ITAT Mumbai Bench Today's order on Article 7(3) Allowability of expenses vs Restriction of Domestic Law Section 43B held in absence of specific restriction sec. 43B do not apply to Article 7; Term not defined in DTAA meaning; Treaty compariso

ITAT Mumbai Bench Today's order on Article 7(3) Allowability of expenses vs Restriction of Domestic Law Section 43B held in absence of specific restriction sec. 43B do not apply to Article 7; Term not defined in DTAA meaning; Treaty comparison

ITA No.2254 & 3005/Mum/2005

M/s.State Bank of Mauritius Ltd. 03rd day of October, 2012. Assessment Year : 1999-2000

It is manifest that difference between the full or partial

deductibility of any expenditure is due to the absence or presence of the restrictive clause in the treaty. But for such restrictive clause, any expenditure incurred by the assessee for the purposes of the business of the permanent establishment becomes deductible in full as per the first part of para 3 of Article 7. It is only due to the occurrence of such restrictive clause that the otherwise full allowability of deduction as per earlier part of the para 3 of Article 7, gets restricted to the extent of deductibility as per the provisions of the Act. The nutshell is that if there is no restrictive clause in the treaty, then the expenditure incurred for the purposes of the business of permanent establishment has to be allowed in full. If, however, there is a restrictive clause in the treaty, then the otherwise full deductibility gets reduced in accordance with the provision of the Act 4.

It is pertinent to note that we are dealing with the Indo- Mauritius DTA. As can be seen from the phraseology of para 3 of Article 7 of the DTA, reproduced above, that there is no restrictive clause therein. It indicates that both the countries have decided to allow expenses incurred for the purpose of business of the permanent establishment in full, without any limit as may be set out in sections of the Act. So long as an expense is incurred for the purpose of the business of the permanent establishment, the same has to be allowed as deduction in full as per the prescription of Article 7(3) As we are dealing with the Indo-Mauritius DTA, which does not expressly contain any restrictive clause in this regard, contrary to the presence of such clause in certain Conventions including Indo-US DTAA, it becomes perceptible that ex facie restrictive provisions of the Act including section 43B cannot be read into Article 7.

Clearly the disallowance of bonus as per section 43B,

cannot be characterized as “any term not defined” as per Article 3(2). In our considered opinion the contention raised on behalf of the Revenue that section 43B should be read into Article 7 by means of  Article 3(2), deserves the fate of rejection. It is trite that a definition provision is ordinarily different from a substantive or machinery provision. Whereas, Article 3 is only a definition clause, para 1 of Article 7 is a substantive clause and para 3 of Article 7 is a machinery clause. We are unable to appreciate as to how Article 3(2) helps the Revenue in  importing the mandate of section 43B in Article 7(3).

4.16. The learned Departmental Representative then focused his

attention on para 1 of Article 23 to bolster his submission that the

restriction u/s 43B should be read in to Article 7(3). Para 1 of Article 23 provides that : “The laws in force in either of the Contracting States shall continue to govern the taxation of income in the respective Contracting States except where provisions to the contrary are made in this Convention”  Thus the

general rule contained in the first part of para 1 of Article 23, being the applicability of the domestic law, has been eclipsed by any provision to the contrary in the DTA. In case there is no contrary provision in the treaty, then it is the domestic law which shall apply. If however, there is some provision in the DTA contrary to the domestic law then it is such contrary provision of the DTA which shall override the provision in the domestic law in the computation of income as per the DTA. In both the cases, that is, under the Act as well as the DTA, the subject matter under consideration is same, being, the granting of deductions in the computation of business profits of the permanent establishment of a foreign enterprise. When there is a

specific provision as per Article 7(3) of the DTA providing for the

deductibility of all expenses incurred for the purpose of permanent establishment, we fail to comprehend as to how Article 23(1) can be applied to invoke disallowance u/s 43B. This contention of the ld. DR, being devoid of any merit, is thus jettisoned. 4.21. We can support our above conclusion from one more angle. If, for a moment, we accept the contention of the ld. DR that Article 23(1) is an authority for importing the provisions containing disallowances under the Act, in the DTA, then absurd results will follow.

It is important to highlight the fundamental distinction

between disallowance under section 14A on one hand and other

sections providing for disallowances, such as section 37, 40, 43B and 44C on the other. This position u/s 14A is in

sharp contrast to other sections as discussed above, such as 37, 40, 43, and 44C. Whereas these later sections apply to take away the deduction of expenses, which are otherwise allowable and have entered into the basket of deductible expenses , section 14A restricts the entry of certain expenses into the basket of deductible expenses. This is the underlying distinction between section 14A and the other set of sections providing for disallowance. 5.10. At this stage, it may be relevant to note para 4 of Article 7 as per which : `No profits shall be attributed to a permanent establishment by reason of the mere purchase by that permanent establishment of goods or merchandise for the enterprise.’ As per this para, no profits can be attributed to a PE in respect of purchase of goods for the general enterprise. The pertinent question which arises is that when no profits can be attributed to the PE in respect of such purchases, is it permissible to include expenses in relation to such purchase in the total expenses of the PE for claiming deduction in

determination of its business profits? The answer is obviously in

negative. The reason for such negative answer is that when no

income in respect of such purchases can be included in the `business profits’ of the PE, then naturally, no expenses in relation to such purchases can be allowed as deduction in computing the business profits of the PE. The same logic applies for not allowing deduction for any expenses in relation to an income, which does not constitute part of the `business profits’. As the interest income from tax free bonds per se is not

includible in the `business profits’ of the permanent establishment and further the assessee has also claimed exemption in that regard which has been rightly granted as well, the expenses incurred in relation to such interest income cannot equally be allowed as deduction.

COMPILED BY CA. KAPIL GOEL