted in any subsequent year or, has been deducted in the previous year but paid in any subsequent year after the expiry of the time prescribed under Sub-section(1) of Section 200, such sum shall be allowed as a deduction in computing the income of the previous year in which such tax has been paid." 30. The assessee in this case is the corporate body and its branches are paying interest to its head office and other offshore branches, i.e., the payment is by one wing of the assessee to its other wing or so to say, by on hand to another. The tax is to be deductible under Chapter XVII-B of the Act and in case of a payment to non-resident it is Section 195 of the IT Act. This section provides that "Any person responsible for paying to a non-resident, not being a company, or to a foreign company, any interest or any other sum chargeable under the provisions of this Act (not being income chargeable under the head "Salaries" shall, at the time of credit of such income to the account of the payee or at the time of payment thereof in cash or by the issue of a cheque or draft or by any other mode, whichever is earlier, deduct income-tax thereon at the rates in force." The branch/PE of the assessee in India is not a person in legal terminology. The person is the corporate body-ABN Amro Bank NV and not its branch or the PE. This is also evident from the fact that assessment in this case is made on the corporate body-ABN Amro Bank NV and not on its branch or PE. We, therefore, find force in the assessee's contention that the provisions dealing with deduction of tax at source under Section 195 presupposes the existence of two distinct and separate entities which is absent in the present case. On both the grounds, therefore, Section 40(a)(i) does not come into play. Disallowance of interest on this by invoking the provisions of this section would not be justified.

31. In the cases before Bombay High Court in the case of Premier Tyres Ltd, (supra) and before Calcutta High Court in the case of Bunge & Co.

Ltd. (supra) it is held that if the assessee is agent of the non-resident, provisions of Section 195 are not applicable. In the first case of Bunge & Co. Ltd. (supra) a foreign company having an office at Calcutta, carried on the business of exporting jute goods from India. It had agents some of whom were also buyers in various foreign countries who were non-residents. During the accounting year 1961-62, it remitted a sum of money to the foreign agents. The ITO sent notices to the company proposing to treat the company as agents of the non-residents under Section 163 of the Act "for the limited purpose of recovery of tax under Section 201 of the Act" in respect of the sum of money remitted to the foreign agents. The Calcutta High Court held that the same person cannot be treated as an agent under Section 163 of the Act and proceeded with under Section 201 at the same time. It was held that the group of sections from Sections 160 to 163 and the group of sections from Sections 195 to 201 of the Act are mutually exclusive and operate on different fields.

32. The Bombay High Court in the case of CIT v. Premier Tyres Ltd. (supra) examined the issue in an analogous circumstances. In this case the assessee, an Indian company, was held as an agent of the non-resident American company in terms of the provisions of Section 163 of the IT Act. It was obtaining technical services from that American company. The assessee was liable to pay tax liability of the American company as an agent. The assessee had, however, not deducted tax under Section 195 from payments to the American company. The tax authorities invoked the provisions of Section 201 of the IT Act. The High Court observed that once the assessee was treated as an agent under Section 163, it is not necessary for such agent to deduct tax under Section 195 from payments to nonresidents. Although the High Court has not specifically mentioned that "no tax is required to be deducted from payment to self", the analysis of the decision gives an impression because the agent is required to discharge the tax liability of the non-resident and is also required to pay advance tax on behalf of the nonresident, in the eyes law the agent and the non-resident are one and the same entity for all practical purposes. In such situation if the agent is required to deduct tax at source then effectively it would lead to a situation wherein tax is deducted from payment to self.

33. We also find force in the submission of the assessee that the interest paid being not the income of the assessee on the ground that no income does arise from self and consequently interest paid by PE to head office is not "chargeable under the provisions of this Act" which is a condition precedent for invoking the provisions of Section 195 and also on the ground that payment by PE is cancelled by the receipt by the head office of the assessee enterprise, in case if the PE is considered as a separate entity than the head office of the assessee enterprise.

34. It is true that the branches of the assessee are taxable but not as separate entities. The branch/PE are so deemed as independent and separate entities for determination of the extent of the income subjected to tax in either country and in that connection, the payment of interest by the bank's branches in India to its head office and other branches located outside India is considered allowable and from that point of view it may not be considered as payment to self. It is by fiction created in Article 7.2 of DTAA when it states that "there shall in each State be attributed to that permanent establishment the profits which it might be expected to make if it were a distinct and separate enterprise engaged in the same or similar activities under the same or similar conditions and dealing wholly independently with the enterprise of which it is permanent establishment". This fiction is only for computing the profits of the PE for levying tax in India. It is not as if a PE is taken as an independent assessee in India for all other purposes. Whenever a fiction is created it has to be restricted to the specified object for which it was created and should not be extended beyond that field. This is well settled proposition of law as we find from the following decisions of various Courts discussed hereunder.

35. In the case of CIT v. Ajax Products Ltd. (supra), the Supreme Court dealt with a case under Section 10(2)(vii) of the IT Act, 1922, whereby under the second proviso to the section, whenever a sale takes place after the cessation of the business, the surplus must be deemed to be the profits of the year previous to the year in which the sale took place and for the purpose of the proviso, the business must also be deemed to have been conducted by the assessee during the said previous year. By fiction, the argument proceeded, all the necessary conditions to the exigibility of tax are introduced though in fact none exists and in that connection, the Supreme Court observed that though the surplus contemplated by the proviso is not in the technical sense of the term 'profits of the previous year', it is deemed to be the profits of the previous year. It is a limited fiction for a specific purpose. What are not profits in commercial practice are treated as profits for the purpose of the proviso. The contention was that the fiction introduced in the proviso is wide in its scope and if fully worked out, all the conditions laid down in the proviso would be satisfied. If by invoking the fiction, there must be deemed to have been a business during the year preceding the assessment year, by the same fiction, the buildings must be deemed to have been used in that business during that year. For enlarging the scope of fiction, reliance was placed upon the decision of the Supreme Court in the case of Addl. ITO and Anr. v. E. Alfred wherein the Court said, "when a thing is deemed to be something else, it is to be treated as if it is that thing, though, in fact, it is not.... It is in this sense that the legal representative becomes an assessee by the fiction, and it is this fiction, which has to be fully worked out, without allowing the mind to boggle...." The Supreme Court in this case of Ajax Products Ltd. (supra) followed the observations in its earlier decision in the case of CIT v. Amarchand N.Shroff and administered a caution that fictions should not be stretched beyond the purpose for which they were enacted.

The Court held "The fiction in the second proviso is a limited one. The surplus is deemed to be the profits of the previous year. As we have pointed out earlier, it adequately serves the purpose of the section.

It was given a limited meaning under the earlier decisions. To sustain the argument of the Revenue, it has to be enlarged in its scope. Many words have to be read in to it which are not there. We cannot, accept this argument." 36. In the case of Mother India Refrigeration Industries (P) Ltd. (supra), the Supreme Court dealing with the carry forward of unabsorbed depreciation, observed that the avowed purpose of the legal fiction created by the deeming provision contained in proviso (b) to Section 10(2)(vi) of the Indian IT Act, 1922, and in Section 32(2) of the IT Act, 1961, is to make the unabsorbed carried forward depreciation partake of the same character as the current depreciation in the following year so that it is available, unlike unabsorbed carried forward business loss, for being set off against other heads of income of that year. Such being the purpose for which the legal fiction is created, the fiction cannot be extended beyond its legitimate field and will have to be confined to that purpose. It cannot be said that because of the legal fiction, the unabsorbed carried forward losses should be given preference not merely over the unabsorbed carried forward depreciation but also over the current year's depreciation. The Court held that it is well settled that legal fictions are created only for some definite purpose and these must be limited to that purpose and should not be extended beyond that legitimate field.37. In the case of Vadilal Lallubhai (supra), the Supreme Court again reiterated that legal fictions are only for a definite purpose; they are limited to the purpose for which they are created and should not be extended beyond their legitimate field. The Supreme Court was dealing with the assets distributed whether to constitute income and held that where the assessee had transferred his share in certain controlled companies and the companies went into voluntary liquidation and distributed their assets, the assets so distributed, which were deemed to be dividends within the meaning of Section 2(6A)(c), were not "income" for the purposes of Section 44F and were also not capable of being deemed to accrue from day-to-day and, therefore, no portion of the assets so distributed and received by the transferees could be assessed in the hands of the assessee under Section 44F.38. In Hindustan Petroleum Corporation Ltd. (supra), the Bombay High Court dealing with Expln. 3 to Section 43 held that unabsorbed depreciation of the amalgamating company with the assessee-company cannot be deducted in computing the written down value of the assets of the assessee-company and in this context it observed that a legal fiction has to be carried to its logical conclusion but only within the parameters of the purpose for which the fiction is created. As far as possible, the legal fiction would not be given a meaning so as to cause injustice.

39. In the case of Nathimal Gaya Lal (supra) before the Full Bench of the Allahabad High Court; fiction created by Section 25A(3) of the 1922 Act deeming the partition of the HUF, if the order under Section 25A(1) has not been passed and it is deemed that HUF continued. The Full Bench of the Allahabad High Court held that as Section 25A(3) is a provision which created a legal fiction, that provision has to be interpreted in such a manner as would not work injustice to a party, for even when the Court steps into the world of legal fantasy, the principle of equity and justice cannot be lost sight of.

40. It may also be noted that wherever the legislature wanted to deem the branch as a separate entity it has provided so specifically as in Sections 92A, 92B, 92F, etc. so also in Article 7.3(a) of DTAA and having not made any specific provision in Section 40(a)(i) or Section 195, the branch of the assessee cannot be treated as a separate entity for the purpose of deduction of tax at source. The fiction created under Article 7 of the DTAA is for a specific purpose and cannot be extended beyond the fixed area and in this connection, transfer pricing provisions introduced in IT Act w.e.f. April, 2002 require transactions between two associated enterprises at arm's length price and in that connection, Section 92F(iii) defines the term "enterprise" as follows : "enterprise means a person (including a PE of such person) who is, or has been, or proposed to be, engaged in any activity, relating to the production, storage...." 41. The bracket in the definition intends to state that, even a PE is to be treated as an enterprise. Though one of the interpretations could be that a PE is to be included in person as its part, i.e., the PE and the person are to be treated as one enterprise. However, that is not the case. Hence, the law itself suggests that person can trade with himself and earn profits out of it.

42. In the instant case, assessee has claimed payment of interest to nonresident ABN Amro Bank, NV situated in Netherlands and being a company incorporated in Netherlands, is a resident of Netherlands for the purpose of income-tax and, therefore, comes under the category of non-resident for the purpose of assessee which is its PE carrying on banking business in India. Therefore, the payee in this case is a non-resident and the amounts remitted are subject to income-tax in its hands in India. The interest paid to the head office, etc. may constitute income chargeable to tax under Section 5(2)/9 of the IT Act, 1961, but no deduction of tax at source on the interest so paid is required under Section 195 as PE of the assessee and head office being same person and hence the provisions of Section 40(a)(i) of IT Act cannot be invoked for disallowing such interest of Rs 55,03,300 in asst. yr. 1997-98 and of Rs. 62,73,106 in asst. yr. 1998-99 in computing the total income.

43. The circular dt. 17th April, 1996 opines in the first part that "the branch of a foreign company/concern in India is a separate entity for the purposes of taxation. Interest paid/payable by such branch to its head office or any branch located abroad would be liable to tax in India and would be governed by the provisions of Section 115A of the Act. If the DTAA with the country where the parent company is assessed to tax provides for a lower rate of taxation, the same would be applicable". To this extent, we may agree that the circular lays down correct state of law. But its subsequent observation in the second part that "consequently, tax would have to be deducted accordingly on the interest remitted as per the provisions of Section 195 of the IT Act, 1961" in our opinion are not in accordance with law particularly in view of the fact that the head office and PE are the two wings of the same person and they are not separate and independent taxable entities.

44. Reliance placed on the decision of Tribunal, Kolkata, dt. 13th Jan., 2003 in MA No. 218/Kol/2002 in the case of Bank of Tokyo Mitsubishi also is misplaced in view of what we have stated above. It mainly relies upon the circular aforesaid. In our opinion, it is a payment to self and the same does not require any deduction of tax at source under Section 195 of the Act. Consequently, Section 40(a)(i) shall not apply entailing no disallowance of interest allowable under Article 7 of DTAA. In case interest is allowable deduction, the second part of the question, therefore, is to be held in favour of the assessee.

45. In the appeal in the case of Bank of Tokyo Mitsubishi Ltd. appearing in ITA No. 899/Kol/2002 the assessee made payment of Rs 5,40,29,702 to their head office in Tokyo and other foreign branches without deduction of tax at source under Section 195 of the Act for the default of which the assessee was held liable under Section 201 and was directed to make payment by the AO. In this case also, the assessee's contention has been that the payment was made to head office and, therefore, there was no obligation of TDS and this contention has been rejected by the AO by stating that once it has been claimed and allowed as deduction for arriving at the total income, the assessee cannot escape from the liability of not deducting TDS under Section 195. It was also pleaded by the assessee that interest paid, by Indian offices to their head office and foreign branches are not chargeable to income-tax in India and, therefore, there is no liability, TDS does not arise and this contention was also rejected by the AO by stating that the argument is misconceived and that TDS can be made under Section 195 of the Act and in the said provision there is no mention of chargeability. The provision of Section 195 is applicable on payment of interest and any other sum. The reliance of the assessee on Article 701 and 7.2 of the DTAA between India and Japan are held to be of no help as in this case neither the head office nor the foreign branches are PE's in India as defined in the DTAA. On the other hand, Article 11 specifically dealing with the taxability of interest income in cases where such interest is paid to any companies located in Japan was applicable and according to Clause (2)(a) of Article 11, the gross amount of interest would be taxed in India @ 10 per cent and on this amount, the assessee, according to him, should have deducted tax. The AO also held that TDS on payment to head office was deductible at the rate of 10 per cent . whereas the payment of interest to other branches was deductible at the rate of 65 per cent and surcharge at the rate of 15 per cent on such tax. The CIT(A) cancelled the order of the AO passed under Section 201 of the Act by relying upon his earlier order wherein it was observed as under : "This leads us to the question whether deduction is admissible in respect of payment to a non-resident (distinct and different from the payer) when admittedly no tax had been deducted at source. It is to be noted that Section 40(a)(i) comes into play only when non-resident payee is assessable to Indian income-tax in respect of the payment made by the "assessee". Location of receipt in the form of interest in the hands of a Japanese resident is governed by the provisions contained in Article 11 of the convention. But when the debt claim in respect of which the interest is paid is effectively connected with PE in India it is not Article 11 but Article 7 (or Article 14 dealing with services) which would govern taxability of the receipt in the hands of the non-resident enterprise. And Article 7(1) provides that the enterprise in the other Contracting State shall be treated in respect of so much of its profits as is directly or indirectly attributable to its PE in India. There is no element of income embedded in a receipt that stands for reimbursement of actual expenses. Interest the head office or the branches abroad earned in the form of receipt from the Indian branch of the enterprise is chargeable to tax in the hands of Japanese enterprise or any of its overseas branches. Stipulation in Section 40(a)(i) thus has no application on the facts and in the circumstances of the case. I am, therefore, inclined to hold that AO was not justified in denying deduction in respect of the payment to non-residents of amounts aggregating to Rs 5,13,09,654. Addition is accordingly deleted and ground 10 fully allowed." 46. In this case, the Revenue is in appeal. The Revenue has raised a similar argument as in the case of ABN Amro Bank NV. The learned Counsel of the assessee submitted that payment of interest to the head office in case of a banking company is an allowable deduction in view of Article 7.3 of the DTAA between India and Japan. It is further submitted that to attract the provisions of Section 195 there must exist two persons namely, the payer and payee where the payee should be a non-resident for the purposes of the Act and further the amount remitted to the non-resident payee should be subject to income-tax in its hands in India, He submitted that the assessee is assessed in India in the status of non-resident by virtue of carrying on banking business through its branches in India which constitute PE. Such PE does not by itself render it a distinct entity separate from the main company. The taxable entity is a nonresident incorporated in Japan and the subject-matter of tax in India is the income earned in India through the business carried out in India by the PE and, therefore, when the branch situated in India pays interest to its head office situated in Japan and also to other branches situated in India partake of the character of payments made to self and, therefore, does not have any insignia of income which presupposes a receipt from one person to another person. The Supreme Court decision in the case of CIT v. Bai Shirinbai K. Kooka is relied upon wherein by following its earlier decision in the case of Sir Kikabhai Premchand (supra) it was held that a man cannot trade with himself nor can he make any profit or loss out of transactions with himself. It is, therefore, submitted that when the assessee remitted the interest to its counterparts outside India, there was no requirement of withholding income-tax thereon under Section 195(1) of the Act. It is further submitted that merely because the India-Japan treaty provides that payments of interest by the branches situated in India is allowed as a deduction, it does not ipso facto lead to the conclusion that interest so paid by the branch would constitute income in the hands of assessee chargeable to tax in India when the same are received by its head office and other branches, all located outside India. This situation is like transferring money from one pocket to the other pocket of the same person. The treaty, according to him, provides for a dispensation in computing the profits attributable to the PE being a tax resident of Japan which are chargeable to tax in India. Such mode of computation, according to him, cannot render the payments of interests made by the branches chargeable to tax in the hands of the assessee in India merely because such interests are received by the head office and other branches. The Circulars dt. 31st March, 1993, and 17th April, 1996, opining that interest payable by Indian branch of a foreign bank to its head office would attract withholding of tax in India under Section 195 of the Act are contrary to what has been submitted above and, therefore, the same cannot be given effect to. It is further submitted that Japanese treaty provides for deduction without being subject to the limitations provided in the domestic tax laws of India except the one relating to the deductibility of general administrative or head office expenses as provided in the protocol to the said Indo-Japan treaty. Section 40(a)(i) of the Act, being a limiting or restrictive provision contained in the domestic tax laws of India, but not relating to general administrative or head office expenses for which there is a specific limiting provision in the Act in the form of Section 44C, would accordingly not have any application in the case of the assessee in view of the favourable provisions of the Indo-Japan tax treaty as contrary to the Indo-Netherlands treaty appearing in the case of ABN Amro Bank NV.47. Article 7 of the Convention between India and Government of Japan for avoidance of double taxation and prevention of fiscal evasion with respect of taxes on income (hereinafter referred to as "Japanese DTAA") is differently drafted and it reads as under : 1. The profits of an enterprise of a Contracting State shall be taxable only in that Contracting 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 that other Contracting State but only so much of them as is directly or indirectly attributable to that permanent establishment.

2. Subject to the provisions of para 3, where an enterprise of a Contracting State carries on business in the other Contracting State through a permanent establishment situated therein, there shall in each Contracting State be attributed to that permanent establishment the profits which it might be expected to make if it were a distinct and separate enterprise engaged in the same or similar activities under the same or similar conditions and dealing wholly independently with the enterprise of which it is a permanent establishment.

3. In determining the profits of a permanent establishment, there shall be allowed as deductions expenses which are incurred for the purposes of the permanent establishment including executive and general administrative expenses so incurred, whether in the Contracting State in which the permanent establishment is situated or elsewhere.

4. In so far as it has been customary in a Contracting State to determine the profits to be attributed to a permanent establishment on the basis of an apportionment of the total profits of the enterprise to its various parts, nothing in para 2 shall preclude that Contracting State from determining the profits to be taxed by such an apportionment as may be customary; the method of apportionment adopted shall, however, be such that the result shall be in accordance with the principles contained in this article.

5. 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.

6. For the purposes of the provisions of the preceding paragraphs of this article, the profits to be attributed to the permanent establishment shall be determined by the same method year by year unless there is good and sufficient reason to the contrary.

7. Where profits include item of income which are dealt with separately in other articles of this Convention, then the provisions of those articles shall not be affected by the provisions of this article.

48. The article dealing with interest in this Japanese DTAA reads as under: "Article 11--Interest 1. Interest arising in a Contracting State and paid to a resident of the other Contracting State may be taxed in that other Contracting State.

2. However, such interest may also be taxed in the Contracting State in which it arises, and according to the laws of that Contracting State, but if the recipient is the beneficial owner of the interest, the tax so charged shall not exceed.

(a) 10 per cent of gross amount of the interest if the beneficial owner is a bank; and (b) 15 per cent of the gross amount of the interest in all other cases.

3. Notwithstanding the provisions of para 2, interest arising in a Contracting State and derived by the Government of the other Contracting State, a political sub-division or a local authority thereof, the Central Bank of that other Contracting State or any financial institution wholly owned by that Government or by any resident of the other Contracting State with respect to debt-claims guaranteed or indirectly financed by the Government of that other Contracting State, a political sub-division or a local authority thereof, the Central Bank of that other Contracting State or any financial institution wholly owned by that Government shall be exempt from tax in the first-mentioned Contracting State.

4. For the purposes of para 3, the terms "the Central Bank" and "financial institution wholly owned by the Government" means: (v) such other financial institution the capital of which is wholly owned by the Government of Japan as may be agreed from time to time between the Government of the two Contracting States: (iii) such other financial institution the capital of which is wholly owned by the Government of India as may be agreed upon from time to time between the Government of the two Contracting States.

5. The term "interest" as used in this article means income from debt-claims of every kind, whether or not secured by mortgage and whether or not carrying a right to participate in the debtor's profits, and in particular, income from Government securities and income from bonds or debentures, including premiums and prizes attaching to such securities, bonds or debentures.

6. The provisions of paras 1, 2 and 3 shall not apply if the beneficial owner of the interest, being a resident of a Contracting State, carries on business in the other Contracting State in which the interest arises, through a permanent establishment situated therein, or performs in that other Contracting State independent personal services from a fixed base situated therein, and the debt claim in respect of which the interest is paid, is effectively connected with such permanent establishment or fixed base. In such a case the provisions of Article 7 or article 14, as the case may be, shall apply.

7. Interest shall be deemed to arise in a Contracting State when the payer is that Contracting State itself, a political sub-division or a local authority thereof or a resident of that Contracting State.

Where, however, the person paying the interest, whether he is a resident of a Contracting State or not, has in a Contracting State a permanent establishment or a fixed base in connection with which the indebtedness on which the interest is paid was incurred, and such interest is borne by such permanent establishment or fixed base, then such interest shall be deemed to arise in the Contracting State in which the permanent establishment or fixed base is situated.

8. Where by reason of a special relationship between the payer and the beneficial owner or between both of them and some other person, the amount of the interest, having regard to the debt claim for which it is paid, exceeds the amount which would have been agreed upon by the payer and the beneficial owner in the absence of such relationship, the provisions of this article shall apply only to the last mentioned amount. In such a case, the excess part of the payments shall remain taxable according to the laws of each Contracting State, due regard being had to the other provisions of this convention." 1. Income derived by a resident of a Contracting State in respect of professional services or other activities of an independent character shall be taxable only in that Contracting State unless he has a fixed base regularly available to him in the other Contracting State for the purpose of performing his activities; in that case, only so much of the income as is attributable to that fixed base may be taxed in that other Contracting State for a period or periods amounting to or exceeding in the aggregate 183 days during any taxable year or "previous year" as the case may be. If he has such a fixed base or remains in that other Contracting State for the aforesaid period or periods, the income may be taxed in that other Contracting State but only so much of it as is attributable to that fixed base or is derived in that other Contracting State during the aforesaid period or periods.

2. The term 'professional services' includes especially independent scientific, literary, artistic, educational or teaching activities as well as the independent activities of physicians, surgeons, lawyers, engineers, architects, dentists and accountants." 50. On a close reading of these provisions, we find that Clause. 1, 2, 5, 6 and 7 of Article 7 of the Japanese DTAA are similarly worded as Clause. 1, 2, 4, 5 and 6 of Netherlands DTAA. Clause 3 of the Japanese DTAA merely incorporates the first part of Clause 3(a) of Netherlands DTAA and the proviso placing a restriction by the law of the State in which PE is situated are not incorporated. Again, Clause 3(b) of Netherlands DTAA which prohibits allowance of certain expenditure is also missing in Japanese DTAA. There is no other material difference between the two treaties. As pointed out by the learned Counsel of the assessee, there are no restrictive covenants in Article 7 for allowance of expenses incurred for the purposes of PE either by the prefix of the words "in accordance with the provisions of the law of that State" or by the suffix words "and subject to limitations of taxation laws of that State". This may be one of the other alternate reasons for not invoking the provisions of Section 40(a)(i) of the IT Act for disallowing the payment of interest in computing the income of the assessee through the PE. However, here also, the deeming fiction of treating the PE as a different and separate entity dealing wholly independently with the enterprise in Clause 2 of the Article 7 of Japanese DTAA or for the specific purpose of computing the income attributable to the PE and not for any other purposes. Therefore, for the reasons stated above, while dealing with the Netherlands DTAA, we hold that no tax was required to be deducted under Section 195 of the Act from the payment of interest by the PE to its head office or other offshore branches of the assessee enterprise, Bank of Tokyo. We, therefore, uphold the order of the CIT(A) in vacating the order under Section 201 of the Act by holding that the assessee was not in default in deducting the tax at source.

51. In the result, the question referred to Special Bench in 2 appeals filed by the assessee in the case of ABN Amro Bank Ltd. are decided against the assessee and one appeal filed by the Revenue in the case of Bank of Tokyo is dismissed.


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