[2005] 97 ITD 89 (KOL.

) (SB)

IN THE ITAT KOLKATA BENCH ‘E’ (SPECIAL BENCH)

ABN Amro Bank NV

v.

Assistant Director of Income-tax, International Taxation-I

R.P. GARG, VICE PRESIDENT G.C. GUPTA AND C.L. SETHI, JUDICIAL MEMBER

IT APPEAL NOS. 694 AND 695 (KOL.) OF 2002 [ASSESSMENT YEARS 1997-98 AND 1998-99]

Assistant Director of Income-tax, International Taxation-I

v.

Bank of Tokyo Mitsubishi Ltd.

IT APPEAL NO. 899 (KOL.) OF 2002 [ASSESSMENT YEAR 1992-93]

AUGUST 22, 2005

I. Section 37(1) of the Income-tax Act, 1961, read with article 7 of the DTAA between India and
Netherlands - Business expenditure - Allowability of - Assessment years 1997-98 and 1998-99
- Whether payment of interest by a Permanent Establishment (PE) of a foreign enterprise to
head office outside India and/or other offshore branches is an allowable deduction - Held, no

Section 40(a)(i), read with section 195, of the Income-tax Act, 1961 - Business disallowance -
Interest, etc., payable outside India - Assessment years 1997-98 and 1998-99 - Whether
interest paid by PE of a foreign enterprise to its head office or other branches located abroad
is a payment to self and same does not require any deduction of tax at source under section
195 - Held, yes - Whether, consequently, section 40(a)(i) cannot be invoked for disallowing
such interest - Held, yes

II. Section 201 of the Income-tax Act, 1961 - Deduction of tax at source - Consequence of
failure to deduct or pay -Assessment year 1992-93 - Whether no tax is required to be
deducted under section 195 from payment of interest by a PE of foreign enterprise to its
head office outside India or other offshore branches and, therefore, failure to deduct tax at
source from such payment would not make assessee liable for payment under section 201 -
Held, yes

FACTS-I

The assessee-bank, incorporated in Netherlands having its original office at Singapore, carried on
banking business in India through its branch (PE). PE had been paying/receiving interest to and
from its head office and/or other branches outside India from year to year. In the relevant two years,
it claimed interest paid to head office as deduction. The assessee had not deducted tax at source as
per provisions of section 40(a)( i) on such payment under the impression that it, being the same
person, was not required to do so. According to the Assessing Officer, however, branch of assessee
in India constituted a separate taxable entity different from head office and other branches located
abroad as far as taxation was concerned and, therefore, on any payment of interest to head office
and other branches located abroad, the tax was deductible and the assessee having failed to so
deduct, the interest was not allowable. He added the same to its income accordingly. On appeal, the
Commissioner (Appeals) upheld the impugned order.

On second appeal :
HELD-I

The income of an assessee carrying on business in India is to be taxed as per the provisions of
Chapter IV-D consisting of sections 28 to 43 and 44BA. The bank, a corporate body, was the
assessee and carrying on banking business in India and, therefore, it was liable to be taxed in India
in respect of the profit earned in India by virtue of section 5(2), read with sections 28 to 44BA. Since
it carried on the business through a branch which was a PE, it had to be assessed only in respect of
that profit which was relatable to the activities and attributable to the PE both by virtue of section 5
as well as section 9. In view of the existence of DTAA, the taxability was to be judged with reference
to the provisions thereof as well. [Para 16]

The proposition of law is well settled that nobody can make profit out of self nor can trade with self
nor earn from self. [Para 18]

The contention of the assessee 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, was an allowable deduction, had 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. 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 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 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, 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. [Para 25]

One could look at the issue from a different angle and on the assumption that the contention of the
parties that PE was a different entity than its head office and the interest payment by the PE to head
office was 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) read with article 11 of
the DTAA. As there was 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 had 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 was 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. [Para 26]

Therefore, the first part of the question as to whether the interest payment was allowable deduction
or not was to be held against the assessee and in favour of the revenue. [Para 27]

As regards the second part of the questions as to whether the provisions of section 40(a)(i ) were
attracted in respect of such payment of interest, the branch/PE of the assessee in India was not a
person in legal terminology. The person was the corporate body/bank and not its branch or the PE,
which was also evident from the fact that assessment was made on the corporate body and not on
its branch or PE. Therefore, there was 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 was absent in the instant case. On both the grounds, therefore, section
40(a)(i ) did not come into play. Therefore, disallowance of interest by invoking the provisions of
said section would not be justified. [Para 30]

There was also force in the submission of the assessee that the interest paid was not the income of
the assessee on the ground that no income did arise from self and, consequently, interest paid by
PE to head office was not ‘chargeable under the provisions of the Act’ which was a condition
precedent for invoking the provisions of section 195 and also on the ground that payment by PE
was cancelled by the receipt by the head office of the assessee-enterprise, in case if the PE was
considered as a separate entity than the head office of the assessee-enterprise. [Para 33]

It was true that the branches of the assessee were taxable but not as a separate entities. The
branch/PE were 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 was considered
allowable and from that point of view, it would 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 or 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. [Para 34]

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 could not 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. [Para
40]

In the instant case, the assessee had claimed payment of interest to non-resident bank, situated in
Netherlands and being a company incorporated in Netherlands was a resident of Netherlands for
the purpose of income-tax and, therefore, would come under the category of non-resident for the
purpose of the assessee which was its PE carry on banking business in India. Therefore, the payee,
in the instant case, was a non-resident and the amounts remitted were subject to income-tax in its
hands in India. The interest paid to the head office, etc., might constitute income chargeable to tax
under section 5(2)/9 but no deduction of tax at source on the interest so paid was required under
section 195, as PE of the assessee and head office were same person and, hence, the provisions
of section 40(a )(i) could not be invoked for disallowing such interest in computing the total income.
[Para 42]

The Circular No. 740, dated 17-4-1996 opines in the first part that "the branch of a foreign
company/concern in India is a separate entity for the purpose 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. 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". To that extent, 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" 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. [Para 43]

It was a payment to self and the same did not require any deduction of tax under section 195.
Consequently, section 40(a)( i) would not apply entailing no disallowance of interest allowable under
article 7 of DTAA. In case interest was allowable deduction, the second part of the question,
therefore, was to be held in favour of the assessee. [Para 44]

FACTS-II

The Indian office of the assessee, a Japanese bank, made interest payment to its head office in
Tokyo and other foreign branches without deduction of tax at source under section 195 for which
default it was held liable under section 201 and was directed to make the payment by the Assessing
Officer. On appeal, the Commissioner (Appeals) cancelled the impugned order.

On revenue’s appeal :

HELD-II

On a close reading of the provisions of various articles of the Japanese DTAA, it is found that
clauses 1, 2, 5, 6 and 7 of article 7 of the same are similarly worded as clauses 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
situate 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. 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 would be one of the other alternate reasons for not invoking the provisions of section
40(a)(i ) for disallowing the payment of interest in computing the income of the assessee through
the PE. However, in the instant case 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 for the specific purpose of computing the income attributable to the PE and not for
any other purposes would apply. Therefore, no tax was required to be deducted under section 195
from the payment of interest by the PE to its head office or other offshore branches of the
assessee-enterprise and, therefore the order of the Commissioner (Appeals) in vacating the order
under section 201 by holding that the assessee was not in default in deducting the tax at source,
was to be upheld [Para 50]

CASES REFERRED TO

Betts Hartley Huett & Co. Ltd. v. CIT [1979] 116 ITR 425 (Cal.) (para 5), CIT v. Premier Tyres Ltd.
[1982] 134 ITR 17/[1981] 7 Taxman 364 (Bom.) (para 8), Bunge & Co. Ltd. v. ITO [1971] 79 ITR 93
(Cal.) (para 8), CIT v. Ajax Products Ltd. [1965] 55 ITR 741 (SC) (para 8), CIT v. Mother India
Refrigeration Industries (P.) Ltd. [1985] 155 ITR 711/ 23 Taxman 8 (SC) (para 8), CIT v. Vadilal
Lallubhai [1972] 86 ITR 2 (SC) (para 8), CIT v. Hindustan Petroleum Corpn. Ltd. [1991] 187 ITR 1/
[1990] 53 Taxman 512 (Bom.) (para 8), CIT v. Nathimal Gaya Lal [1973] 89 ITR 190 (All.) (FB)
(para 8), Citibank [IT Appeal No. 1487 (Bom.) of 1981, dated 28-8-1982] (para 8), British Bank of
Middle East [IT Appeal No. 4514 (Bom.) of 1985, dated 21-7-1989] (para 8), British Bank of Middle
East [IT Appeal No. 8031 (Bom.) of 1992, dated 28-7-2003] (para 8), Societe Generale [IT Appeal
No. 4099 (Mum.) of 2000, dated 24-5-2004] (para 8), Bank of Nova Scotia [IT Appeal No. 298
(Bom.) of 1995, dated 28-1-2004] (para 8), Bank of Tokyo Mitsubhishi [MA No. 218 (Kol.) of 2002,
dated 13-1-2003] (para 10), Sir Kikabhai Premchand v. CIT [1953] 24 ITR 506 (SC) (para 18), Ram
Lal Bechai Ram v. CIT [1946] 14 ITR 1 (All.) (para 21), Mitsui Bank Ltd. v. IAC [1989] 35 TTJ (Bom.)
426 (para 23), Addl. ITO v. E. Alfred [1962] 44 ITR 442 (SC) (para 35), CIT v. Amarchand N. Shroff
[1963] 48 ITR 59 (SC) (para 35) and CIT v. Bai Shirinbai K. Kooka [1962] 46 ITR 86 (SC) (para
46).

F.V. Irani, K.S. Shah and Amit Patel in the case of ABN Amro Bank NV and R.K. Mitra in the case
of Bank of Tokyo Mitsubishi Ltd. for the Appellant.

Rajkumar for the Respondent.

ORDER

Per R.P. Garg, Vice President. - The President, Income-tax Appellate 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 assessment year 1997-98) and Rs.
62,73,106 (in assessment year 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 profit and loss account and was offered to tax.

4. In the assessment proceedings, the Assessing Officer 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 Assessing Officer, 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 so deduct the 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 debits 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 [1979] 116 ITR 425 , 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 profit and loss
account 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. [IT Appeal No. 899 (Kol.) of 2002] was relied upon wherein it
was held that interest debited to Indian permanent establishment 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 ld. 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 allow 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 Income-tax Act, 1961 are not attracted as by virtue of article 7 such interest paid by the
permanent establishment 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 Income-tax 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 to 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. [1982] 134 ITR 17 1 and of Calcutta High Court in the case of Bunge & Co. Ltd. v.
ITO [1971] 79 ITR 93 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 sections 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. [1965] 55 ITR 741 (SC) at 750, CIT v. Mother India Refrigeration Industries (P.) Ltd.
[1985] 155 ITR 7111 at 718 (SC), CIT v. Vadilal Lallubhai [1972] 86 ITR 2 at page 3 (SC). Reference
is also made to the decision of Bombay High Court in the case of CIT v. Hindustan Petroleum
Corpn. Ltd. [1991] 187 ITR 1 2 and of Allahabad High Court in the case of CIT v. Nathimal Gaya Lal
[1973] 89 ITR 190 (FB). Reference is also invited to the Tribunal decision in the case of Citibank [IT
Appeal No. 1487 (Bom.) of 1981 for assessment year 1976-77 dated 28-8-1982] and in the case of
British Bank of Middle East [IT Appeal No. 4514 (Bom.) of 1985 dated 21-7-1989] and a reference
thereagainst was rejected vide order in RA No. 2057/Bom./1989 dated 7th August, 1990. The
decisions in the case of British Bank of Middle East [IT Appeal No. 8031 (Bom.) of 1992 dated 28-7-
2003], in the case of Societe Generale [IT Appeal No. 4099 (Mum.) of 2000 dated 24-5-2004] and in
the case of Bank of Nova Scotia [IT Appeal No. 298 (Bom.) of 1995 for assessment year 1991-92
dated 28-1-2004] were relied on.

9. The ld. Departmental Representative, on the other hand, submitted that in accordance with the
provisions DTAA, the assessee is subject to tax in India on the profits and other income attributable
to such permanent establishment 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
Income-tax 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
Income-tax Act, no deduction can be allowed in respect of such interest of Rs. 55,03,300 in
assessment year 1997-98 and of Rs. 62,73,106 in assessment year 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 permanent establishment 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. It is further submitted that the Central Board of Direct
Taxes vide its Circular No. 740 (F. No. 500/99/94-FTD) dated 17-4-1996 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 situated 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 Income-tax 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 Income-tax Act, 1961."

10. Reliance was placed on the decision of ITAT, Kolkata in the case of Bank of Tokyo Mitsubishi
dated 13-1-2002 wherein the same view is taken [MA No. 218 (Kol.) of 2002]. 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 profit and loss account 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 profit and loss account. 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 permanent establishment 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. Section 4 of the Income-tax
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 on 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. Explanation 1 to section 5 carves out an exception stating that the income
accruing are 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 sections 92, 93 and 168, includes a person who is not ordinarily resident within the
meaning of section 6, sub-section (3) of section 6 defines a company to be a resident in India in any
previous year if (a) it is an Indian company or (b) building that year, the control and management of
its affairs is situated wholly in India. ABN Amro Bank is a non-resident company. Section 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. Explanation 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. Explanation 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 non-resident, 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 for wholly for the non-resident for that non-resident 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 Income-tax 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 corr-esponding 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-section (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 terms 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 attended at a
higher rate at which domestic companies is chargeable, shall not be regarded as less favourable
charge or levy of tax in respect of such foreign company.

13. It may be stated here that there is a DTAA between Netherlands (DTAA for short) wherein the
assessee-bank is incorporated and India wherein it has a branch office. Article 7 of the DTAA
between the two countries reads as under:—

"Article 7. - Business profits.—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 paragraph 3 where an enterprise of one of the State 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 :—

"Article 11. Interest.—(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.

(3) Notwithstanding the provisions of paragraph 2:

(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.

(4) For the purposes of paragraph 3, the term ‘Government’ means :

(a)in the case of the Netherlands, the Government of the Kingdom of the Netherlands and shall
include :

-the local authorities;

-the Netherlands Bank (Central Bank);

-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;

-a local authority;

-the Reserve Bank of India (Central Bank);

-the Export Import Bank of India;

-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 paragraph 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 paragraphs 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 :—

"Article 14. Independent personal services.—(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 sections 28 to 43 and 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) read with sections 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 I.T. Act. In view the existence of DTAA the
taxability is to 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
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. 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 permanent
establishment. 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 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 Articles of this Convention,
then the provisions of those Articles shall not be affected by the provisions of this Article.

17. By Article 11 interest arising in one of the country 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 permanent establishment 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 country 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 [1953] 24 ITR 506 where the assessee, a dealer in silver and shares,
withdrew some silver bars and shares from the business and settled them on certain trust 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 income-tax 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 page 509 of
the Report as under :—

"It is well recognized 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 face 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 Income-tax
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 & Co. Ltd.’s case (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."

21. Another case on the issue is of Ram Lal Bechai Ram 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 Mitsui 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 [IT Appeal No. 1487 (Bom.) of 1981 for
assessment year 1976-77, dated 28-8-1982] and in the case of British Bank of Middle East [IT
Appeal No. 4514 (Bom.) of 1985, dated 21-7-1989] and a reference there against was rejected vide
order in RA No. 2057/Bom./1989, dated 7-8-1990. The decisions in the case of British Bank of
Middle East [IT Appeal No. 8031 (Bom.) of 1992, dated 28-7-2003]. In the case of Societe Generale
[IT Appeal No. 4099 (Mum.) of 2000 dated 24-5-2004] and in the case of Bank of Nova Scotia [IT
Appeal No. 298 (Bom.) of 1995 for assessment year 1991-92 dated 28-1-2004] 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 ld. 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 make 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) demonstrate 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 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." [Emphasis supplied] By the mere fact that a particular
expenditure is excluded from 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) provide 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 ld. 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 read with
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.

29. Section 40(a)(i ) reads as under :—

"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’,—
 (a)in the case of any assessee—

(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,—

(A)outside India; or

(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 (1) 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."
[Emphasis supplied]

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 IT 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 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 CIT v. Premier Tyres Ltd. [1982] 134 ITR
17 1 and before Calcutta High Court in the case of Bunge & Co. Ltd. v. ITO [1971] 79 ITR 93 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 Income-tax Officer 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 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 ITA. 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 ITA. 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 non-residents.

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 non-resident, in the eyes of 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 a 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 or 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. [1965] 55 ITR 741 , the Supreme Court dealt with a
case under section 10(2)(vii) of the Income-tax 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 v. E. Alfred [1962] 44 ITR 442
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 [1963] 48 ITR 59 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 into it which are not
there. We cannot accept this argument."

36. In the case of CIT v. Mother India Refrigeration Industries (P.) Ltd. [1985] 155 ITR 7111 , 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 Income-tax Act, 1922, and in section 32(2) of the Income-tax 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 CIT v. Vadilal Lallubhai [1972] 86 ITR 2 , 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 CIT v. Hindustan Petroleum Corpn. Ltd. [1991] 187 ITR 1 1, the Bombay High Court dealing
with Explanation 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 should not be given a meaning so as to cause injustice.

39. In the case of CIT v. Nathimal Gaya Lal [1973] 89 ITR 190 before the Full Bench of the
Allahabad High Court, fiction created by section 25A(3) of the 1922 Act deeming the partition of the
Hindu undivided family, if the order under section 25A(1) has not been passed and it is deemed that
Hindu undivided family 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 and92F 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 with
effect from 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 Permanent Establishment 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 is that, even a PE is to be treated as an enterprise.
Though one of the interpretation 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 suggest that person can trade with himself and earn profits out of it.
42. 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 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 Income-tax 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 I.T. Act cannot be invoked for disallowing
such interest of Rs. 55,03,300 in assessment year 1997-98 and of Rs. 62,73,106 in assessment
year 1998-99 in computing the total income.

43. The Circular dated 17-4-1996 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 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". 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
Income-tax Act, 1961" in our opinion are not in accordance with 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 ITAT, Kolkata in the case of Bank of Tokyo Mitsubishi [MA
No. 218 (Kol. of 2002 dated 13-1-2003] 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 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 IT Appeal No. 899 (Kol.)
of 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
Assessing Officer. 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 Assessing Officer 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 Assessing Officer by
stating that the argument is misconceived and that TDS is to 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 Articles 7.1
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 PEs (PE for short) in India as defined in the DTAA. On the
other hand, Article 11 is 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 Assessing Officer 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 Assessing Officer 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 Assessing
Officer 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 ld. 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 non-resident 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 [1962] 46
ITR 86 is relied upon wherein by following its earlier decision in the case of Sir Kikabhai
Premchand v. CIT [1953] 24 ITR 506 (SC) 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 dated 31-3-1993 and 17-4-1996 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 :—

"Article 7 - Business Profits

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 paragraph 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 paragraph 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 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 paragraph 2, interest arising in a Contracting State and

derived by the Government of the other Contracting State, a political submission-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 submission-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 paragraph 3, the terms ‘the Central Bank’ and ‘financial institution wholly
owned by the Government’ means :

(a)in the case of Japan :

(i)the Bank of Japan;

(ii)the Export-Import Bank of Japan;

(iii)the Overseas Economic Co-operation Fund;

(iv)the Japan International Co-operation Agency; and

(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;

(b)in the case of India :

(i)the Reserve Bank of India;

(ii)the Export-Import Bank of India;

(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 paragraphs 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."

49. Article 14 of the Japanese DTAA reads as under :—

"Article 14. Independent personal services .—(1) Income derived by a resident of one 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—
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 clauses 1, 2, 5, 6 and 7 of Article 7 of the
Japanese DTAA are similarly worded as clauses 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 situate 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 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 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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