ABU DHABI COMMERCIAL BANK PJSC,MUMBAI vs. DCIT (INTERNATIONAL TAXATION)-1(1)(1), MUMBAI

Noticing the above, the A.O. was of the view that once the interest income is taxable on gross basis in terms with Article 11(2) of the Treaty, no further deduction, including, set off of loss against such income, is impermissible. Accordingly, he issued a show cause notice to the assessee to explain why the claim of set off of loss against the interest income should not be disallowed. In response to the show cause notice, the assessee furnished a detailed reply justifying its claim. It was the say of the assessee that the word “gross” used in Article 11(2) has not been defined under the Treaty. It was submitted, the word “gross” means ‘the amount without allowing any deduction on account of expenses’. It was submitted, loss cannot be equated with expenses. However, the A.O. was not convinced with the submissions of the assessee. He was of the view that since Article 11(2) provides for taxation of gross interest income at the concessional rate of 5%, no further deduction including set off of loss can be allowed. In this context, he relied upon CBDT Circular No. 333 dated 02.04.1982 to emphasize that where the DTAA provides for a particular mode of computation of income the same has to be followed irrespective of the provisions in Income Tax Act. Thus, he observed, once the assessee has chosen to be governed by DTAA, it cannot again go back to the provisions of the Income Tax Act for computation of income. He observed, since the Treaty does not provide for set off of loss, the assessee cannot claim such benefit by referring to the Income Tax Act. In this context, he relied upon the decision of the Hon’ble Calcutta High Court in the case of CIT vs. Davy Ashmore India Ltd. [1991] 190 ITR 626 (Cal.) and various other decisions. Referring to Article 31(1)

The ld. Counsel appearing for the assessee, more or less, reiterated the submissions made before the Departmental Authorities. He submitted, the word “gross” as used in Article 11(2) of the Treaty, though has not been defined under the Treaty, however, in general parlance, it would mean the amount without allowing any deduction on account of expenses. He submitted, the assessee, as such, has not claimed any expense from the to the return of income, he submitted, the assessee has offered the income under the head ‘income from other sources’. He submitted, even the return form provides for set off of losses from the interest income through intra head adjustments. In this context, he drew our attention to Schedule CYLA in the return of income. He submitted, once the return of income itself permits set off of business loss against the interest income, it cannot be said that intra head adjustment is not allowable. He submitted, in terms with section 90(2) of the Act, the assessee has option to choose either to be governed by the treaty provisions or the domestic law, depending upon which is more beneficial. Therefore, there is no bar on the assessee in going back to the Domestic Law, even if it has chosen to be governed by the treaty provisions. In support of such contention, he relied upon a decision of the co- ordinate bench in case of Foramer S.A. vs. DCIT [1995] 52 ITD 115 (Del).

Without prejudice, ld. Counsel submitted, even assuming that the assessee cannot adopt the hybrid approach as alleged by the Departmental Authorities, the interest income is covered under the Domestic Law. As per section 115A(1)(a)(iiaa) r.w.s. 194LC of the Act, the interest income is subject to concessional tax rate of 5% with applicable surcharge and cess. He submitted, while negating assessee’s claim and holding that the interest income would be subject to tax @ 20% u/s. 115A(1)(a)(ii), the DRP has completely overlooked the press release dated 21.09.2012 by the CBDT, wherein, it is specifically stated that no specific approval in case of each loan agreement is required to be given by the Central Government, in case, the loan agreement complied with ECB Regulations, as administered by Reserve Bank of India (RBI for short). Thus, he submitted, in view of the aforesaid clarification issued by CBDT, no case to case approval of the Central relied upon the decision of the co-ordinate bench in case of Hitachi Zosen Corporation vs. JCIT [1999] 68 ITD 235 (Mum).

Strongly relying upon the observations of the A.O. and learned DRP, learned Departmental Representative ('ld. DR' for short) submitted, since Article 11(2) of the Treaty provides for applicability of the concessional rate of 5% on the gross amount of interest income, no further deduction from such amount can be allowed.

We have given a thoughtful consideration to the rival contentions and perused the materials on record. We have also applied our mind to the judicial precedents cited before us. Undisputedly, the assessee has earned an amount of Rs.138,48,09,049/- towards interest on ECB loans advanced to Indian customers. It is the claim of the assessee that the head office in UAE has advanced the ECB loans directly to Indian customers without any involvement of the PE in India. It is also a fact on record that in the return of income filed for the assessment year under dispute, the assessee had offered the interest income on ECB loans under the head ‘income from other sources’ and claimed concessional rate of tax u/s. 115A(1)(a)(iiaa). Further, the assessee has also chosen to be governed under the India- UAE DTAA and claimed that the interest income is subject to tax at concessional rate of 5% u/s.11(2) of the Treaty. However, the bone of contention between the assessee and department is with regard to claim of set off of business loss of the PE in India against the interest income. While the assessee has justified its claim of such set off of loss against interest income by submitting that the word “gross” used in Article 11(2) only refers to the amount without claiming deduction towards expenses, the department has taken the stand including loss’.

Keeping in perspective the respective stand of the parties, it is necessary to examine the position under the India-UAE tax treaty. At this stage, we must hasten to add, though, ld. DRP has opined that the interest income on ECB loans should be treated as ‘business income’ under the domestic law, however, ultimately ld. DRP has grudgingly accepted that in terms with Article 11(2) r.w.s. 7(7) of India-UAE Treaty, the interest earned on ECB loans has to be treated as ‘interest income’ under the treaty provision. Even otherwise also, it is a fact on record that the assessee has offered the interest income as income under the head ‘other sources’ in the return of income and there is no change in head of income by the A.O. even in the final assessment order, as the A.O. has taxed the interest income under Article 11(2) of the Treaty, though, after disallowing the set off of loss. Thus, in our opinion, there is no controversy with regard to the nature of income that its interest income taxable under the head ‘income from other sources. Having held so, it is necessary to examine the position under Article 11(2) of the India-UAE treaty, which reads as under:

There cannot be any manner of doubt that the assessee is covered under Article 11(2)(a) of the Treaty. A reading of Article 11(2) shows that it is in two parts. In the first with the domestic law of the source country. The second part of the Article says that if the recipient of the interest income is the beneficial owner of such income, the tax rate applicable would be not in excess of 5% or 12.5%, as the case may be, of the gross amount of interest. Thus, it is very much clear from a reading of Article 11(2) that in the first step, the taxability of interest income has to be determined in terms with the domestic law of the source country. Only after the income is computed in terms with the domestic law, then one has to again revert back to the Treaty Provision for applicable tax rate on such income.

Sections 15 to 59 provide the mode and manner of computation of income under each of the aforesaid heads of income. Once income under different heads are computed, Chapter VI and VI-A get triggered. While Chapter VI provides for aggregation of income and set off and carryforward of loss, Chapter VIA provides for deduction to be made in computing total income. The expression ‘total income’ has been defined u/s. 66 of the Act.

At this stage, we must find the meaning of the word “gross” used in Article 11(2)(a) of the Treaty. It is a fact that the word “gross” is not defined in the Treaty. Though, Article 3(2) of the Treaty permits adoption of the meaning of a particular word given in the domestic law, however, even under the Income Tax Act we were unable to locate any definition given to the word “gross”. Of course, there is a definition of “gross total income” u/s. 80B(5) of the Act. Thus, in absence of any definition of word “gross” either in the Treaty or under the Act, we can make a useful reference to the meaning ascribed to the word “gross” in commentary to OECD Model Tax Convention on Income and Capital, means the amount regardless of expenses incurred to earn such interest. Accordingly, in our view, denying the benefit of set off on the ground that Article 11(2)(a) provides for “gross” interest is not correct since, the term “gross” here means interest without claiming deduction towards any expenditure. As discussed earlier, Chapter IV of the Act provides for computation of income under various heads. In so far as computation of income under the head “income from other sources” is concerned, Section 57 of the Act enlists the deductions to be made for computing the income. It is a fact on record that assessee has not claimed any deduction of expenses. Hence, the income computed by the assessee does not violate the conditions of Article 11(2)(a) of the Treaty. Thus, according to our understanding of the relevant provisions, in the first stage, the total income of the assessee has to be computed in terms with the provisions of the Act and after set off of loss as provided u/s. 71 of the Act, the applicable rate of tax as per Article 11(2)(a) can be applied to bring to tax the interest income. Thus, we hold that assessee’s claim of set off of loss of PE against the interest income is allowable.

Having held so, it is necessary to look into the alternative claim of the assessee u/s. 115A(1)(a)(iiaa). The ld. DRP has rejected such claim of assessee on the ground that the condition of approval of the loan agreement by the Central Government as provided under Section 194LC has not been satisfied. In this context, we may refer to the following press release by CBDT:

A reading of the aforesaid would clearly demonstrate that case to case approval of loan agreement by the Central Government has been dispensed with and the only condition imposed is that the ECB loans must be in consonance with the ECB regulations framed by RBI. There is no allegation by the Departmental Authorities that the ECB loans are in violation of RBI guidelines. That being the case, in our considered opinion, the interest income would be covered u/s.115A(1)(a)(iiaa) of the Act, hence, subject to concessional rate of tax at 5% with applicable cess and surcharge. Thus, ground nos. 5 & 8 are decided in favour of the assessee.

In ground no. 10, the assessee has raised the issue of adjustment of refund of Rs.17,37,439/- without issuing ay notice of demand u/s. 156 of the Act or section 245 of the Act.

Having considered rival submissions, we direct the A.O. to verify assessee’s claim and decide the issue in accordance with law and after providing reasonable opportunity of being heard to the assessee. being premature at this stage is dismissed.

In the result, the appeal is partly allowed.