Business expenditure: TDS: Disallowance u/s.40(a)(i) r.w.s 195: Payment of interest by branch (PE) to head office abroad: By virtue of convention head office not liable to pay any tax in India: No obligation on branch to deduct tax at source: Interest to be allowed as deduction in the hands of branch.

The assessee-foreign company incorporated in the Netherlands had its principal branch office in India. Indian branch remits funds to head office as payment of interest. The Indian branch had not deducted tax at source on such interest payment to the head office. The following two issues were for consideration by the Calcutta High Court:

“(i) Whether interest payment made by the Indian branch of the appellant to its head office abroad was to be allowed as a deduction in computing the profits of the appellant’s branch in India?

(ii) Whether in making such payment to the head office, the appellant’s said branch was required to deduct tax at source u/s.195 of the Income-tax Act, 1961?”

The Calcutta High Court held as under:

“(i) An unnecessary complication has been created by the interpretation made of section 40(a) (i) r.w.s 195 by both the appellant and the respondents. A proper meaning has to be ascribed to the expression ‘chargeable’ under the provisions of this Act. Section 195(1) says that if any interest is paid by a person to a foreign company, which interest is chargeable under the provisions of this Act, tax should be deducted at source. The word ‘chargeable’ is not to be taken as qualifying only the phrase ‘any other sum’, but it qualifies the word ‘interest’ also. Where the interest is not so chargeable, no tax is deducted.

(ii) In this case, by virtue of the convention, the head office of the appellant is not liable to pay any tax under the Act. Therefore, there was and still is no obligation on the part of the appellant’s said branch to deduct tax while making interest remittance to its head office or any other foreign branch.

(iii) Therefore, if no tax is deductible u/s.195(1), section 40(a)(i) will not come in the way of the appellant claiming such deduction from its income. Therefore, in the circumstances, the appellant would be entitled to deduct such interest paid, as permitted by the convention or agreement, in the computation of its income.”