Foreign company having Permanent Establishment in India cannot be taxed at the rate applicable to domestic company

Permanent Establishment of a Mauritian company in India cannot be considered as a ‘domestic company’ and accordingly, it will have to pay a higher rate of tax prescribed under the Act.

Mumbai bench of the Income-tax Appellate Tribunal (the Tribunal) in the case of JCIT Vs State Bank of Mauritius Ltd. (2009-TIOL-712-ITAT-MUM) has held that the foreign company having Permanent Establishment (PE) in India cannot be taxed at the rate applicable to domestic company in view of insertion of Explanation 1 to section 90 of the Income-tax Act, 1961 (the Act) by Finance Act 2001 with retrospective effect from 1 April 1962. Accordingly, it will have to pay tax at the rate prescribed in the Finance Act (i.e. at higher rate) even if a taxpayer is covered by the provisions of the India-Mauritius tax treaty (the tax treaty).

Facts of the case

The taxpayer was a company incorporated in Mauritius and it had a Permanent Establishment (PE) in India. The taxpayer, as per article 24 of the tax treaty i.e. ‘non-discriminatory’ clause, claimed its status as equivalent to a ‘domestic company’ as defined under section 2(22A) of the Act and contended that higher rate of tax (50 percent) prescribed for non-resident companies and also surcharge will not be applicable in its case. However, the AO contended that non-resident company has to pay taxes at the rate provided in the Finance Act. Accordingly, the AO held that the taxpayer was liable to pay tax at higher rate. Commissioner of Income-tax (Appeals) observed that there was no limitation to non­ discriminatory provision of the tax treaty and once it prevailed in a conflict situation, lower rate of 40 percent will apply and not the higher rate of 50 percent.

Taxpayer’s contentions

After referring article 24 ‘Non Discrimination’ of the tax treaty the taxpayer claimed that its status was equivalent to ‘domestic company’ as defined in section 2(22A) of the Act and therefore, it was liable to pay tax at the rate of 40 percent and not at the rate of 50 percent. Further, surcharge applicable to other ‘non-resident’ companies will not apply in its case.

Tax department’s contentions

The tax department relied on the decision of the Authority for Advance Rulings in the case of Societe Generate wherein it was held that a non- domestic company has to pay taxes at the given rate in the Finance Act. Accordingly, the taxpayer was liable to pay tax at the rate of 50 percent.

Tribunal’s ruling

• The Tribunal observed that earlier there were certain decisions in favour of the taxpayer wherein it was held that since the provisions regarding levy of higher taxation of the Act was less favourable to the foreign companies which is against the provision of the tax treaty, provisions of the tax treaty would override to the normal provisions of the Act and hence foreign companies would be chargeable at the rates prescribed for domestic companies. However, Finance Act 2001 inserted an explanation 1 to section 90 of the Act with retrospective effect from 1 April 1962² to end this controversy.

Note:-  The explanation states that the charge of tax in respect of a foreign company at a rate higher that the rate at which a domestic company is chargeable, shall not be regarded as less favourable charge or levy of tax in respect of such foreign company.

• The Tribunal further observed that a similar view was taken by the Mumbai Tribunal in the case of Chohung Bank v. DDIT [2006] 102 ITD 45 (Mum) where the Mumbai Tribunal held that the higher rate of tax charged was not affected by the non-discrimination clause incorporated in the tax treaty since the domestic and foreign banking companies did not function under similar circumstances.
• The Tribunal held that tax rates prescribed in the Finance Act has to be applied even if a taxpayer foreign company is covered by the provisions of the tax treaty. Accordingly, the taxpayer was liable to pay tax at the higher rate of tax.
• Further, the Tribunal on the issue of dis allowance of expenditure under section 37(2) of the Act observed that as per article 7 of the tax treaty expenditure is to be allowed on the basis whether the same is incurred for the purposes of business of the PE and no restriction provided in the Act can be imposed. Accordingly, the Tribunal held that since the expenditure incurred by the taxpayer was in relation to the PE in India and therefore, as per article 7 of the tax treaty dis allowance cannot be made as per the restrictions provided under the Act.

Our Comments

It is to be noted that the Mumbai Tribunal has followed the decision of Chohung Bank where it was held that if after a treaty comes into force, an enactment of Parliament is passed which contains provisions contrary to the non-discrimination article 24, the scope and the effect of the legislation cannot be curtailed by reference to the tax treaty.

The Mumbai Tribunal in the case of Sakura Bank Ltd.⁵ and Kolkata Tribunal in the case of ABN AMRO Bank NV⁶ also held that the explanation to section 90 expressly permits differential rates for domestic and overseas companies.

However, even without the explanation the AAR in the case of P-1 6 of 1998, In re⁷ and Mumbai Tribunal in the case of Mashreq Bank PSC⁸ denied relief to a foreign bank of a lower tax rate applicable for domestic companies.

It is also pertinent to note that certain tax treaties (eg. UK) expressly provide that article 24 cannot be construed to mean that the tax rate in respect of a PE and an Indian company must be the same.