Payment of interest by Indian branch of a foreign bank to its Head Office would be subjected to tax

The issue with respect to payment of interest by branch/permanent establishment (PE) to its foreign bank/head office (HO), by the Indian PE to its HO was twofold, i.e. firstly, whether the interest paid by the Indian PE to its HO was liable to be taxed in the hands of the HO in India and whether such

payment of interest would be deductible in the hands of the Indian PE. There were contrary rulingsin this respect¹.

This controversy was decided by the Special Bench of the Mumbai Tribunal in case of Sumitomo Mitsui Banking Corporation² wherein the Mumbai ITAT held as under:

  1. Indian PE and the HO along with its other branches are the same legal entity and one cannot make profit out of self. Hence, interest paid by the Indian PE to the HO are neither taxable as income nor tax deductible as expenditure under the domestic tax law of India.

  2. CBDT Circular No. 740 dated 17-4-1996 which indicates that branch of a foreign company or concern in India is a separate entity for the purpose of taxation, covers clarification related to interest earned by a foreign company from an Indian concern on moneys borrowed or debt incurred by the Indian concern in foreign currency. This circular is inapplicable to a situation where the taxability of interest payments by an Indian branch to HO is being discussed. In case if the interest income is not chargeable to tax under the provisions of the domestic law, the same cannot be brought to tax by way of a board circular.

  3. The concerned tax treaty treated the PE and HO as separate entities and there existed specific provisions that enabled Indian PE to claim tax deduction of interest paid by Indian PE to HO.Hence, a deduction under the tax treaty was allowed. Nevertheless, there being no specific provision either under the domestic law or the tax treaty to charge to tax the interest being paid by the Indian PE to the HO, no such tax can be levied in India.

As a result it was held that interest paid by PE of a Bank to its HO or other offshore branches would not be liable to tax in India but the PE in India would be entitled to claim deduction of the same while arriving at its taxable incomebased on the provisions under the tax treaty. However, on the contrary, the Indian PE of HO located in a non-treaty jurisdiction or non-favourable taxtreaty country would not be able to claim deduction of the interest payable to the HO while arriving at its taxable income in India.

Considering the above, the Finance Minister, with an intentionto provide certainty, as indicated in the Memorandum to the Finance Bill, 2015, on this aspect has proposed to amend the Act to provide that, in the case of a non-resident assessee, engaged in the business of banking, any interest payable by the Indian PE to the HO or any PE or any other part of such assessee entity outside India shall be deemed to accrue or arise in India and would be chargeable to tax in addition to any income attributable to the Indian PE in India. The PE in India shall be deemed to be a person separate and independent of the non-resident assessee. Accordingly, the Indian PE shall be obligated to deduct tax at source on any interest payable either to the HO or any other branch or PE, etc. of the entity outside India. This amendment has been proposed to be brought out under section 9(1)(v) of the Income-tax Act, 1961 (the Act) by way of an Explanation and is proposed to be made applicable from the assessment year 2016-17.

The result of such an amendment can be understood from the numerical example tabulated below:

Particulars	Pre- amendment		Post-amendment
	Non-Treaty scenario	Favourable Treaty scenario	Treaty as well as non-treaty scenario
Income of PE in India	100	100	100
Less: Interest payment to HO (as per the DTAA, without withholding of tax)		20	203
Taxable income of the PE	100	80	80
Income of the HO	-	Nil	20

The fundamental issue which may still remain unanswered is whether, payment of interest by the Indian PE to its HO can be said to be 'income' in the hands of the entity as defined under the current definition of 'income' under section 2(24) of the Act or there is a need to amend the definition of 'income' then only the amendment can be brought in the deeming fiction of Section 9 of the Act.

Further, whether the interest paid by Indian PE to the HO would be characterised as 'interest' income or 'business income' in the hands of HO and if characterised as 'business income' whether the same can be said to be attributed to the Indian PE.

By Sarika Dhameja and Alpa Shahi