Skip to content


Metchem Canada Inc. Vs. Deputy Commissioner of Income Tax - Court Judgment

LegalCrystal Citation
CourtIncome Tax Appellate Tribunal ITAT Mumbai
Decided On
Judge
Reported in(2006)100ITD251(Mum.)
AppellantMetchem Canada Inc.
RespondentDeputy Commissioner of Income Tax
Excerpt:
.....are required to adjudicate in all these appeals is whether or not the limitation on deduction of head office expenditure, as set out in section 44c of the indian it act, will apply in the case of non-resident companies governed by the india canada double taxation avoidance agreement (dtaa) [(1987) 164 itr (st) 87], particularly in the light of non-discrimination clause in the said dtaa. this issue is raised by the revenue by way of the following solitary ground of appeal : on the facts and in the circumstances of the case, the cit(a) has erred in holding that the provisions of section 44c of the act will not be applicable and the quantum of expenditure will be allowed without the restriction imposed by section 44c.the assessee has raised the grievance by way of following grounds of.....
Judgment:
1. These three appeals, two by the Revenue and one by the assessee, involve a common issue. The short and neatly identified legal issue that we are required to adjudicate in all these appeals is whether or not the limitation on deduction of head office expenditure, as set out in Section 44C of the Indian IT Act, will apply in the case of non-resident companies governed by the India Canada Double Taxation Avoidance Agreement (DTAA) [(1987) 164 ITR (St) 87], particularly in the light of non-discrimination clause in the said DTAA. This issue is raised by the Revenue by way of the following solitary ground of appeal : On the facts and in the circumstances of the case, the CIT(A) has erred in holding that the provisions of Section 44C of the Act will not be applicable and the quantum of expenditure will be allowed without the restriction imposed by Section 44C.The assessee has raised the grievance by way of following grounds of appeal : The CIT(A) erred in upholding the AO's view that deduction for expenses incurred at the head office was allowable in accordance with the provisions of Section 44C of the IT Act. The appellant submits that it is governed by the provisions of the DTAA entered into by the Government of India with the Government of Canada, and the provisions of Section 44C of the IT Act (which restrict the head office expenses allowable in the case of non-resident) are inapplicable.

The CIT(A) erred in holding that the provisions of Article 24(1) and (2) of DTAA are subject to Article 7(4) of the DTAA and as such the view taken by the AO in applying the provisions of Section 44C are not only within the express provisions of income-tax and relevant Finance Act, but also well within the various provisions contained in the DTAA.2. The assessee-respondent is a company incorporated in Canada. The assessment years involved in these appeals are 1993-94, 1994-95 and 1996-97. The assessee entered into an agreement with an Indian company for erectioning, commissioning and running of HRC project at Hazira in Gujarat. In the course of the assessment proceedings, the AO noticed that the assessee had claimed deduction in respect of allocation of overhead expenses incurred by the head office. In response to AO's requisition to show cause as to why limitation on deduction of expenses, as set out in Section 44C of the Act, will not apply on the facts of this case, it was submitted that in the light of the provisions of Article 24 of the applicable India Canada DTAA ('the treaty' in short), Section 44C will have no application in this case inasmuch as the provisions of Section 44C are discriminatory in favour of an Indian enterprise vis-a-vis PE of a Canadian enterprise. The AO rejected the plea of the assessee on the ground that in terms of Article 7(4) of the treaty the profits of the PE are to be computed "in accordance with the provisions of and subject to limitations of the taxation laws of that State" and, therefore, the limitation set out in Section 44C could not be ignored. The AO was also of the view that there is no question of discrimination in the present context because the domestic Indian enterprise and the non-resident companies cannot be said to be "in the same circumstances" which is sine qua non for application of non-discrimination clause. The AO was of the view that comparison of a nonresident company with a resident taxpayer in India is not at all contemplated by the treaty. It was in this backdrop that the AO concluded that "the main Article in Article 7(4) of the treaty read in conjunction with Section 44C of the IT Act" will apply in this case. Aggrieved assessee carried the matter in appeal before the CIT(A). In one of the years before us, the CIT(A) upheld the action of the AO but in the remaining two years the CIT(A) upheld the contentions of the assessee. While confirming the order of the AO, the view of the CIT(A) was that "the provisions of Article 24(1) and (2) [i.e., of non-discrimination clause] are to be read subject to the other provisions of the convention, including Article 7(4) and 24(4) [i.e., computation of business profits and exclusion of applicability of different tax rates between domestic companies and enterprise of the other State by the non-discrimination clause]". The CIT(A) further added that the provisions of Section 44C "only provide for a mode of computation of income". It was noted that the head office expenses incurred by the non-resident companies cannot be allocated with accuracy and the question, therefore, remains one of estimate on one basis or the other, and that "the provisions of Section 44C embody a fair method of estimation". The CIT(A) thus confirmed the action of the AO for the asst. yr. 1993-94. In the two subsequent years, however, the CIT(A) decided the same issue in favour of the assessee by holding that "the special provisions of Article 24 will override the general provisions of Article 7(4)". Reliance was also placed on the decision of the Tribunal in the case of Standard Chartered Bank v. IAC (1991) 39 ITD 57 (Bom). The CIT(A) thus upheld the contention of the assessee in principle but remitted the matter to the file of the AO to enable the AO "to re-examine the quantum of allowable expenditure on the basis of information and allocations, etc. provided by the appellant (the assessee before us)". The assessee is aggrieved of the CIT(A)'s order for the asst. yr. 1993-94 and Revenue is aggrieved of the CIT(A)'s orders for the asst. yrs. 1994-95 and 1996-97. That is how both the parties are in appeal, though for different years, before us. As a matter of convenience, we have heard all the appeals together and we are disposing of all the three appeals by way of this consolidated order.

3. We have heard the rival contentions, perused the material on record, and duly considered factual matrix of the case as also the applicable legal position.

4. We may, first of all, reproduce the relevant extracts from the provisions of arts. 7 and 24 of the applicable Indo-Canadian DTAA for ready reference : 1. The profits of an enterprise of a Contracting State shall be taxable only in that State unless the enterprise carries on business in the other Contracting State through a PE situated therein. If the enterprise carries on or has carried on business as aforesaid, the profits of the enterprise may be taxed in the other Contracting State but only so much of them as is attributable to : (b) sales of goods and merchandise of the same or similar kind as those sold, or from other business activities of the same or similar kind as those effected, through that PE. 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 PE situated therein, there shall in each Contracting State be attributed to that PE, 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 PE. In any case, where the correct amount of profits attributable to a PE is incapable of determination or the ascertainment thereof presents exceptional difficulties, the profits attributable to the PE may be estimated on a reasonable basis provided that the result shall be in accordance with the principles laid down in this Article.

3. In the determination of the profits of a PE, there shall be allowed those deductible expenses which are incurred for the purposes of the business of the PE including executive and general administrative expenses, whether incurred in the State in which the PE is situated or elsewhere as are in accordance with the provisions of and subject to the limitations of the taxation laws of that State. However, no such deduction shall be allowed in respect of amounts, if any paid (otherwise than as a 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, know-how or other rights, or by way of commission or other charges, 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, know-how or other rights, or by way of commission or other charges 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.

2. The taxation on a PE which an enterprise of a Contracting State has in the other Contracting State shall not be less favourably levied in that other State than the taxation levied on enterprises of that other State carrying on the same activities.

5. The core issue, as we have noted earlier as well, is whether or not the limitation on deduction of head office expenditure, as set out in Section 44C of the Indian IT Act, will apply in the case of non-resident companies governed by the India Canada DTAA, particularly in the light of non-discrimination clause in the said DTAA. As a corollary to this question, we must decide whether restriction on admissibility of deduction on account of head office expenditure, as contemplated by Section 44C of the Act, constitutes "taxation on a PE which an enterprise of a Contracting State has in the other Contracting State" as "less favourably levied in that other State than the taxation levied on enterprises of that other State carrying on the same activities". Another aspect which requires to be considered by us is whether the provisions of computation of business profits in Article 7 are to viewed as subject to the application of non-discrimination clause in Article 24(2), or is it the other way round i.e., non-discrimination clause to be read as subject to the clause regarding computation of business profits. There are other peripheral or subsidiary issues raised before us, such as, whether the provisions of Section 44C can be viewed as a restriction on admissibility of deduction of head office expenditure at, and, whether the provisions of Section 44C, only provide for a fair method of estimation of deductible head office expenses and are enabling provisions in nature.

6. Article 24(2) of the Indo-Canadian DTAA is worded on the lines of Article 24(3) of the OECD Model Convention. In fact, it is verbatim extract from the Model Convention. While elaborating upon the scope of the said clause the OECD Model Convention Commentary, inter alia, states as follows : With regard to the basis of assessment of tax, the principle of equal treatment normally has the following implications : (a) PE must be accorded the same right as resident enterprises to deduct the trading expenses that are, in general, authorised by the taxation law to be deducted from taxable profits in addition to the right to attribute to the PE a proportion of overheads of the head office of the enterprise. Such deductions should be allowed without any restriction other than those imposed on the resident enterprise.

It is thus clear that according to the scope of this clause as explained by the OECD Commentary, includes the deduction on account of head office expenditure. In addition to the deduction of normal business expenditure of a PE as permissible under the domestic taxation laws, the deduction is also required to be allowed for a proportion of overheads of the head office and such a deduction is to be allowed without any restriction other than those imposed on the resident enterprise. This makes two things clear-(a) that the restriction on admissibility of expenditure in accordance with the domestic law is, according to the OECD Commentary, is in respect of the normal business expenditure incurred by the PE; and (b) that the deduction on account of overheads of the head office is to be allowed without placing any restriction on such deduction save and except such restrictions as may also be placed on the resident enterprises. As the provisions of Article 24(2) of Indo-Canadian DTAA and of the provisions of Article 24(3) of the OECD Model Convention are in pari materia, the OECD Model Convention Commentary has a key role in determining the scope and connotations of art 24(2) of the Indo-Canadian DTAA. Hon'ble Andhra Pradesh High Court in the case of CIT v. Vishakhapatnam Port Trust (1983) 144 ITR 146 (AP), referred to the OECD Commentary on the technical expressions and the clauses in the model conventions, and referred to, with approval, Lord Redcliffe's observation in Ostime v.Australian Mutual Provident Society (1960) 39 ITR 210, 219 (HL) which have described the language employed in those documents as the 'international tax language'. These documents are thus in the nature of contemporanea expositio inasmuch as the meaning indicated in these documents to the clauses and expressions in the tax treaties can be inferred as the meaning normally understood in, to use the words of Lord Redcliffe, 'international tax language' developed by the organizations like OECD. This is so held in the case of Graphite India Ltd. v. Dy. CIT (2003) 78 TTJ (Cal) 418 : (2003) 86 ITD 384 (Cal).

When an expression or a clause is picked up from the OECD Model Convention, the normal presumption is that the persons using the said clause or expression are also aware about the meanings assigned to the said clause or expression by the OECD and have used it in the same sense and for the same purpose. Unless a contrary intention is specifically expressed, say by a protocol attached to the DTAA, it is only axiomatic that the clause or the expression will have the same meaning as normally assigned in the tax literature by the OECD.Therefore, when an expression or a clause from the OECD Model Convention is used even in a bilateral tax treaty involving a non OECD country, one has to proceed on the basis that it is used in the same meaning and with the same connotations as assigned to it by the OECD Model Convention Commentary. As per the OECD Commentary, placing a restriction on the deduction on account of overheads of the head office, except when the same restriction is also placed on the resident enterprises, does constitute discrimination under Article 24. The taxation on a PE of a Canadian company, by the reason of placing a restriction on deduction of head office expenditure which is not applicable in the case of resident companies, does, therefore, constitute less favourable tax treatment in India than the taxation levied on Indian enterprise carrying on the same activities in India.

Viewed in this perspective, it is clear that the limitation on deduction of head office expenditure, as stipulated by Section 44C of the Act, will be hit by the non-discrimination clause in the Indo-Canadian DTAA. In any event, on a plain reading of the provisions of the Article 24(2), we are of the considered view that a restriction on admissibility of head office overheads of PE of a Canadian company constitutes discrimination against such a PE vis-a-vis a domestic Indian entity because no such restriction is applicable for deduction of head office or controlling office overheads of an Indian entity. It puts PE of a Canadian company to an unfair disadvantage inasmuch as even legitimate business expenses attributable to the PE and deductible under Section 37(1) cannot be allowed as a deduction in the light of restriction placed under Section 44C of the Act, whereas all the legitimate business expenses of the Indian entity operating in India will be allowed as a deduction. The scope of deduction under Section 37(1) thus stands curtailed for PE of a Canadian company.

7. In the Indo-Canadian DTAA, arts. 24 to 28 are clubbed together under Chapter VI titled "specific provisions", whereas the provisions of arts. 6 to 21 are contained in Chapter III titled "taxation of income".

It is thus clear that the provisions of Article 24 are specific provisions whereas the provisions of Article 7 are in the nature of general provisions. While taxation of business profits under Article 7 refers to the general principles on the basis of which the business profits are to be computed, Article 24(2) refers to the specific provision that the PE of the residents on one State shall hot be subjected to any taxation which is less favourable vis-a-vis the taxation levied on enterprises of that other State carrying on the same activities. On the issue whether the general provisions will prevail over the special provision or vice versa, the law is fairly well settled. As aptly conveyed by the legal maxim generalia specialibus non derogant', i.e., special things derogate from general things. As observed by a co-ordinate Bench, in the case of ITO v. Titagarh Steels Ltd. (2001) 73 TTJ (Cal) 297 : (2001) 79 ITD 532 (Cal) and relying upon Hon'ble Supreme Court judgment in the case of South India Corporation (P) Ltd. v. Secretary, Board of Revenue AIR 1964 SC 207, 'a special provision normally excludes the operations of general provision'. The provisions of Article 7 being general in nature are therefore, required to be read as subject to the provisions of Article 24. Revenue's argument that since the business profits are to be computed "in accordance with the provisions of and subject to the limitations of the taxation iaws of that State" under Article 7(3) and, therefore, limitation placed under Section 44C of the Indian IT Act cannot be ignored, cannot, therefore, be accepted. What Article 24(2) seeks to remove is the discrimination to the permanent residents of Indian and Canadian residents in the other States visa-vis the domestic business entities of that other State. When domestic tax laws permit such discrimination, such legal provisions have to be treated as overridden by the provisions of the Indo-Canadian DTAA. There is no dispute about the fact that when the provisions of the IT Act and the DTAA are in conflict, the provisions of the Act will be applicable only to the extent the same are more beneficial to the assessee. In other words, the provisions of the treaty prevail over the provisions of the Act.

Therefore, the restriction placed on the allowability of the head office expenditure by Section 44C of the Act is to be ignored in the light of the provision of Article 24(2) of the Indo-Canadian DTAA.8. The next contention of the Revenue is that the provisions of Section 44C are not in the nature of restriction but provide only a fair method of allocation of head office overheads. It is also contended that in the absence of the provision of Section 44C, the head office expenses cannot be allowed at all for want of verification of expenses. We see no substance in this plea either. In the case of CIT v. Deutsche Bank AG (IT Ref. No. 139 of 1997, judgment dt. 24th July, 2003), upholding the action of this Tribunal, Hon'ble Bombay High Court held that in a case where Section 44C is held to be not applicable, the head office expenditure was allowable under Section 37(1) of the Act and that Section 44C puts a ceiling on the deduction of head office expenditure.

Whatever be the object of the said section, it is clear that it is in the nature of a disabling provision which puts a ceiling on the admissibility of a deduction. It does constitute a restriction-and a restriction which is not similarly placed for a domestic enterprise.

The head office expenses, to the extent the same can be fairly allocated to the PE, are admissible as deduction under Section 37(1) and this is so held by the Hon'ble jurisdictional High Court in Deutsche Bank's case (supra).

9. We have noted that the CIT(A) has, in the asst. yrs. 1994-95 and 1996-97 restored the matter to the file of the AO for examining the claim of expenditure as attributable to the PE in India, and the assessee is not in appeal against these directions. Therefore, beyond dispute, only such expenses are to be allowed as a deduction on account of head office expenses as can be fairly allocated to the PE. The only impact of the applicability of non-discrimination clause will be that the scope of deduction under Section 37(1) will not stand curtailed by the restriction placed under Section 44C of the Act. In our considered view, this direction of the CIT(A) is justified and calls for no interference.

10. As far as asst. yr. 1993-94 is concerned, the CIT(A) has held that the provisions of Section 44C will apply but then, for the reasons set out above, we are of the considered view that Section 44C has no application in the matter and that the assessee is to be allowed deduction of such head office expenses as can be fairly allocated to the PE. Accordingly, as for the asst. yr. 1993-94, the matter is to be restored to the file of the AO for adjudication de novo in the light of the above observations.

11. In the result, the appeals filed by the Revenue are dismissed and the appeal filed by the assessee is allowed for statistical purposes.


Save Judgments// Add Notes // Store Search Result sets // Organizer Client Files //