Facts of the Case

The Revenue challenged the order of the Income Tax Appellate Tribunal dated 30 January 2018 concerning Assessment Year 2003-04. The dispute centered on whether interest received by the Indian Permanent Establishment (PE) of a foreign bank from its Head Office and overseas branches was taxable in India.

The interest in question, amounting to ₹70,02,160, arose from deposits maintained by the Indian branches with the bank’s Head Office and foreign branches outside India. Although the assessee initially included the amount in taxable income, it later claimed that such interest constituted a payment to itself and therefore was not taxable.

Issues Involved

  1. Whether interest received by an Indian PE from its Head Office or overseas branches is taxable in India.
  2. Whether a branch and Head Office of the same entity can be treated as separate persons for tax purposes.
  3. Applicability of DTAA provisions governing attribution of profits to a Permanent Establishment.
  4. Relevance of amendments introduced by the Finance Act, 2015 to Section 9(1)(v).

Petitioner’s (Revenue’s) Arguments

The Revenue contended that under the applicable Double Taxation Avoidance Agreement (DTAA), particularly provisions relating to taxation of interest and profits of a PE, such receipts should be treated as taxable income.

It relied on treaty provisions that permit taxation of interest payments between a PE and Head Office in certain circumstances, especially for banking enterprises.

Respondent’s (Assessee’s) Arguments

The assessee argued that a branch and its Head Office constitute the same legal entity and cannot be regarded as separate persons. Therefore, interest received from the Head Office or other branches amounted to a payment to itself and could not give rise to taxable income.

Reliance was placed on the well-established legal principle that a person cannot earn income from himself. The assessee also emphasized that treaty provisions for banking enterprises did not alter this fundamental concept in the present factual context.

Court Order / Findings

  • A branch office does not possess an independent legal personality separate from its Head Office.
  • Interest received by the Indian PE from its Head Office represents a transaction within the same entity.
  • Applying the settled principle that “one cannot make profit out of oneself,” such receipts cannot be treated as income.
  • Article 7 of the DTAA, which deals with business profits and attribution to a PE, did not support taxation of these internal transactions.
  • Judicial precedents, including the Supreme Court decision in Kikabhai Premchand, affirm that fictional profits from self-dealing cannot be taxed.
  • Amendments introduced by the Finance Act, 2015 deeming such interest to accrue in India for banking PEs were prospective and applicable only from Assessment Year 2016-17 onwards.
  • Since the relevant assessment year was 2003-04, the amended provisions were inapplicable.

 Important Clarification

The judgment clarifies that internal financial transactions between a foreign bank’s Indian branch and its Head Office do not give rise to taxable income under the pre-2016 legal regime. It also highlights that statutory fictions introduced by later amendments cannot be applied retrospectively.

This ruling has significant implications for foreign banking entities operating in India through branch structures, particularly regarding inter-office funding arrangements and profit attribution.

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