M/S. MASHREQ BANK PSC.,MUMBAI vs. DDIT (IT) - 3(2), MUMBAI

In ground no. 1, the assessee has challenged disallowance of deduction claimed of head office expenses of Rs.1,78,07,340/- allocated to the Indian branches. Whereas, in ground no. 4, assessee has challenged disallowance of deduction claimed of Rs.3,58,421/-, being expenses specifically incurred outside India for the Indian branches.

The material facts relevant for deciding these issues are, the assessee is a non-resident banking company incorporated in United Arab Emirates (UAE) and operates in India through its branches in Mumbai and New Delhi. As stated by the Assessing Officer, in the assessment year under consideration, assessee had carried out corporate banking business and had undertaken foreign exchange business only to the extent of covering operations for its existing clients.

For the assessment year under dispute, the assessee had initially filed a return of income on 31.10.2002 declaring book profit under section 115JB of Rs.3,19,76,508/-. Whereas, It offered nil business income after set off of brought forward losses.

In course of hearing, Shri Percy Prdiwala, learned Senioor counsel for the assessee advanced detailed submissions, both orally and in writing. Broad propositions put forward by him, insofar as, general and administrative expenses allocated to Indian Branches, can be summarized as under:  Head office expenses are fully deductible as per Article 7(3)

Drawing our attention to Article 25(1) of the Tax Treaty, learned Departmental Representative submitted, the term ‘taxation of income’ used in Article 25(1) will also include computation of such income to be taxed, as, computation is an integral part of taxation. He submitted, a reading of Article 25(1) of the treaty would make it clear that the laws of the Contracting States would continue to govern the taxation of income unless there is an express provision in the Treaty restricting application of domestic tax laws. He submitted, since, the income under the Act has to be computed as per the provisions of section 28 to 44, restricting the application of domestic law provisions, as per Article 25(1) of the Treaty, income has to be computed by applying the provisions of the Act. Hence, the head office expenses allocated to the Indian branches have to be allowed in terms with section 44C of the Act. He submitted, use of words ‘express provision to the contrary’ in Article 25(1) would mean, there should be a provision expressly denying the applicability of section 44C. Drawing our attention to Article 7(3) of the Treaty, he submitted, there is no such express provision contained therein denying applicability of section 44C of the Act. He submitted, even prior to the Protocol amending Article 7(3) w.e.f.

Thus, he submitted, even considering Article 7(3) of the Tax Treaty on standalone basis, it has to be interpreted that expenses attributable to the PE has to be allowed as deduction, subject to, 44C is a specific provision limiting the head office expenditure, it cannot be said that deduction of such expenditure under Article 7(3) is not subject to the restriction imposed under section 44C of the Act. He submitted, if such interpretation is given to Article 7(3), it will lead to absurdity, inasmuch as, other limitations of sections 28 to 44 would also not apply and expenditure may be allowed irrespective of the fact, whether it is capital or revenue in nature, and whether tax is deductible at source or not etc. In support of such contention, he heavily relied upon the decision of the Tribunal in assessee’s own case in assessment year 1996-97.

In rejoinder, learned Senior Counsel for the assessee submitted, reliance on the decision of Maru Ram & Ors Vs. Union of India (supra) is totally misplaced as Hon’ble Supreme Court has held that section 433A of Criminal Procedure Code, being a specific provision states that in case of a person imposed with life imprisonment or death sentence commuted under section 433 to life imprisonment, then such person shall not be released from prison unless he has served at least fourteen years of imprisonment. He submitted, Hon’ble Supreme Court has held section 5 of Procedure Code as it expressly states that specific provisions, if any, to the contrary will prevail over any special or local law. On the contrary, he submitted, in case of Sumitomo Mitsui Banking Corporation, the Special Bench of Tribunal has held that if there is an express provision made in the convention giving benefit to the assessee, which is contrary to the domestic law, then the provision of the treaty can be relied upon, as, it will override and prevail over the provisions of the domestic law to give any benefit expressly given to the assessee under the treaty.

We have carefully considered the rival submissions and perused the materials on record. We have applied our mind to the judicial precedents cited before us, as well. The issue arising for consideration is, whether head office expenses allocated to the PE in India is allowable under Article 7(3) of the treaty without any limit or subject to the restrictions imposed under section 44C of the Act. After carefully examining the various decisions placed before us, we find, there are two viewpoints on the issue. As per the first viewpoint, Article 25(1) of India – UAE Tax Treaty provides for applicability of domestic law for computation of income, unless, there is an express provision in the agreement restricting such applicability. Upon interpreting Article 7(3) of the Treaty it has been held that, since, it does not contain any restrictive covenant regarding applicability of domestic law provisions, the restrictions imposed under domestic law cannot be imported. The Benches have held that Article 7(3), being an 25(1) of the treaty, it will override the provisions of domestic law, including section 44C. While doing so, the subsequent amendment made to Article 7(3) by Protocol dated 28.11.2007 was also taken note of and it was held that only after the amendment to Article 7(3) w.e.f. 01.04.2008, the deduction allowable would be subject to the domestic law provisions. The aforesaid proposition has been laid down in the following decisions:

Whereas, there is a second viewpoint on the issue, which says that Article 25(1) clearly provides for computation of income as per respective laws of the Contracting States in absence of any express provision. It has been held that Article 7(3) cannot be interpreted in a manner to say that it excludes applicability of proposition has been laid down in assessee’s own case in the appeal decided by the Tribunal in assessment year 1996-97. Of course, it will be pertinent to mention here that while deciding assessee’s appeals for assessment years 1998-99 and 2001-02, the Tribunal has not followed its earlier decision but has proceeded to accept the first viewpoint and held that Article 7(3) has to be applied without applying the restrictions of section 44C of the Act.

Keeping in perspective the conflicting views expressed by different benches of the Tribunal in case of other assessee’s as well as in assessee’s own case, it is necessary to examine the issue on first principle. Undisputedly, it is a common point between the assessee and the Revenue that assessee would be governed by the provisions of India – UAE DTAA. It is the say of the assessee that head office expenses allocated to the PE has to be allowed in full in absence of any restriction/condition put in Article 7(3) of the Treaty. Whereas, it is the case of the Revenue that Article 25(1) of the Tax Treaty provides for computation of taxable income as per the applicable law of the Contracting States, unless, there is an express provision to the contrary. It is India – UAE DTAA to exclude applicability of section 44C of the Act. In this context, learned Departmental Representative has submitted that there is no such express provision in Article 7(3) of the Treaty restricting applicability of section 44C of the Act. In this context, it is necessary to examine Article 25(1) and Article 7(3) of the Treaty for better understanding.

A reading of Paragraph 1 of Article 25 makes it clear that it is in two parts. First part of Article 25(1) says that taxation of income and capital arising in respective Contracting States shall be governed by the domestic laws in force in the respective Contracting Staes. Whereas, the second part of Article 25(1) carves out an exception by providing that where express provisions to the contrary are made in the Treaty, taxation of income and capital in respective Contracting States would be governed by such express provisions and not by the provisions of domestic laws in force in the respective Contracting States. In other words, if there is an express provision in the Treaty conferring benefit to the assessee, which is contrary to the domestic law, then the provision of the Treaty will override the domestic law and would be applicable. This line of interpretation Article 25(1) has to be read as a whole and not on piecemeal basis to get the true meaning. It is relevant to observe, there is no change in Article 25(1) of the Treaty prior to or post amendment of Article 7(3). In case of Sumitomo Mitsui Banking Corporation (supra), the Special Bench of the Tribunal, while interpreting Article 23 of India-Japan treaty, akin to Article 25(1) of India-UAE Treaty, observed that only interpretation, which can be assigned to the said Article so as to bring the provision in consonance with section 90(2) of the Act is that if there is an express provision in the treaty giving benefit to the assessee, which is contrary to the domestic law, the treaty provision shall override the provision of domestic law, to the extent, it is more beneficial to the assessee.

Whereas, Article 7 of the Treaty provides the mode and manner of taxability of business profit. Paragraph 3 of Article 7 of the Treaty says that while determining the profit of a PE all expenses incurred for the purpose of business of the PE, including executive and general administrative expenses, whether incurred in the State in which the PE is situated or elsewhere, has to be allowed as deduction. A reading of Article 7(3) of the Treaty, as it stood prior to its amendment by the protocol, makes of expenditure to be allowed with reference to the PE. nor there was any reference to applicability of domestic law. The language used in Article 7(3) makes it further clear that the deduction of expenditure allowable in respect of the PE is neither subject to any limitation nor restriction imposed under the domestic law as it does not refer to any domestic law provision, including, section 44C of the Act. Thus, in absence of any restriction imposed regarding the limit of expenditure to be allowed, the restriction imposed under the domestic law cannot be read into Article 7(3).

There is another aspect to the issue. The contextual interpretation of Article 25 of the Treaty. Article 25 of the Treaty starts with the heading ‘Elimination of Double Taxation’. Thus, from the heading of the Article, it becomes clear that it provides the mechanism for elimination of double taxation of income in the Contracting States. Further, on a careful reading of Article 25 as a whole and paragraph 1 of Article 25 in particular, it becomes very much clear that it provides for taxation of income from various sources arising in the respective Contracting States in accordance with laws in force governing the taxation of such income or capital in the particular Contracting State, unless, Thus, what the Article provides is, elimination of double taxation in respect of taxation of various sources of income. In other words, what income is to be taxed or made exempt is to be governed by the domestic law, unless, there is an express provision contrary to the domestic law provided in the agreement.

For the purpose of understanding the role of Articled 25(1) with regard to the manner of computing tax on income arising in each of the contracting state, it is important to look at the principles of "Elimination of Double Taxation" as per OECD (2019), Model Tax Convention on Income and on Capital 2017. As

It is also relevant to mention here that DTAAs entered into by the countries are generally on broad contours of the Model Tax Convention on Income and Capital. Articles 6 to 21 are to determine, with regard to different classes of income, the respective rights to tax of the State of source or situs and of the State of residence, and Article 22 does the same with regard to capital. The purpose of Articles 23 A and 23 B (Article 25 in our case) is to provide that the State of residence must allow relief so as to avoid double taxation. Articles 24 to 30 are for special provisions in the Convention such as the elimination of tax discrimination in various circumstances, the exchange of information between the tax authorities of the Contracting States etc. Thus the Model Convention has clearly defined the purpose of each of the Articles and there is no overlapping or there is no reason for a conjoint reading of the provisions of the various Articles.

be expanded to mean the manner of taxing the income in each of the contracting states but is to reiterate that taxing the income arising in each of the contracting states should be either under the domestic law or as per the express provisions contained in the convention. This, when read with Section 90(2) of the Act, would mean that the assessee has option to choose whichever is beneficial to it. Accordingly, Article 25(1) cannot be interpreted to impose restrictions on the manner of computing the tax which is beyond its scope of eliminating double taxation.

Article 7 of India-UAE treaty deals with taxability of business profits. Paragraph 3 of Article 7 provides the mode of computation of profit of PE. In that context, it says that while determining the profits of the PE, all expenses incurred for the business of the PE, including executive and general administrative expenses, whether incurred in the State where PE is located or elsewhere, has to be allowed as deduction. Therefore, Article 25(1) cannot be interpreted in a manner to say that it will influence the computation of business profits under Article 7(3) or thrust the restriction imposed under the domestic law for computing the business profits. Article 25(1) and Article 7(3) elimination of double taxation, Article 7 deals with taxability of business profits and paragraph 3 of Article 7 lays down the mechanism of computation of business profit of PE. Therefore, while computing the business profit PE under Article 7(3) of the Treaty, the language used/employed therein has to be seen.

On a careful reading of Article 7(3) of the Treaty, as it existed prior to its amendment, it becomes very much clear that while determining the profit of a PE, all deductions and expenses attributable to the PE have to be allowed. There are no restrictions/conditions imposed in Article 7(3) of the Treaty to limit the expenditure to a particular percentage. Therefore, in absence of any restrictions/conditions expressly provided in Article 7(3), no such restrictions/conditions can either be imported or read between the lines.

On a query from the Bench learned Counsel for the Revenue expressed his inability to place on record the object behind bringing the protocol amending Article 7(3) of the Treaty.

However, it could possibly be for the reason that the Treaty Partners decided to put a cap on the expenditure allowable while computing business profits of PE to bring Article 7(3) of the treaty available in some other treaties entered by India with other countries. Of course, we may hasten to add, the theory of ‘reverse discrimination’ does not apply to the facts of the present appeal, as, we are concerned with applicability of section 44C of the Act, which arises in case of non-residents alone.

Be that as it may, Treaty partners entered into negotiations and the Protocol amending certain provisions in the treaty was signed between the countries, which was made effective from 1st day of April, 2008 by virtue of notification no. SO 2001(E) (NO)

Thus, in the amended Article 7(3) of the Treaty, specific restriction/condition was imposed providing that the deduction of expenses relating to the PE has to be allowed in accordance with the provisions of and subject to limitations of the tax laws of the particular State where the PE is situated. A reading of the restrictions/conditions imposed with regard to the limit of deduction of expenses earlier to the Protocol. If Revenue’s contention that even without the Protocol amending Article 7(3), Article 25(1) provided for computation of deduction under Article 7(3) as per the provisions of domestic law is accepted, then there was no need for amending Article 7(3) by the Protocol. The amendment of Article 7(3) clearly establishes that the countries to the agreement, prior to the date of Protocol, had intended to allow deduction of all expenses relating to the PE without applying any restrictions/conditions imposed in the domestic laws of the respective Contracting States.

One more argument advanced by the Revenue is, restrictions/limitations for deduction of expenses under Article 7(3) was always there in view of Article 25(1) and the Protocol amending Article 7(3) is only for clarifying the position existing earlier. In our view, this argument of Revenue is a nonstarter.

As observed by the Hon’ble Apex Court, while interpreting the provisions of bilateral treaties between two sovereign nations, it has to be borne in mind that Treaties are negotiated and entered at political level and have several considerations as their base. A bilateral treaty should be seen in the context of aiding commercial relations between treaty partners and as being essentially a bargain between two treaty countries as to the division of tax revenues between them in respect of income falling Convention Law Treaties says that a treaty shall be interpreted in good faith in accordance with the terms of the treaty in their context and in the light of its object and purpose. Had the treaty partners intended to apply the restrictions of domestic law to Article 7(3) of the treaty, they would have specifically brought in such restrictive covenant in Article 7(3) itself from the very inception. In this context, the observations made by the Hon’ble Apex Court in paragraphs 123, 124 and 125, as reproduced above, makes interesting reading. Hon’ble Court has observed, at the time of entering into bilateral agreement, treaty partners permit treaty shopping to encourage capital and technology inflows, unless, the revenue losses are significant compared to other tax and non-tax benefits from the treaty or the treaty shopping leads to other unintended tax abuses. Even, accepting that there is some amount of treaty shopping, which may have taken place when the bilateral agreement was entered into, however, whether it should continue and if so for how long, is a matter which is best left to the discretion of the executive, as, it is dependent upon several economic and political considerations.

The language of Article 7(3) of the Treaty, as it existed prior to its amendment by way of Protocol, makes it clear that there was nothing in the provision to infer that restrictions/conditions imposed in the domestic law, including section 44C, would be applicable while allowing deduction of expenses attributable to the PE. However, the situation stands substantially altered after amendment of Article 7(3), as, specific restriction has been imposed by providing for allowance of deduction in accordance with the provisions of the domestic laws of the State where the PE is situated. The language used in Article 7(3) of the treaty prior to and post amendment demonstrates that at the time of entering into the DTAA, the treaty partners, initially, never intended to put any restriction of the domestic laws on allowability of expenses in computing the business profits of the PE. Subsequently, the treaty partners having felt that the benefits provided under Article 7(3) needs to be withdrawn or restricted, agreed to amend the provision. Thus, in our view, prior to amendment of Article 7(3), the understanding between treaty partners is to allow all limitation/restriction imposed under the domestic laws.

Having held so, the next issue which arises for consideration is, whether the amendment brought to Article 7(3) by way of protocol will apply retrospectively. As stated earlier, the protocol amending Article 7(3) was specifically made effective from 01.04.2008. Therefore, it is very much clear, treaty partners intended to apply the amendment prospectively. Had the Treaty partners wanted the amendment to apply retrospectively, they would have specifically provided such retrospective operation.

On a comparative analysis of identical provisions, like Article 7(3), in various Treaties, it is interesting to note, in treaties entered by India with UAE, France, Mauritius and Japan, Article 7(3) in its original form provided for deduction of expenses attributable to the PE without imposing restrictions of domestic laws. Whereas, in treaties entered with UK and Germany, the treaty partners intended to apply the restrictions of domestic laws deduction of expenses on computing the profits of the PE. It is relevant to observe, the Treaty with France has been amended subsequently to apply the limitations of domestic laws. Thus, a comparative analysis of Treaties entered by India with various countries would make it clear, wherever the countries intended to apply the restrictions imposed in the domestic laws, it was specifically provided in the Treaty. Further, wherever the treaty partners intended to amend the provisions of the treaty retrospectively, they specifically provided for it.

Thus, the aforesaid factual and legal position make it clear that the conditions imposed in Tax Treaties are specific to each Treaty, as, a Bilateral Treaty is entered between two countries on the basis of negotiations and consideration of both commercial and political factors. Therefore, a provision of the Treaty has to be interpreted strictly in accordance with the language used therein.

Ground no. 4 relates to allowability of certain expenses exclusively incurred for the Indian branches outside India. In view of our decision qua ground no. 1, supra, separate adjudication of this ground was not necessary, as, the expenditure will have to be allowed under Article 7(3) of the Treaty, being expenditure of the PE. However, considering the fact that parties were heard at length on this issue as well, for the sake of completeness, we deem it appropriate to address the issue.

Having considered rival submissions, we find, the disputed expenses are-(i) SWIFT expenses of Rs. 1,68,349.17, and (ii)

Looking at the nature of expenditure incurred, there cannot be any doubt that they are exclusively related to the operations of Indian branches. Whereas, section 44C speaks of head office expenditure. The expression ‘head office expenditure’ has been defined in clause (iv) of Explanation to section 44C as under:-

As could be seen from the aforesaid definition, head office expenditure broadly means executive and general expenditure incurred by the non-resident assessee outside India. In circular no. 649 dated 31.02.1993 issued in the context of section 44C of the Act, the CBDT has clarified that expenditure not covered under section 44C of the Act are to be allowed without any limit while computing the business profits of the branch office. In case of CIT Vs. M/s. Emirates Commercial Bank Ltd. Vs. (Civil Appeal No. 1527 of 2006, dated 26th August, 2008), the Hon’ble Supreme Court upheld the decision of Hon’ble Bombay High Court, wherein, it was held that section 44C contemplates allocation of expenses amongst various entities. The expenditure covered under section 44C is of common nature, which is incurred for various branches or which is incurred for the head office and branches. In case of DIT Vs Credit Agricole Indosuez, [2016] 69 taxmann.com 285, the Hon’ble Bombay High Court has held that expenses incurred by head office on behalf of Indian branch are deductible under section 37(1) of the Act without applying the restrictions of section 44C of the Act. Same view was expressed by the Hon’ble Bombay High Court again in case of American deduced from these decisions are, the expenditure specifically incurred for the branches has to be allowed without the restrictions of section 44C. Thus, keeping in view the definition of head office expenditure under section 44C and the ratio laid down in the judicial precedents, discussed above, we hold that the expenditure incurred outside India exclusively for the Indian branches does not fall within the ambit of section 44C. Hence, would be allowable in full. This ground is allowed.

In the result, the appeal is allowed, as indicated above.