S/s. 43-B, 14-A – Article 7(3) of India Mauritius DTAA not restrictive – No disallowance u/s. 43-B – Section 14-A operates at threshold and to be considered while computing income
Facts:
The taxpayer was a banking company incorporated in Mauritius and entitled to benefit of India-Mauritius DTAA.
The taxpayer had claimed deduction in respect of bonus. However, tax auditors had reported that a part of the amount was not paid on or before the due date of filing of return of income. Accordingly, the AO disallowed the same u/s. 43B of I T Act. Further, the taxpayer had borrowed funds from RBI and invested in tax-free bonds and claimed exemption in respect of interest from the same. Hence, the AO disallowed certain amount u/s. 14A of I T Act as interest on the borrowed funds despite the taxpayer having provided funds flow statement to the AO to demonstrate that it had adequate interest free funds available with it and hence no disallowance should be made.
Held:
The Tribunal observed and held as follows.
(i) Disallowance u/s. 43B
In terms of Article 7(3) of DTAA, for determining profits of a PE, all the expenses incurred for the business of the PE are to be deducted3. Unlike several other DTAAs where Article 7(3) is restrictive, as India-Mauritius DTAA does not have such restrictive clause, expenditure incurred for the purpose of a PE is to be allowed in full. Accordingly, disallowance cannot be effected u/s. 43B.
(ii) Disallowance u/s. 14A
There is a fundamental distinction between disallowance u/s. 14A and other disallowance provisions under business income head, since the other disallowances are in respect of expenses which are otherwise deductible. However, in contrast, section 14A at the threshold snatches away deductibility of expenses incurred in relation to an exempt income.
For instance, in terms of Article 7(4), profits cannot be attributed to a PE by reason of mere purchase of goods. The question is, if no profit can be attributed, whether expenses can be claimed? Obviously, if no profit is included in ‘business profits’, no expenses can be deducted. On the same logic, as interest on tax free bonds is not included in ‘business profits’, expenses pertaining to that cannot be allowed as deduction.
Since the taxpayer borrowed funds for investing in tax free bonds and on the next day repaid the interest bearing funds out of its interest free funds, and also since the taxpayer had sufficient profit from business operations for the year, disallowance of interest should be restricted to interest for only one day.
