Income
Tax Appellate Tribunal - Mumbai
Mashreque
Bank vs Dy. Director Of IncomeTax on 23 August, 2007
1. This is an appeal
filed by the assessee and is directed against the order dated 15-1-2001 by the Commissioner
(Appeals) in the matter of assessment under Section 143(3) of the Income Tax
Act, 1961, for the assessment year 1997-98.
2. Ground Nos. 1, as
raised in the grounds of appeal before us, was stated to be not pressed. As
such the same is dismissed for want of prosecution.
3. In ground Nos. 2 and
3, the only grievance pressed before us is that in view of the provisions of Article
7(3) of India-UAE tax treaty, artificial disallowances such as in respect of
entertainment expenses and in respect of payments in violation of Rule 6D
cannot be made.
4. This issue also came
up in assessee's own case for the assessment year 1996-97 which was heard along
with this appeal. Learned representatives have fairly agreed that whatever is
decided in the assessment year 1996-97 will follow in this year as well.
5. While dealing with
the assessment year 1996-97, and vide our order dated 13-4-2007, we have observed
as follows:
5. We find that all the
three orders passed by the co-ordinate Benches, which have been cited at the bar
by the learned Counsel, dealt with the issue as to whether or not artificial
disallowances under the Indian Income Tax Act can be made while computing the
profits attributable to a PE under the old India-France tax treaty [(1970) 76
ITR (St.) 1]. In thefirst order in the case of Degremont International(supra),
which has beensubsequently followed in other orders cited at the bar, the co-ordinate
Bench was dealing with the question whether restriction on deduction ofhead
office expenses under Section 44C is to be viewed as contrary to the provisions
of the India-France tax treaty. A note was taken of Article 111(3) of the
treaty which provided that, as summarised in the said order,"whatever is
reasonably allocable out of the expenditure incurred in boththe countries, should
be allocated and allowed as deduction". In theimmediately following
sentences and in the same breath, the co-ordinate Bench concluded that "We
consider it a very specific provision incomputing the income of a non-resident
having activities in India and France. Therefore, the provisions of Section 44C
will not be applicable". In the present case, we are not concerned with Section
44C. In any event, having carefully gone through this decision, we find that
the attention of the Tribunal was apparen tly not invited to the provisions of
Article XIX(1) of the same treaty which specifically provided that "the
laws in force in either of the Contracting State will continue to govern the
taxation of income in the respective Contracting State except where specific
provisions to the contrary is made in the present agreement". The
provisions of Article 111(3) of India-France treaty obviously cannot be read in
isolation with other relevant provisions of the treaty. However, since attention
of the Tribunal was never invited to article XIX(1), nor did the Tribunal have
any occasion to deal with the same, the conclusion arrived at by the Tribunal
did not take into account provisions of the treaty as a whole. In a later
decision by another co-ordinate Bench of this Tribunal, ie., in the case of
DCIT v. Mitsubishi Heavy Industries Ltd. 61 TTJ 656, took note of similar
provision in Indo-Japan tax treaty, and, in view thereof, rejected the
contentions of the assessee by observing as follows:
Ground No. 5 relates to
the findings given by the Commissioner (Appeals) holding that in view of Article
111(3) of DTA with Japan, no disallowance can be made under Rule 6D, Section
40A(3), Section 40A(12), Section 37(2A) and Section 43B of the Income Tax Act,
1961.
Article 111(3) in the
relevant DTA relating to the year under consideration only provides that in
determining the industrial or commercial profits of a permanent establishment,
there shall be allowed as deduction all expenses, wherever incurred, reasonably
allocable to such permanent establishment. It does not expressly provide that
the provisions of domestic income-tax law governing the allowability of various
expenses will be subject to limitations and conditions prescribed in the
relevant provisions contained in the Income Tax Act, 1961. We. however, find in
article XI(1), it has been clearly provided as under:
Article XI : The laws
in force in either of the Contracting State will continue to govern the
taxation of income in respective Contracting State except where provisions to
the contrary are made in the present agreement.
In view of the
aforesaid clause, the provisions of the Income Tax Act, 1961, relating to
computation of taxable income will apply in the case of the assessee except
where the provisions contained in the DTA are contrary to the conditions
specifically mentioned in the Income Tax Act. Therefore, the Commissioner
(Appeals) was not justified in deleting the aforesaid disallowances on the
ground that all the provisions will not be applicable in the case of the
assessee....
6. In this view of the
matter, Tribunal's decision in the case of Degremont International (supra) was not
applied in subsequent decisions in the context of the tax treaties where
specific provisions are made to the effect that the laws in force in either of
the Contracting State will continue to govern the taxation of income in
respective Contracting State except where express provisions to the contrary are
made in the such agreement. The decision in Mitsubishi's case (supra) is a
later decision, is arrived at after taking into account all the relevant
provisions and not only Article 111(3) in isolation, and is specifically in the
context of artificial disallowances under Section 40A(3), Section 40A(12), Section 37(2A) and
Section 43B, etc. We have to accept the fact, as clearly discernible from unequivocal
stand taken by another co-ordinate Bench in Mitsubishi's case (supra), that
Degremon International (supra) was rendered by oversight and oblivious of the
provisions of article XIX(1) of old India-France tax treaty. In any event, it
does not have precedence value in the context of India-UAE tax treaty,
particularly as we take note of the provisions of Article 25(1) of the tax
treaty read with observations made by another co-ordinate Bench in Mitsubishi's
case (supra). The provisions in India-UAE tax treaty are specific and admit no
ambiguity on question of applicability of domestic tax laws in the absence of
specific provisions to the contrary under the tax treaty.
7. When this was
pointed out to the learned Counsel, our attention was drawn to the decision of Kolkata
Special Bench in the case of ABN Amro Bank v. ADIT 97 ITD SB 89 (Kol) wherein,
on materially identical provision, the Special Bench has held that provisions
of Section 40(a)(i) are not applicable in the case of interest paid by the
banks. In our considered view, however, the ABN Amro Special Bench decision
(supra) is certainly not an authority for the proposition that disallowance under
Section 40(a)(z) are impermissible under the provisions of India-Japan tax
treaty. As a matter of fact, in the said decision, the Special Bench held that
the provisions of Section 195 do not come into the play in the case of Branch
head office transactions because these are transactions from self to self.
The Special Bench,
inter alia, observed as follows:
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 one 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 Income Tax Act. This section provide 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 pre-supposes 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.
8. As regards the
question of impermissibility of artificial disallowances by the virtue of the provisions
of Article 7(3), there is no specific finding by the Special Bench. We
reproduce below the entire paragraph, on which learned Counsel has placed the
reliance, for ready reference:
50. On a close reading
of these provisions, we find that Clauses 1, 2, 5, 6 and 7 of Article 7 of the Japanese
Double Taxation Avoidance Agreement are similarly worded as Clauses 1, 2, 4, 5
and 6 of Netherlands Double Taxation Avoidance Agreement. Clause 3 of the
Japanese Double Taxation Avoidance Agreement merely incorporates the first part
of Clause 3(a) of Netherlands Double Taxation Avoidance Agreement and the
proviso placing a restriction by the law of the State in which PE is situate
are not incorporated. Again, Clause 3(b) of Netherlands Double Taxation Avoidance
Agreement which prohibits allowance of certain expenditure is also missing in
Japanese Double Taxation Avoidance Agreement. 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 Income Tax 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 Double Taxation Avoidance Agreement 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 Double Taxation Avoidance
Agreement, 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 Commissioner (Appeals) 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. (Emphasis herein italicised print in supplied)
9. A plain reading of
the above paragraph indicates that while the Special Bench has indeed taken note
of the argument that in terms of the provisions of Article 7(3), the provisions
of Section 40(a)(i) do not apply, the decision of the Special Bench rests on
the principle, as laid down while dealing with Netherlands treaty, that
payments from self to self cannot saddle the assessee with tax withholding
liability. We are in respectful agreement with the principle so laid down by
the Special Bench. We have noted that the Tribunal has not given any finding
direct or even indirect-approving the argument that artificial disallowances
are not permissible under the provisions of the India-Japan tax treaty. The
Special Bench has merely speculated about the reasons of the assessing officer's
stand about non-deduction of tax at source, and has not adjudicated upon the
same. The Special Bench did not see, and very appropriately so, any need to
adjudicate on this ground, because irrespective of whether or not provisions of
Section 40(a)(z) laying down disallowance of expenditure in respect of which
tax withholding liability is not discharged by the assessee, apply to the assessee,
there was no tax withholding requirement on payments from branch office to head
office, or vice versa. The question about applicability of Section 40(a)(i),
therefore, was entirely academic in this context. Merely because the Special
Bench has noted an argument, even though it has not adjudicated upon the same,
it cannot be inferred that the Special Bench has approved the said argument. We
reject the plea of the learned Counsel. The next line of defence by the learned
Counsel is his reliance on the Tribunal's decision in the case of Siemens AG v.
ITO 22 ITD SB 87. It is submitted that in this decision, the Tribunal has held
that definition of 'royalty' under the Income Tax Act will not have any bearing
in deciding the scope of expression 'royalty' for the purposes of the tax
treaty. We are in respectful agreement with the views so stated by the
Tribunal, but we are unable to comprehend as to how this proposition can enable
us to ignore the specific provisions of the India-UAE tax treaty. Article 25(
1) of the applicable India-UAE tax treaty [(1994) 205 ITR (St.) 49]
specifically provides that "the laws in force in either of the Contracting
State will continue to govern the taxation of income in respective Contracting
State except where express provisions to the contrary are made in the present
agreement". We are, therefore, not persuaded by the submissions of the
learned Counsel to the effect that provisions of the Income Tax Act have no
application in the matter. In view of this specific provision being a part of
the India-UAE tax treaty, it cannot be said that by the virtue of Article 7(3)
of the treaty which provides that "in determining the profits of a
permanent establishment, there shall be allowed as deductions expenses which
are incurred for the purposes of the business 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",
the provisions of Indian Income Tax Act will not apply with regard to deducibility
of expenses. In this view of the matter, and respectfully following the
Mitsubishi decision (supra), we hold that the provisions of domestic tax laws
in India as also in UAE will continue to apply except to the extent specific
contrary provisions are set out in the India-UAE tax treaty. The assessee thus
derives no advantage from the provisions of Article 7(3) so far as freedom from
artificial disallowances under Section 40A(3), Section 40A(12), Section 37(2A)
and Section 43B is concerned. As there is no specific contrary provision in the
treaty, these and similar other restrictions on deductibility of expenses under
the Indian Income Tax Act continue to be applicable, in computation of profits
attributable to Indian PEs of UAE tax residents. The plea of the assessee is thus
devoid of legally sustainable merits.
10. The Canadian
Federal court had an occasion to deal with the question whether a tax treaty,
when providing that 'in determining the profits of a PE, there shall be allowed
as deduction, expenses which are incurred for the purposes of the PE, including
executive and general administrative expenses so incurred, whether in the State
in which PE is situated or elsewhere' enable the deduction of items not
permitted by domestic law, so that non-residents are better off than residents.
Even without the aid of a provision similar to one which exists in Article
25(1) of the India-UAE tax treaty, the court answered this question in negative
and decided the issue against the taxpayer. In the case of Utah Mines v. The
Queen 92 DTC 6194 : (1992) 1 CTC 306, and while dealing with the issue whether
in view of the provisions of Article 7(3) of Canadian-US tax treaty, royalties
paid by PE of US company to the provincial government, which were not tax
deductible under the Canadian domestic tax law, could be allowed as deduction,
the court observed:
The interpretation
proposed by the appellant, on the other hand, would have the effect of giving;
a US taxpayer with a permanent establishment in Canada a more favourable tax
treatment than its Canadian competitor engaged in the same business in this
country. Such a result would not be in accordance with the policy expressed in
the preamble to the Convention and indeed would be contrary to it. It would
take much clearer language than a simple reference to 'all expenses' to bring it
about.
11. In a situation,
therefore, in which a specific provision like the one in Article 25(1) in
India-UAE tax treaty exists, there cannot be any occasion to ignore the
limitations on deduction of expenses under the domestic tax legislation. That
would be a case of, what can be termed as, reverse discrimination. Just as much
a discrimination against a non-resident assessee is undesirable, a discrimination
against the resident assessee is also not desirable. As is the underlying
philosophy of the tax treaties, there should be a level paying ground for
everyone, which must include domestic enterprises as well. When we put this to
the learned Counsel, it was submitted that it is not clear as to what was the
language in the relevant Double Taxation Avoidance Agreement and whether the government
of Canada has used different terminology in different tax treaties. Learned
Counsel also submitted that this 'reverse discrimination', as we term it, is
not only permissible under the tax treaties, it is also permissible under the
Income Tax Act. Our attention was then invited to the provisions of Section
10(15) which provides for certain exemptions only to non-residents, as also the
provisions of Section 115A which provides for lower rates of taxes for certain
category of incomes of the non-residents. Learned Counsel has also invited our
attention to different phraseology employed in different treaties, and contended
that a uniform meaning given to all these different expressions will make
differentiation in expression meaningless. It is also contented that once a tax
treaty is legally entered into by a Contracting State, it is duty of the
Contracting State to apply the same in letter and in spirit. Our attention is
invited to the CBDT Circular No. 333 which is also referred to by some of the
Tribunal decisions cited by the learned Counsel. Learned Counsel submits that
it cannot be open to a Contracting State to shy away from implementing a tax
treaty on the ground that the consequences of its implementation could be
contrary to the intentions of the treaty. We are thus urged to interpret the
provisions of Section 7(3) to mean that all the expenses, irrespective of the limitations
under the domestic tax laws, incurred by the PE are to be allowed as deduction
in computing the taxable profits of the PE.
12. We are not
impressed with this line of reasoning either. As far as learned Counsel's
reference to exemptions available to non-resident taxpayers, under the Indian
Income Tax Act, is concerned, it is important to bear in mind that an exemption
for aliens essentially seeks to restrict host country's jurisdiction to tax,
and it is well-settled that, as has also been observed by Prof. Kees Van Raad,
'while nationality is
virtually unconditionally employed as a ground of non-discrimination...it is
not related to the use of nationality as jurisdictional basis for
Income-taxes....' [Non-discrimination in Income Tax Law - Prof. Kees Van Raad,
at page 15]. Therefore, non-taxability of any of an aliens income source in the
host country cannot be viewed as discrimination in his favour. It is,
therefore, too far-fetched to suggest that availability of certain tax
exemptions to aliens shows that reverse discrimination is generally permissible
under the scheme of Indian Income Tax Act. We reject this proposition. As far
as learned Counsel's reference to Section 115A is concerned, this is also
fallacious inasmuch as it does not take into the fact that the related incomes
are taxed on gross basis in the hands of the nonresidents taxpayers and net
basis in the hands of the resident taxpayers. Dealing with this aspect of the
matter, a co-ordinate Bench of this Tribunal, in the case of DCIT v. Boston Consulting
Group (P) Ltd. 94 ITD 31 has observed as follows:
19. Section 44D was
brought on the statute, with effect from 1 -4-1976, by the Finance Act, 1976.
By the same Finance Act, Section 115A was also introduced. Section 44D, as we have
already seen, provides for taxation of royalties and fees for technical
services on gross basis and without allowing any deduction for expenses
incurred in earning the said income. Section 115A, on the other hand, provides
for a special rate of tax on certain incomes including the income from
royalties and fees for technical services. The provisions of these two Sections
are required to be read together inasmuch as while one section lays down that
no deductions are permissible in computation of income from, inter alia,
royalties and fees for technical services, the other section provides for a
lower rate of tax from the said income. These are complementary provisions in
that sense. These two Sections are to be read in conjunction and not in
isolation. Explaining the scope and nature of these sections, Board Circular
No. 202, dated 5-7-1976 105 ITR Statute 17 stated that:
Special provision for
computing income by way of royalties and technical service fees in the case of foreign
companies - New Section 44D.
26.1 Hitherto, income
by way of royalties received under agreements made after 31-3-1961, and approved
by the Central Government wastaxed in the hands of foreign companies at the
rate of 52.5 per cent [income-tax 50 per cent plus surcharge 2.5 per cent].
Income by way of technical service fees received under agreements made after
29-2-1964, and approved by the Central Government was also taxed at the same
rate. In either case, the taxable income was determined on net basis, ie., after
allowing deduction in respect of costs and expenses incurred for earning the
income.
26.2 The Finance Act
has inserted a new Section 44D in the Income Tax Act, 1961, which lays down special
provisions for computing income byway of royalties and fees for technical
services received by foreign companies from Indian concerns....
26.3 As regards
royalties and technical service fees received under agreements made on or after
1-4-1976 [other than agreements which though made on or after that date or
regarded as having been made before that date as explained in paragraph 26.2]
no deduction will be allowed in computing the income from the aforesaid
sources, regardless of whether the agreement has been....
36.1 ...income by way
of royalty or fees for technical services received by them from Indian concerns
in pursuance of approved agreements made on or after 1-4-1976, will now be
charged to tax at flat rates applicable on the gross amount of such income. The
rates of income-tax to be applied in respect of such income have been specified
in new Section 115A of the Income Tax Act and are as follows:
(iii) Income by way of fees for technical
services received by a foreign company from an Indian concern in pursuance of
an approved agreement made on or after 1-4-1976, will be charged to tax at the
rate of 40 per cent on the gross amount of such fees.
The periodic changes in
Section 441 have been accompanied by the corresponding changes in Section 115A.
It is thus clear that non-deduction of expenses under Section 44D, which means
that the taxability is on gross basis, is coupled with a special rate of tax
for such income on gross basis under Section 115A....
13. In this view of the
matter, the comparison of lower tax rates under Section 115A, for the non-resident
tax payers, with higher tax rates under the Finance Act, for resident tax
payers, is irrelevant. In the case of nonresidents, there were restrictions for
deduction of expenses incurred for earning dividend, interest and royalty
incomes. It is also interesting to note that when the restrictions under
Section 44D ceased to be effective from 1-4-2003, the corresponding income,
ie., income from royalties and fees for technical services, was also taken out
of the ambit of lower tax rate under Section 115A. Therefore, taxability of incomes
at a lower rate under Section 115A cannot be viewed in isolation. The relevant
incomes are taxed on net basis in the formal case, while taxability is on the
net basis in the latter. When tax base is not the same, the comparison of tax
rates is meaningless.
14. Let us also not
forget the fact that principles governing a tax treaty arequite different vis-à-vis
principles governing a tax legislation. Hon'ble Supreme Court, in the case of
Union of India v. Azadi Bachao Andolan (2003) 263 ITR 706 (SC) had an occasion
to deal with the principles governing the interpretation of tax treaties. In
this regard, Hon'ble Supreme Court held that the principles adopted in the
interpretation of treaties are not the same as those adopted in the
interpretation of statutory legislation. Their Lordships quoted, with approval,
following passage from the judgment of the Federal court of Canada in the case
of M. Gladden v. Her Majesty the Queen 85 DTC 5188, at page 5190 wherein the
emphasis is on the 'true intentions' rather than 'literal meaning of the words employed':
Contrary to an ordinary
taxing statute, a tax treaty or convention must be given a liberal interpretation
with a view to implementing the true intentions of the parties. A literal or
legalistic interpretation must be avoided when the basic object of the treaty
might be defeated or frustrated insofar as the particular items under
consideration are concerned.
In the said judgment,
as noted by their Lordships at page 743, the Federal Court of Canada recognized
that "we cannot expect to find the samenicety or strict definition as in
modern documents, such as deeds, or Acts of Parliament, it has never been habit
of those engaged in diplomacy to use legal accuracy but rather to adopt more
liberal terms."
15. It is thus clear
that one of the basic principles governing the interpretation of tax treaties
is that a tax treaty must be interpreted ingood faith. Article 31(1) of the
Vienna Convention governing the interpretation of tax treaties also lays down
that, "a treaty shall be interpreted in good faith, in accordance with the
ordinary meaning to be given to the terms of the treaty in their context and in
the light of its objects and purpose". It is, therefore, important that
undue emphasis should not, in any event, be given to a legalistic and literal
approach in interpreting a tax treaty; the effort should always be made to
harmonise the interpretation of the words of the treaty with its object and purpose.
Viewed in this perspective, in our considered view, it is not possible to
proceed on the basis that a discrimination in favour of the non-resident tax
payer by the host country, without any specific provision to that effect, can
be inferred. It is only elementary that a tax treaty is required to be read as
a whole and, when the India-UAE tax treaty is read as a whole, the scheme of non-discrimination
is clearly discernible from the scheme of things. It would, therefore, be quite
inappropriate to read the provisions of the treaty in such a manner so as to
result in discrimination against residents of one of the Contracting States;
there cannot be any justification for exception to this underlying object of
the treaty by reading the provisions of tax treaty in such a manner as to permit
discrimination against residents of PE host country. When a treaty explicitly
seeks to ensure that there is no discrimination by the host country against a
non-resident, who is resident of the other Contracting State, it is really
incongruous to interpret the treaty in such a manner that host country has to
discriminate against its own residents vis-a-vis the residents of the other
Contracting State. Such an interpretation will not only be contrary to the
provisions of the Vienna Convention but also contrary to the law laid down by
the Hon'ble Supreme Court of India, which, in turn, has concurred with Canadian
Federal court on the principles governing tax treaties. For this reason also, the
proposition advanced by learned Counsel does not meet our approval.
16. The next thing that
needs our consideration is learned Counsel's suggestion that different phraseology
employed in the Indian tax treaties warrant an interpretation in such a manner
that a uniform meaning is notgiven to all these different expressions because
differentiation in Gexpression will then be rendered meaningless. Unlike a
piece of tax legislation, which is creature of a sovereign State, a tax treaty
is a result of bilateral negotiations. Therefore, the wordings of a tax treaty
are essentially dependent on the priorities of, and acceptability by, the
Contracting States parties to such a tax treaty. It is only elementary that
these factors vary from one of set of Contracting States to another set of
Contracting States. The same purpose, therefore, can indeed be intended even by
radically different phraseology employed in tax treaties to which a particular country
is one of the parties. In the case of tax legislation, however, things are
quite different, because, as we have emphasized earlier, tax legislations are
unilateral acts of the law making bodies, and when a law making body makes even
slightest departure from the expression it is used earlier, the normal
inference is that such deviation, being a unilateral act, has some specific
intent and purpose. The tax treaties being product of bilateral negotiations,
deviation in language of the tax treaties entered into by a country, does not
necessarily indicate a deviation in objectives and purpose that these tax
treaties seek to achieve. It is also not common that some of the Contracting States
are too conservative in their approach and insist on certain provisions as a
measure of abundant caution [ex abudanti coutela]. As regards learned Counsel's
contention that once a Contracting State enters into a tax treaty it cannot be open
to that Contracting State to shy away from implementing such a tax treaty on
the ground that the consequences of its implem entation could be contrary to
the intentions of the treaty, we quite agree with the learned Counsel. However,
what is needed to be implemented is a clear and unambiguous provision. At best,
if there is an ambiguity in the provisions, it needs to be resolved by way of
harmonious construction in accordance with the well-settled principles of tax
treaties. It cannot be, in any event, open to anyone to embark upon the voyage
of discovery in search of hidden meanings or intent of parties, net supported
by the specific expressions to articulate the same, and then proceed to give
life to these inferences - that too in a manner contrary to the scheme of the
tax treaty. We do not find any specific provision in the tax treaty which
supports learned Counsel's understanding about the scope of Article 7(3); in
fact, we find, as we have elaborated earlier, specific provision in the treaty
which is quite to the contrary. We, therefore, reject this contention as well.
17. In United Kingdom,
revenue's International Tax Handbook (IH 859) uses exactly the same argument,
as was taken by the Federal court of Canada in the case of Utah Mines (supra),
and states that:
We take the view that
neither the Business Profit article in general nor the specific provision concerning
the expenses in particular requires us to allow expenses which are not
admissible in United Kingdom domestic law. For example, we could not allow
capital expenses or entertaining expenses. We say that each Contracting State
is entitled to apply its own general principles and rules in computing the
profits it has right to tax. It would be inequitable to permit a non-resident
trading in a territory though a permanent establishment to deduct items that a
resident competition would not be permitted to deduct.
18. Once again, here
also the applicability of domestic law restrictions on deduction of expenses is
on an independent reading of Article 7(3) and without recourse to a treaty
provision analogous to the provision of Article 25(1) in India-UAE tax treaty.
The case before us is much more favourable to the revenue because there is a
specific provision for the applicability of the domestic law in the light of
the provisions of the Article 25(1) of the India-UAE tax treaty.
19. Well known
international tax scholar Prof. Klaus Vogel, in his book 'Klaus Vogel on Double
Taxation Conventions' has taken note of some of the tax treaties which contain,
in Article 7(3), a specific provision to the effect that allowability of
expenses incurred for the purposes of PE has to be "according to the
domestic law of the Contracting State in which the permanent establishment is situated"
and, in this specific context, observed as follows:
...And the additional
phrase that the deductible expenses shall be determined according to the domestic
law of the State of the permanent establishment is merely a clarificatory one,
since such profits of a permanent establishment as are subject to tax would
have to be determined under the domestic law of the State of permanent
establishment even if this were not expressly stipulated....
20. In this view of the
matter, unless there is a specific provision to the effect that restrictions
under domestic tax laws on deduction of expenses are to be ignored, the same
will have application in computation of PE profits. The specific provisions in
some of the treaties [such as India-Australia tax treaty for example] to the
effect that profits are to be computed according to the domestic law of the
Contracting State in which a PE is situated, is, according to the learned
scholar, no more than clarificatory in nature. A school of thought thus exists
that specific mention of the applicability of domestic law limitations in
computation of profits of the. permanent establishment is justified as a measure
of abundant caution and is made ex abudanti coutela. It is, however, not
necessary to go into that aspect of the matter any further at this stage.
21. In view of the
above discussions, and particularly bearing in mind the provisions of Article
25(1) of the India-UAE tax treaty, we are of the considered view that the
limitations under the domestic tax laws are to be taken into account for the
purposes of computing profits of a PE under Article 7(3) of the India-UAE tax
treaty. The plea of the assessee is incompatible with overall scheme of the tax
treaties, particularly India-UAE tax treaty. Accordingly, the conclusion
arrived at by the Commissioner (Appeals) meets our approval. We confirm the
same and decline to interfere in the matter.
6. We see no reasons to
take any other view of the matter than the view so taken by us for the assessment
year 1996-97. Accordingly, for the detailed reasons set out in the said order
and which have been reproduced above, we dismiss the grievance of the assessee
and decline to interfere in the matter. The disallowances sustained by the
Commissioner (Appeals) are approved and confirmed.
7. Ground Nos. 2 and 3
are thus dismissed.
8. In Ground No. 4, the
assessee has raised the following grievance:
The Commissioner
(Appeals) erred in upholding the Assistant Commissioners action of not allowing
the appellant's claim that the tax rate applicable to its business income is 43
per cent [40 per cent tax and 7.5 per cent surcharge] and not 55 per cent being
the rate applicable to foreign companies for the year under appeal.
The appellant submits
that in view of Article 26 of the tax treaty, i.e. non-discrimination clause,
read with Section 90(2) of the Income Tax Act, the business income is
chargeable to tax at the rate of 46 per cent as is applicable to domestic
companies.
9. This issue has also
been considered by us while adjudicating upon assessee's appeal for the assessment
year 1996-97, which was heard alongwith this appeal. Learned representatives
have fairly agreed that our decision on the appeal for the assessment year
1996-97 will apply on this year as well. In our decision dated 13-4-2007 on the
said appeal, we have, inter alia, observed as follows:
28. It is also
important to bear in mind that provisions of a tax treaty, override domestic
law in India, by the virtue of specific provision to that effect in the Income
Tax Act. Therefore, this superior position of the tax treaties vis-a-vis
domestic law is subject to the conditions so laid down in the 'enabling
provision set out under Section 90 of the Act. Now, this enabling provision
itself clarifies that differential tax rate between a domestic company vis-a-vis
foreign company shall not be construed as discrimination against the foreign
companies. To that extent, therefore, overriding effect of the tax treaty
provisions is nullified, and the provisions of Article 26(2) of India-UAE tax treaty
have to be construed in the light of this limitation. Article 26(2) of the
India-UAE tax treaty provides that, "the taxation of a permanent
establishment which an enterprise of a Contracting State has in the other
Contracting State shall not be less favourably be levied in that other State
than the taxation levied on enterprise of that other carrying on the same
activities in same circumstances or under similar conditions". In our
view, the basic mandate of Article 26(2) of India-UAE tax treaty is that a
permanent establishment, in one State, of a non-resident enterprise must not be
taxed any less favourably that the enterprise of that State. To that extent, we
agree with the learned Counsel.
However, we do not
think that for the purpose of this comparison, it is possible to ignore the
form of ownership. A comparison can only be made with comparables. Under
Article 3(1)(g), the expression "enterprise of a Contracting State"
has been defined "as an enterprise carried on by the resident of that
Contracting State". And, on the basis of definition of 'resident' under
Article 4(1) and of 'person' under
Article 3(1)(e), the expression 'resident* refers to "any individual, a
company, and any other entity which is treated as a taxable unit under the
taxation laws in force in the respective Contracting States, who, under the
laws of that State, is liable to tax therein by the reason of his domicile,
residence, place of management, place of incorporation or any other criterion
of similar nature". The form of ownership, therefore, becomes relevant. An
enterprise cannot be considered in isolation with the person [i.e. individual,
company or co-operative society etc.] which carries it on. It is also important
to bear in mind that a PE has no distinct form of ownership; the ownership characteristics
of a PE have to be the same as that of the enterprise of which it is a PE.
Therefore, in a case PE belongs to a banking company formed in UAE, and taxable
units of that banking company is "company", such PE can only be
compared with a domestic enterprise in India which is assessed as
"company" and carries on the same business. In the present case, the
assessee before us is admittedly a company incorporated in the UAE, and,
therefore, for the purposes of Article 26(2), PE of the assessee can only be
compared with a domestic company carrying on the same activities in the same
circumstances or similar conditions. The plea of the assessee, therefore, does
not meet our approval.
29. Prof. Kees Van
Raad, a very well known international tax scholar, in his book "Non-discrimination
in International Tax Law", published by Kluwer Law International (ISBN 90 6544
2669), has, at page 135, has observed that:
...a foreign
entrepreneur who resides in State 'B' as individual, his tax position in State
'A' in respect of permanent establishment income mustbe compared with that of a
resident individual of State 'A' who operatesa similar enterprise in State 'A'.
And if the foreign enterprise is operated by a corporation, its tax position
must be compared with that of an 'A' State resident corporate taxpayer.
30. Prof. Raad has made
the above observations in the context of Article 24(3) of the OECD Model Convention
which provides that "the taxationof a permanent establishment which an
enterprise of a Contracting Statehas in the other Contracting State shall not
be less favourably be leviedin that other State than the taxation levied on
enterprise of that other carrying on the same activities". The observations
will, therefore, apply with equal force in the context of Article 24(2) of
India-U AE tax treaty. We are in considered agreement with the views so
expressed by this eminent international tax scholar.
31. Prof. Vogel,
another distinguished international tax scholar, also makes some interesting observations
in this regard. In his book Vogel on Double Taxation Conventions' and in the
context of Article 24(3) of the OECD Model Convention, he observes, at page
1315, as follows:
...Since tax burdens
often depend on the legal form of the enterprise to be taxed, this criterion should
be taken into account additionally when determining the enterprise with which
to compare the permanent establishment. Since the latter is only a part of the
enterprise that has its head office in another State and no independent legal
status, the comparison should attach to the legal set up of that enterprise....
32. We agree with the
distinguished scholar. It would thus follow that comparison of a PE of one State
carrying on business in the other Contracting State, with enterprise in the other
Contracting State is not activity specific alone, it must bear in mind the form
of ownership as well. The question of comparing tax rates applicable on PE with
that of the domestic co-operative societies carrying on the same business can
only arise when the enterprise of which it is a PE also the same form of ownership,
i.e. co-operative society.
33. We would also like
to refer to another interesting observation madeby Prof. Vogel, which is relevant
in the context of issue in appeal beforeus. On the same page i.e. 1315, Prof.
Vogel has also observed as follows:
Protection against
discrimination does not include special tax privileges granted to public bodies
of taxing State and non-profit institutions, provided that their activities are
performed for the purposes of public benefit exclusively specific to that
State. In those cases, a comparison with activities of a permanent
establishment aiming to make profits for its own account is impossible. This
restriction, which MC Commentary expressly refers to in connection with
non-discrimination of nationals applies mutatis mutandis to the rule of
non-discrimination for permanent establishment.
34. The views so
expressed by Prof. Vogel are quite appropriate; we share his perception. It
will indeed be unreasonable to expect parity in taxation of profit making
organizations with non-profit making organizations, and taxation of local
public welfare bodies in a State with taxation of bodies which are
transnational in their operations.
35. In view of the
above discussions, and for the detailed reasons set out above, we hold that
just because Indian PEs of foreign banking companies are taxed at a rate higher
than the rate at which Indian co-operative societies carrying out the same
business activity are taxed, the provisions of Article 24(2), dealing with
non-discrimination in taxation of PE, cannot be invoked. We, therefore, reject
the grievance of the assessee as unsustainable in law.
10. We see no reasons
to take any other view of the matter for the year before us. Following our decision
for the assessment year 1996-97, we dismiss the grievance of the assessee and
decline to interfere in the matter. The order of the Commissioner (Appeals)
stands approved and confirmed on this issue as well.
11. Ground No. 4 is
also dismissed.
12. In Ground No. 5,
the assessee has raised the following grievance:
The Commissioner
(Appeals) erred in confirming the action of the ACIT of disallowing Rs.
10,14,045 being the loss on Forward Foreign Exchange Contracts which were
unmatured on the last day of the previous year.
The appellants submit
that Forward Exchange Contracts are mainly entered into to cover the risk arising
due to fluctuation in the exchange rate of currencies. Such contracts are
entered into on an on going basis depending upon the currency position in the
books of the bank. The forward exchange contracts are in the nature of
stock-in-trade and the same are valued at the forward exchange rate notified by
the Foreign Exchange Dealers Association of India as required by Reserve Bank
of India. The forward contracts are normally for a short period. In view of the
above submission any loss on revaluation would be properly allowable as a
deduction in arriving at the business income. Moreover, such contracts are entered
into the ordinary course of business on a day-to-day basis and the revaluation
profit/loss represents the banks business income/loss. The bank has been
consistently following this method in the past which does not result in the
distortion of income/loss booked during the accounting period, and is also in
accordance with the general practice being followed by the banking industry. It
is submitted that the arguments put forward by the assessing officer are
erroneous. The appellants pray that the assessing officer be directed to allow
loss on revaluation of Forward Foreign Exchange Contracts of Rs. 10,14,045.
13. The material facts
are like this. In the course of assessment proceedings, the assessing officer noticed
that the assessee had booked a loss on forward exchange contracts which were
unmatured as on the balance sheet date. The loss to be claimed as a deduction
was Rs. 10,14,045. The loss so computed is by this method. The assessee-bank,
like many other banking institutions, enters into an forward agreement to buy
or sell foreign currencies at a certain price on a specified date. The unmatured
contracts as on the balance sheet dates are the contracts in respect of which
the date of sale or purchase is a date later than such a balance sheet date.
The difference between the prevailing market rate, and the agreed rate, as on
the date of balance sheet date is profit/loss on unmatured contract. For
example, if the assessee bank agrees to sell US $ 10,000 at the rate of 42 on
10-5-1997 and the market rate of US $ as on 31-3-1997 is Rs. 45 the loss on
this unmatured contract as on 31-3-1997 is Rs. 30,000. It is this loss which
was claimed as a deduction by the assessee. The deduction was declined by the
assessing officer on the ground that it is a contingent loss which depends on
how the markets will move on a future date; the actual loss or profit will
depend on the prevailing market price as on the date when the contract is to
mature, e.g. on 10-5-1997 in this case.
Reliance was also placed
upon the Hon'ble High Court judgment in the case of CIT v. Motor Industries Co.
Ltd. (1998) 229 ITR 1371 (Karn). The assessing officer concluded that a loss,
if any, on such forward contracts will only accrue on the date on which the
contract is settled. Referring to Hon'ble Madras High Court's judgment in the
case of Indian Overseas Bank v. CIT (1990) 183 ITR 2002 (Mad), the assessing
officer noted that profit on unmatured forward contract could not be taxed as
income, and that such profits were only notional profits. The assessing officer
concluded that similar loss on unmatured contracts is also a contingent loss
and not eligible for deduction from business income. Aggrieved, assessee
carried the matter in appeal before the Commissioner (Appeals), but without any
success. The assessee is not satisfied and is in appeal before us.
14. We have heard the
rival contentions, perused the material on record and duly considered the factual
matrix of the case as also the applicable legal position.
15. We have taken note
of the fact that the assessing officer has primarily contended that when anticipated
profits on unmatured contracts are held, to be non-taxable, as in the case of
Indian Overseas Bank (supra), there is no good reason as to why anticipated
losses on unmatured contracts can be taken into account while computing
business income. There is, however, an inherent fallacy in this approach
inasmuch as anticipated losses and anticipated profits are not treated in the
same manner in the computation of business profits. The accountancy principle
of conservatism, which has been duly recognized by the courts, mandates that
anticipated losses are to be provided for in the computation of income but it
does not permit anticipated profits to be taken into account till the profits
actually arise. That is the underlying reason that in the case of unsold stock,
when market rate is higher than the purchase price, the market price is ignored
in computation of value of stock, and, as a result, anticipated profit on sale
of such stock is ignored. However, when the market price of stock is lower than
the purchase price, the market price is taken into account, and, accordingly, anticipated
loss is taken into account. These dual standards in recognizing anticipated
losses and anticipated profits are accepted accounting norms. In the case of
Chainrup Sampatram v. CIT , Hon'ble Supreme Court took note of this position
and observed that "while anticipated loss is taken into account,
anticipated profit...is not brought into account as no prudent trader would
care to show increased profit before its actual realisation. This is the theory
underlying the rule that the closing stock is to be valued at cost or market
price whichever is lower, and it is now generally accepted as an established
rule of commercial practice and accountancy". No doubt these observations
were made in the context of valuation of stock but what is material is the
theory underlying the principle of valuing closing stock at cost or market
price whichever is lower and the fact that such a theory has the acceptance of
the Hon'ble Supreme Court. Just because anticipated profits are not assessed to
tax, it would not follow, as a corollary thereto, that anticipated losses cannot
be allowed as deduction in computation of business income. In the light of
these discussions, we are of the considered view that the very basis of the
action of the assessing officer was vitiated in law and on facts. We,
therefore, deem it fit and proper to direct the assessing officer to delete the
impugned disallowance. The assessee gets the relief accordingly.
16. Ground No. 5 is
thus allowed.
17. In Ground No. 6,
the grievance raised by the assessee is as follows:
The ACIT erred in
upholding the Assistant Commissioners action and disallowing Rs. 1,43,200 by way
of capital expenditure out of the pre-operative expenses.
The appellants submit
that it has already considered a sum of Rs. 26,17,500 paid to framework interior
as capital expenditure. The sum of Rs. 1,43,200 towards payment of framework interior
represents revenue expenditure and is allowable as such.
18. As far as this
disallowance is concerned, the material facts are like this. The assessee did
some interior decoration work and a sum of Rs. 26,17,500was spent for that
purpose. This expense was treated as capital expenditure by the assessee
himself. The assessing officer noticed that the assessee has also spent a sum
of Rs. 1,43,200 on account of travelling expenses of the interior decoration team.
As the travelling expenses was in connection with the capital work of interior
decoration, the assessing officer disallowed this travelling expenditure as
well. Aggrieved, assessee carried the matter in appeal, inter alia, on the
issue that the travelling expenses cannot be held to be capital expenses in
nature, but without any success on this aspect of the matter. The assessee is
not satisfied and is in further appeal before us.
19. Having heard the
rival contentions and having perused the material on record, we are inclined to
uphold the plea of the assessee. In the case of CIT v. Bush Boake Allen (India)
Ltd. , Hon'ble Madras High Court has held that expenses incurred cannot always
be viewed as derivative expenses taking colour from the particular transaction
to which they relate. Their Lordships were dealing with legal expenses. As to
the suggestion that if the transaction in connection with which legal expenses
are incurred is in capital field, the legal expenses will be treated as capital
expenditure, Their Lordships observed that "the only merit in this
argument is apparent logical simplicity of it, but abstract logic has seldom
conditioned the evolution of principle in tax laws, as in other laws."
Their Lordships held that as the expenses are of revenue nature in their own right,
the same have to be allowed as revenue deduction irrespective of its linkage
with a capital expense. In our considered view, the same holds good true for
travelling expenses as well. The travelling expenses are revenue expenses in
nature and merely because the travel was in connection with doing the interior
decoration work, it cannot be held to be capital expenditure in nature. We,
therefore, deem it fit and proper to delete the impugned disallowance of Rs
1,43,200. The assessee gets the relief accordingly.
20. Ground No. 6 is
thus allowed.
21. In the result, the
appeal is partly allowed in the terms indicated above.
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