By Geeta Jani, Dhishat B. Mehta Chartered Accountants
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• Interest paid by Indian branch (BO) to its foreign head office (HO) is to be allowed as deduction in terms of Article 7(2) and 7(3) of Double Taxation Avoidance Agreement (DTAA ) between India and Japan and such Interest received cannot be taxed in the hands of HO on the principle of mutuality.
• Interest received by BO for deposits placed with HO/other branches is taxable in India.
Facts:
Taxpayer (HO) is a banking company incorporated in Japan. HO was engaged in carrying on banking operations in India under license from Reserve Bank of India, through a branch in India (BO), which constituted Permanent establishment (PE) for HO in India.
During the relevant financial year
• HO received interest from its BO in India
• BO received interest from HO and other overseas branches of HO for the funds of BO lying with HO and other foreign branches.
In computation of income of BO, being the PE,
• Deduction was claimed for interest payments made by BO to HO.
• Interest received by BO was not offered to tax on the basis of principle of mutuality.
Tax Authority disallowed interest payments made by BO on the grounds that the BO failed to withhold taxes on interest payments made to HO and also taxed the interest income of HO in India. Additionally, interest received by BO was also taxed on the basis that the same was attributable to the PE in India.
Held:
On interest paid to HO by BO:
As per Article 7(2) and 7(3) of DTAA between India and Japan, the interest paid by BO (being the PE) to HO is to be allowed as deduction in computation of profits of the BO as BO and HO are to be treated as a distinct and separate enterprise. However, interest received by HO from the branch cannot be taxed in the hands of HO on the ground of mutuality as held by Special Bench in the case of Sumitomo Corporation (147 TTJ 649)(Mum).
On interest received by BO from HO:
Under the Act, specific deeming provision u/s. 9(1)(v) will override the concept of mutuality and hence interest income of BO would be taxable in India. As a result interest earned by Indian branch is taxable in India.
Under the DTAA, no exemption has been provided for taxation of interest income of BO. Once the interest received by BO is deemed to be income of BO and there is no bar in the DTAA on its taxability then it cannot be excluded from computation of income earned by virtue of Article 7. Thus interest accrued or received by BO on funds lying with HO and other foreign branches should be taxable in India.
