A T Kearney Ltd., UK (assessee), a company engaged in the business of providing management consulting services, carried on its business operations in India through its branch office . The assessee deputed highly experienced personnel to train and develop the local expertise to provide services to Indian clients in line with its global standards. The expatriate employees continued to draw their salaries from the overseas office.
In computing the total income of the branch office (being treated as a permanent establishment of the assessee), the assessee claimed deduction for the salary paid to the expatriates by the overseas office.
The Assessing Officer (AO) disallowed the deduction for salaries paid to the expatriates in computing the total income of the Indian branch office.
The Commissioner of Income Tax (Appeals) deleted the disallowance of the salary of the expatriates. The Revenue filed an appeal before the Income Tax Appellate Tribunal (ITAT) whereas the assessee filed cross objection.
Contentions of the assessee
• Salaries paid to expatriates by the overseas office is deductible business expenditure in computing income of the branch office as the employees were working wholly and exclusively for the branch office.
• The legitimate business expenditure incurred for the branch including business development, marketing, practice development and general administration expenses are eligible and deductible expenses in computing the income of the branch office.
• In order to determine income chargeable to tax in India, relying on Article 7 of the Tax Treaty between India and the UK, only profits attributable to the PE?s activities in India should be taxable.
Contentions of the revenue
• In computing the profits of the Indian branch office, the AO has rightly disallowed the deduction for expatriates? salary as the expatriates continued to work for the overseas office and salaries were paid to them by the overseas company for its own benefit to have global presence. Therefore, the said expenses cannot be said to have been incurred by the Indian branch office for earning its income.
• The expenses incurred in relation to earning of income in India are pre-determined and pre-negotiated. Thus, once the amount of these expenses is known, there is a certain mark-up and income is derived from the client, it is only such expenses which can be said to have been incurred wholly and exclusively for earning of income in India and claimed as deduction.
• As the salaries of expatriate employees was paid by the overseas entity, section 44C (dealing with disallowance of expenses incurred by the head office) should be invoked and proportionate disallowance of head office expenses should be made.
Ruling of the ITAT
• Salaries of the expatriate employees and expenses incurred for promoting and running the business in India are attributable to the branch operations in India and should be allowed as deduction.
• Since the year under consideration was the first year of the assessee in India, the assessee incurred significant expenses in business development/ marketing, etc and in order to have a better relationship with the clients, heavy discounts were given to them. All these resulted in heavy losses to the assessee. The expenses so incurred towards business development and marketing expenses were to gain in market share and contact for clients, which are integral to earning of income.
• Where audited accounts were maintained and produced, the same cannot be ignored and profits cannot be estimated nor can expenses be curtailed or disallowed.
• There is nothing on record that the expatriates to whom salaries were paid by the assessee were managing the affairs outside India for the employer. The provisions of section 44C were not applicable as the same apply only to the expenditure of common nature which is incurred for various branches and head office.