Income earned from foreign branches being PE not taxable in India

IN THE ITAT MUMBAI BENCH ‘B’

Bank of India

Versus

Deputy Commissioner of Income-tax

IT Appeal No. 2781 (Mum.) of 2011

[Assessment year 2003-04]

JUNE 15, 2012

ORDER

Vivek Varma, Judicial Member – The cross appeal have been filed by the assessee bank and the department against the order of CIT(A) 4, Mumbai, dated 17/02/2011.

As the impugned order is the same, for the sake of convenience, we are, passing a consolidated order, covering both the appeals.

ITA No. 2781/Mum/2011 (Appeal by the assessee) :

2. The assessee has filed the following grounds of appeal:

01.  On the facts and circumstances of the case and in law, the learned CIT (A) had erred in determining the disallowance u/s 14A at 0.5% of average investments yielding tax free income without appreciating the fact that the appellant had not incurred any expenditure to earn the said income. The CIT (A) should have followed the decision of ITAT Delhi in the case of Minda Investments Ltd. v. Dy. CIT [2011] 48 SOT 169 (Delhi) (URO)/15 taxmann.com 376 (Delhi) wherein it was held that no disallowance can be made on estimated basis.

Without prejudice to the above contention, the CIT (A) ought to have followed the decision of Jurisdictional ITAT Mumbai in the case of Godrej Agrovat Ltd. v. Asstt. CIT [IT Appeal No. 1629 (Mum.) of 2009, dated 17-9-2010] wherein it had been held that the disallowance will be 2% of exempt income.

02.  On the facts and circumstances of the case CIT(A) erred in disallowing a sum of Rs. 2,93,434/- as prior period expenses on the ground that evidence that these have accrued or crystallized during the year was not submitted. The CIT(A) ought to have appreciated that in the case of appellant which has branches throughout India and abroad, incurring of expenditure is a continuous process and therefore no amount can be treated as prior period expenses based on decision of Jurisdictional ITAT in the case of Toyo Engg. India Ltd v. Jt. CIT [2006] 5 SOT 616 (Mum.) & Saurashtra Cement & Chemical Industries Ltd v. CIT [1995] 213 ITR 623 (Guj.).

03.  On the facts and circumstances of the case and in law, the learned CIT (A) erred in disallowing the lease premium expenses of Rs. 1,55,43,817/- on the ground that it is a capital expenditure. The CIT(A) should have noted that the said sum being amortization of premium paid on leasehold properties cannot be termed as capital expenditure. The CIT(A) ought to have allowed the entire premium of Rs. 124,43,05,430/- as held in the case of CIT v. Ucal Fuel Systems Ltd. [2008] 296 ITR 702 (Mad.) and against which decision the Supreme Court had dismissed the SLP filed by the department (195 Taxman 52 stat).Without prejudice to the above contention, the CIT(A) ought to have allowed at least the proportionate amount of Rs. 1,55,43,817/- claimed by the appellant.

3. The facts relating to the first ground of appeal is that the AO, taking the basis of addition made in respect of infrastructure lending interest @ 12%, disallowed a sum of Rs. 12,48,06,374 of Rs. 112,33,86,448, being the aggregate figure computed, on account of disallowance to be made under section 14A. The calculations taken by the AO was the result of the following :

4. Aggrieved the assessee approached the CIT(A), before whom the assessee submitted as under (relevant portions, as extracted from the CIT(A)’s order) :

The AO ought to have noted that the appellant is having substantial own funds represented by Share Capital and Reserves and non interest bearing funds in the form of Current Account, Sundry Creditors etc. The position of “own funds” and investments in tax free bonds on 31.03.2002 are as under:

Investment in assets earning tax free income 502.61

Further since these assets are held by the bank in the course of its normal business for trading the provisions of Section 14A are not applicable.

Without prejudice to the above contention if any disallowance is to be made u/s 14A, the same cannot exceed the proportionate expenditure incurred by the treasury department. The amount relating to tax free income proportionately arrived at based on exempt income to total income amounts to Rs. 15,76,875/-. Therefore, if at all any disallowance is to be made the same cannot exceed Rs. 15,76,875/-.

Without prejudice to the above contention, if at all any disallowance is warranted the same cannot exceed 2% of the tax free income. Reliance was placed for this view on the decision of Jurisdictional ITAT Mumbai in the case of Godrej Agrovet Ltd. (supra) and ITAT Chennai in the case of Bharat Overseas Bank Ltd. in ITA No. 2622/Mds/2005 for the Assessment Year 2002-03 dated 15.09.2006.

5. The CIT(A), on consideration of the assessee’s submissions held that the disallowance made by the AO at 12% of 112.33 crores, is very high, and after referring to the latest decision of Hon’ble Bombay High Court in the case of Godrej & Boyce, held that reasonable disallowance may be made and he, therefore, directed the AO to compute the disallowance at .5% of the average of investment yielding tax free income.

6. The assessee, still not satisfied, is now before the ITAT on this issue.

7. Before us the AR representing the assessee bank submitted that even this disallowance is against the various decisions of various coordinate Benches of the ITAT as well as decisions rendered by the various Hon’ble High Courts. The AR pointed out that in the case of Reliance Capital Ltd. v. Dy. CIT [IT Appeal No. 3303/Mum/2003], the coordinate Bench at Mumbai deleted the entire disallowance made by the revenue authorities. The AR further referred to the case of Dy. CIT v. Jindal Photo Ltd. [IT Appeal No. 814/Del/2011 dated 23-9-2011]. The AO also referred to the case of HDFC Bank Ltd. v. Jt. CIT [IT Appeal No. 4529/Mum/2005 and CO No. 75/Mum/2006] (eight appeals covering asst. Years 2001-02 to 2004-05), wherein the coordinate Bench at Mumbai, restricted the disallowance to 1% of the total administrative expenses :

“5 The second common issue in the appeals of the revenue for the Assessment Year 2001-02, 04-05 and 05-06 is whether in the facts and circumstances of the case, the CIT(A) is justified in restricting disallowance of administrative expenses u/s 14A to 1% as against 2% disallowed by the AO.”

“7.1 In the case in hand, the CIT(A) considered the facts and pointed out that the assessee is maintaining the treasury department which looks after the day to day investment portfolio of the bank including tax free investments. Having regard to the said factual proposition, the administrative expenses relatable to the income not forming part of the total income can be attributable to the expenditure of special treasury department maintained by the assessee; but it seems the assessee has not filed the exact detail of the operating expenses and therefore, no option was left but to estimate the disallowance.

7.2 Even otherwise, the overall administration of the bank looks after all the department including the treasury department; therefore, in the absence of the exact expenditure incurred in relation to the activity relating to tax free investment and earning the income not forming part of the total income, in our considered opinion, the CIT(A) is justified in restricting the said disallowance to 1%. Accordingly, we do not find any reason to interfere with the order of the Id CIT(A) on this issue of disallowance of administrative expenditure u/s 14A. Accordingly, the ground raised by the revenue as well as the assessee in the respective appeal and cross objection are liable to be dismissed.”

8. The AR further referred the case of Dy. CIT v. Diamond Co. Ltd. [IT Appeal No. 1625/Kol/2010], wherein the issue was whether 1% disallowance was justified on the total dividend income, where Rule 8D is not applicable, the coordinate Bench at Kolkata held, “In view of the above and respectfully following the aforesaid decision of jurisdiction Tribunal (cited supra), we direct the AC to restrict the disallowance at 1% of exempted income as expenses related to this income. We order accordingly. This ground of appeal of revenue and cross objection of assessee is partly allowed as indicated above”. The AR, therefore, reiterated the submissions made before the CIT(A) and pleaded, that despite the fact that no disallowance under section 14A is called for, as the assessee bank was having interest free investments at Rs. 502.61 crores and own funds of Rs. 13,819.70 crores and keeping in view the latest decision of Godrej & Boyce, Mfg. Co. Ltd. v. Dy. CIT [2010] 328 ITR 81/194 Taxman 203 (Bom.), he however, prayed that disallowance of .5% of tax free income, which according to the AR came to Rs. 15,76,875, would be reasonable.

9. The DR strongly supported the orders of the revenue authorities and submitted that the CIT(A) has already made a substantial reduction in the disallowance. The DR submitted that although the CIT(A)’s order is not acceptable, but atleast the direction given by the CIT(A) should be held to be reasonable, so far as the disallowance is concerned.

10. We have heard the arguments from both the sides and have also perused the material and case laws, placed on record and cited before us. The cases cited by the AR give indication that the disallowance is to be made on a reasonable basis, but we have not found any working on the disallowance, and how the AR has arrived at figure of Rs. 15,76,875 and how and why .5% of average of investment yielding tax free income was excessive. In this sense, we feel it would be appropriate to restore the issue to the file of the AO with a direction that a reasonable disallowance under section 14A may be arrived at, as per law and taking into consideration, the directions given in the various decisions of the coordinate Benches.

11. We, therefore, set aside the order of the CIT(A) on this issue and restore the issue to the file of the AO with directions as given in the above para. The ground of appeal, is thus allowed in part.

12. The next ground is against the disallowance of Rs. 2,93,434, held to be prior period expenses, debited to the P&L Account.

13. The facts involved in this issue are that there are claims on expenses such as rent, electricity, payments to R&T Agents, repairs etc. pertaining to preceding year, where the payments made in the current year. The AO held that these are prior period expenses, the AO disallowed the same and added these to the income of the assessee.

14. Aggrieved the assessee approached the CIT(A), who sustained the disallowance, simply by observing that since the assessee has not been able to substantiate the claims made along with evidence that the expenses having accrued or crystallized in the current year.

15. Aggrieved the assessee is before the ITAT.

16. Before us the AR reiterated the submissions made before the revenue authorities and submitted, “The expenditure stated as relating to prior period consisted of rent, electricity charges, payment to R & T agents, repairs etc. The claims in respect of all these expenses were received only during the current assessment year and hence they cannot be treated as prior period expenses. Further the liability to pay these sums arose only in the current year and therefore these are not prior period expenses. It is also submitted that in the case of assesses like that of the appellant with branches spread across the country, incurring of expenditure is a continuous process and no part of the expenses can be cut off and treated as prior period expenses. Reliance for this view is placed on the decision of ITAT, Mumbai in the case of Toyo Engineering India Ltd. (supra) wherein it was held as under:

“Even though a previous year is directly cut off on 31st March of every year, the actual carrying on of business which is a live process, cannot be cut off as exactly, especially in an organization like that of the assessee where activities are carried out through various site offices. Therefore, it is quite natural that there would be an amount of overflow of in formation after the close of the accounting year. Therefore, to certain extent, the claim of the assessee that the details of such expenditure were received only after the close of the accounting year, could be accepted. It is a continuous process to incur expenditure and to account for in the books of account. Therefore, even though they are treated technically as prior period expenses, it relates to a continuous flow of expenditure. Therefore, there is no justification in disallowing the expenditure, otherwise normally eligible for deduction. Reliance is also placed on the decision in the case of Union Bank of India in ITA no. 4720 to 4724/Mum/2010 for the assessment years 2002-03 to 2006-07 dated 30/06/2011 where under similar circumstances the claim of the appellant was allowed. Copy of the above decision is enclosed in annexure 6. Reliance is also placed on the decision of Saurastra Cement and Chemical Industries v. CIT 213 ITR 523 (Guj.).

The AR, therefore, submitted that since the issue is settled, no disallowance should be made.

17. DR relied on the orders of the revenue authorities.

18. We have heard the arguments of both the sides and have also perused the written submissions made before us and the case laws cited. We find that coordinate Bench at Mumbai in the case of UOI v. Asstt. CIT [2012] 49 SOT 32/16 taxmann.com 304 (appeals filed by the department), it was held,

Ground No. 1 raised by the Revenue (in ITA Nos. 4702 to 4706/M/10 for A.Yrs. 2002-03 to 2006-07) is with respect to prior period expenses.

The expenditure disallowed as in the nature of rent, municipal taxes etc. where usually the amounts are paid after detailed negotiations and receipt of demand of the arrears amount from the parties. The Ld. CIT(A) taking into consideration the nature of expenditure had come to a conclusion that since the bank is a nationalized bank subjected to audit, the claim that the liability to pay the expenses arose in the relevant assessment year would not be a matter of doubt particularly considering the nature of expenditure. He therefore allowed the amount on the ground that no infallible or demonstrable proof had to be necessarily given to allow the above sum as an expenditure.

The Ld. counsel for the assessee submitted as follows : “Further in the case of assessee like that of the respondent, which has branches all over India incurring of expenditure as a continuous process and cannot be cut off at any point of time to be classified as prior expenditure and disallowed.” We find that the decision of the Jurisdictional Court in the case of Engg. India Ltd. v. JCIT 110 TTJ 373 wherein it has been held as follows: “It is quite natural that there would be an amount of overflow of information after the close of the accounting year. Therefore, to certain extent, the claim of the assessee that the details of such expenditure were received only after the close of the accounting could be accepted. It is a continuous process to incur expenditure and to account for in the books of account. Therefore, even though they are treated technically as prior period expenses, it relates to a continuous flow of expenditure. Therefore, there is no justification in disallowing the expenditure, otherwise normally eligible for deduction.” Respectfully following the above, we dismiss the ground raised by the Revenue.”

Since the issue now is settled on identical grounds by the coordinate Bench, respectfully following the decision in the case of Union Bank of India, we delete the addition made by the revenue authorities on this issue.

Addition of Rs. 2,93,434 is deleted.

19. The next ground is against the disallowance of Rs. 1,55,43,817, wherein the AO has treated the expenses to be capital in nature.

20. The AR conceded that the expenses, treated to be of capital in nature, has been decided by the Special Bench in the case of Jt. CIT v. Mukund Ltd. [2007] 106 ITD 231/13 SOT 558 (Mum.)(SB). The AR submitted that a view may be taken by the Bench.

21. The DR relied on the orders of the revenue authorities and the decision by the Special Bench in the case of Mukund Limited.

22. We have heard both the sides. The claim of expenses made by the assessee have been treated as capital in nature and hence cannot be allowed, has been decided by the Special Bench, as conceded by the AR. Respectfully following the decision rendered by the Hon’ble Special Bench, we sustain the disallowance of Rs. 1,55,43,817, as made by the revenue authorities.

The ground of appeal is dismissed.

23. Next ground of appeal is against the charge of interest under section 234D.

24. The AR, though argued the case vehemently in the written submissions, but conceded, that since the assessment has been framed after 01/06/2003, the issue now gets covered by the insertion of Explanation 2 to section 234D by the Finance Act, 2012.

25. The DR supported the orders of the revenue authorities and added that the issue now is against the assessee.

26. From the impugned order, we find that the CIT(A) has directed the AO to charge interest as per law, we, subscribe the same, but we alter the direction made by the CIT(A), by directing the AO to charge interest as per law, keeping in view the newly inserted Explanation 2 to section 234D. We hold accordingly.

27. In the result the appeal filed by the assessee is partly allowed.

ITA No. 3534/Mum/2011 (Appeal by the department) :

28. The department has taken the following grounds of appeal :

On the facts and in the circumstances of the case and in law, the learned CIT(A) has erred in allowing relief to the assessee to the extent impugned in the grounds enumerated below :

 1.  On the facts and in the circumstances of the case and in law the Ld. CIT(A) erred in allowing the whole of the bad debts claimed without reducing the provision for bad debts made, the facts and in the circumstances of the case and in law, the learned CIT(A) erred in excluding the profits of the foreign branches amounting to Rs. 90,63,29,182/- crore from the total income without appreciating that the bank is a ‘resident’ assessee and under the provisions of section 5 of the I.T. Act all the income including income from foreign sources are to be included in the total income chargeable to tax.

2.  On the facts and in the circumstances of the case and in law, the learned CIT(A) erred in excluding the profits of the foreign branches amounting to Rs. 90,63,29,812/- crore from the total income without appreciating that credit for taxes paid in foreign countries shall be allowed to set-off against the tax chargeable on total income including the income from foreign sources which were subjected to tax in reign countries.

29. The first ground of appeal is against the allowance of whole of the bad debts claimed.

30. The facts are that the AO disallowed Rs. 549,60,45,703/- claimed as bad debts, on the ground that the assessee has not actually written off the amount in the books. According to the AO, the bad debt is allowable only if it is irrecoverable and is actually written off in the accounts of the assessee. the AO observed that only prudential write off and not actual write off as irrecoverable cannot be allowed.

31. Aggrieved, the assessee approached the CIT(A), who, relying on the decision of assessee’s own case in assessment year 2000-01 by the CIT(A) and also by following the decision of Hon’ble Supreme Court in the case of Vijaya Bank v. CIT [2010] 323 ITR 166/190 Taxman 257, wherein the Hon’ble Apex Court held, “Though a mere debit to the profit and loss account would constitute a provision for a bad and doubtful debt, yet that would not constitute actual write off. But where besides debiting the profit and loss account and creating a provision for bad and doubtful debt, the assessee has correspondingly/simultaneously obliterated the said provision from its accounts by reducing the corresponding amount from loans and advances/debtors on the assets side of the balance-sheet, and, consequently at the end of the year, the figure in the loans and advances or the debtors on the assets side of the balance-sheet is shown as net of the provision for “impugned bad debt”, the assessee will be entitled to the benefit of deduction under section 36(1)(vi), as there is an actual write off by the assessee in his books. Disallowance cannot be made on an apprehension that if the assessee failed to close each and every individual account of its debtor, it may result in the assessee claiming deduction twice over”, allowed the appeal of the assessee, allowing the claim of bad debts.

32. The DR conceded that the issue now stands settled in favour of the assessee.

33. Considering the submissions, we do not find any reason to disturb the decision of the CIT(A), wherein he has followed the decision of Hon’ble Supreme Court. The ground is dismissed.

34. The next two grounds are interlinked, wherein the assessee has sought relief of Rs. 90,63,29,812/- in respect of profit in foreign branches. The AR submitted that complete and comprehensive submissions made before the CIT(A), who after considering the submissions, allowed the assessee’s appeal. The AR, thus pointed out the relevant portion of the written submissions also placed before us. “The respondent had excluded the income from foreign branches based on Double Tax Avoidance Agreement entered into between the Govt. of India and the Govt. of the respective countries. The AO had granted relief only in respect of branches at Singapore and Japan and in respect of the other branches denied the benefit to the appellant. The CIT (A) allowed the claim of the respondent based on the decision of Hon’ble ITAT in appellant’s own case. The respondent submits that this issue has been decided in favour of the assessee by Supreme Court of India in CIT v. PV.A.L. Kulandagan Chettiar [2004] 267 ITR 654/137 Taxman 460 which upheld the decision of ITAT Chennai in the case of P.V.A.L. Kulandagan Chettiar v. ITO [1983] 3 ITD 426 (Chennai) (SB). The ITAT had held that “So the argument that the agreement must be so interpreted as to retain the taxation powers with the Government of India in order to prevent fiscal evasion has only to be rejected. The agreement is mainly for avoidance of double taxation. That means the income shall not be taxed at the same time in both the countries in India and Malaysia. So, if we interpret the agreement to mean that the Indian Government and the Malaysian Government both still retain even after the execution of the agreement the power to tax at the same time the same income it will only frustrate the object with which the agreement is executed”. The ITAT had therefore concluded, “As regards business profits paragraph I of Article 7 provides that the profits of an enterprise of a contracting state shall be taxable only in that contracting state. We will take it that the assessee being a resident of India, the enterprise is an Indian enterprise. So the Profits are taxable in India. But this power of India to tax, as further provided in the Article, exists only when the enterprise does not carry on business in Malaysia through a permanent establishment situated in Malaysia. This is an undisputed fact. So the right of the Indian Government to levy tax in respect of business profits of these types of Indian Enterprise as provided in opening paragraph of Article 7 is taken away because a permanent establishment is situated in Malaysia.” In the appellant’s case also in all the foreign countries the operation is carried out through its branches which is a permanent establishment situated outside India. Hence the income attributable to these branches cannot be taxed in India. This issue has also been decided in favour of the appellant by ITAT in appellant’s own case in ITA No. 1679/Mum/2001 dated 27/03/2008 for the AY 1997-98, wherein the coordinate Bench has held, “….The Learned CIT(A) after examining articles 23, 24 and 25 of the different DTAAs found that the laws in force in either of the contracting states would govern the taxation of income in the respective contracting states, i.e. credit of tax paid in one state would be given in the other state. He also found that Article 7 stated that if enterprise of one State carries on business in another State through permanent establishment then the State where the business is carried out would levy tax on the profits attributable to the permanent establishment. On analysis of these provisions the learned CIT(A) found that Article 7 of the different DTAAs are specific provision while Articles 23, 24 and 25 are general provisions. The coordinate Bench in the case of the assessee, in the earlier year’s case held, “As a result he also found that the issue already decided by the Tribunal in assessee’s own case for the earlier years have to be followed. We do not find any infirmity in the above finding of the CIT(A). Therefore consistent with the earlier finding of the Tribunal in assessee’s own case for the earlier years case, we do not see any merit in the ground taken by the Revenue”. The AR submitted that in the instant case also, the view should be taken in the assessee’s favour.

36. Respectfully following the decisions, we dismiss the appeal of the department on this issue.

37. In the result, the appeal filed by the department is dismissed.