Court: Mumbai Tribunal
Citation: Besix Kier Dabhol, SA Vs. DDIT
Brief- This is an important decision of the Tribunal, which brings out the importance of a Double Taxation Avoidance Agreement (Treaty), that where thin capitalization rules are not in the domestic law/Treaty, there can be no artificial dis allowance of interest paid on borrowings.
Facts:
Besix Kier, Dabhol (assessee), a company registered under the laws of Kingdom of Belgium, was engaged in the business of carrying out project of construction of fuel jetty and a backwater near Dabhol, India, pursuant to a contract entered into by the asses see with Lingtec Constructors LP .The assessee company had issued 2,500 shares , at the relevant point of time, of Belgian Francs (BEF) 1,000 each amounting to BEF 2,500,000 , out of which, 60% equity shares, i.e. 1,500 shares, were held by N V Besix SA, Belgium, and the remaining 40% equity shares, i.e. 1000 shares, were held by Kier International (Investments) Limited, United Kingdom. The total share capital was thus approximately US $ 83,334 or Rs. 3 8,20,000.
The assessee also raised the capital by resorting to borrowings from the shareholders, Rs. 57,09,18,579 from NA Besix SA and Rs. 37,01,55,921 from Kier International (Investments) Limited, which was in the same ratio in which equity was held by the shareholders i.e. 60: 40. This debt was raised by the permanent establishment (PE) of the assessee directly from the shareholders, and not routed through the assessee’s head office. Thus, the assessee had an equity capital of Rs. 38 lakhs (Rs. 3.8 million) approximately, and a debt capital of Rs. 9,410 lakhs (Rs. 941 million) approximately. The debt equity ratio thus worked out to 248:1. It was in this backdrop that the assessee claimed deduction of interest in assessment year 2002- 03 on these borrowings from the shareholders.
The Reserve Bank of India (RB I) approved the assessee to set up a project office in India on the conditions that the Indian project office will meet all its expenses in India out of “inward remittances received from the head office and the Indian project office will not borrow or lend to any person in India without a specific permission of the RBI.
The Assessing officer (AO) disallowed interest payments on the footing that the borrowings from the shareholders were nothing but borrowings from the head office, and payments made by the branch office to the head office. Further, under the Income Tax Act, 1961 (Act) such payments of interest on borrowings do not constitute admissible deductions, as these payments are from “self to self”. Also, under the India-Belgium Double Taxation Avoidance Agreement (Treaty) in terms of provisions of Article 7(3)(b), interest payments from the branch to the head office, are de facto not deductible in computation of profits of the PE .
The AO also raised an objection that the borrowings by the assessee, on which interest had been claimed as deduction, were in fact part of the capital of the assessee which was brought in the garb of borrowings purely on tax considerations.
The Commissioner of Income Tax (appeals) [CIT (A)] upheld the dis allowance under the provisions of Article 7 (3)( b) of the treaty and held that interest payment having made in violation of RBI guidelines was not allowable as deduction in view of specific provisions of Explanation to Section 37 of the Act.
Aggrieved by the order of CIT (A), the assessee preferred an appeal before Income Tax Appellate Tribunal (‘Tribunal’).
Observation and decision of the Tribunal:
