Profits of dealings with HO by MNCs branch taxable      
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MUMBAI. Vide a significant ruling AIT-2006-222-ITAT ; the Tribunal has settled the issue whether, under the Indian Income Tax Act 1961,  the profits arising out of dealings of a foreign company’s Indian branch office, with its head office and with other foreign branches, is taxable in India  or not.        

T H E  F A C T S:

The assessee was a non resident banking company incorporated in Germany, and operating in India through its branch office in Mumbai. During the course of assessment proceedings, the AO noticed that “the assessee has given a note to the computation of income that inter-branch income/ expenditure credited/debited to profit and loss account   have been excluded while arriving at the total income since the Bank cannot be regarded as trading with itself i.e. having earned income or incurred expenditure by mere reason of Mumbai branch debiting/ crediting the ledger account of the other branches outside India”. In response to AO’s requisition as to why the income from inter-branch transactions should not be brought to tax in India, the assessee reiterated that the branch and head office transactions are transactions with oneself.

The AO was of the view that the income of the assessee would be covered by section 9(1) of the Act. The Assessing Officer was also of the view that if the branch and head office are to be viewed as one and the same thing, then there was no reason to file ‘return in respect of India operations’. The AO observed that it was accepted international tax law practice that income “accruing or arising” in a country is  taxed in that country. The Assessing Officer further took note of the factual position that in notes forming part of the computation of income “the assessee has mentioned that profits have been computed in accordance with the provisions of the DTAA  (between India and Germany). The AO then referred to various articles  of India Germany DTAA and having analyzed the same, concluded that “these articles are very clear that the income of the assessee is quite independent of its head office” and that “the statute has made it mandatory to treat these as separate entities”.  The AO also concluded that “the interest earned from NOSTRO would be deemed to have been accrued or arisen in India as it was emanated from India operations of the bank”.

• AO made an addition of Rs 5,17,39,005 to the returned income of the assessee company. CIT(A) confirmed the Order of AO.

T H E  R U L I N G:

Under the Income Tax Act, so far as foreign companies are concerned, taxable unit is a foreign company and not its branch or permanent establishment in India, even though the taxability of such foreign companies is confined to (i) an income which ‘accrues or arises in India’ or is ‘deemed to accrue or arise in India', and (ii) an income which is received or is deemed to be received by or on behalf of such foreign company. 

 A non resident assessee may have several incomes accruing or arising to it inside India or outside India, but, so far as taxability u/s 5(2)(b) in India is concerned, it is restricted to incomes which accrue or arise, or is deemed to accrue or arise in India. The scope of this deeming fiction is set out under section 9 of the Act. As for the income accruing or arising in India, an income which accrues or arises to a foreign enterprise company in India can essentially be only such a portion of income accruing or arising to such a foreign enterprise as is attributable to its business carried out in India. This business could be carried out through one or more branches or some other form of its presence in India. To determine income accruing or arising in India to a foreign enterprise, therefore, we have to compute income attributable to such branch(es) in India, or other form(s) of presence in India such as office, project site, factory, sales outlet etc, (hereinafter collectively referred to as ‘permanent establishment’ or ‘PE’) of foreign enterprise. It takes us to the question as to what is the scope of  income accruing or arising to a foreign company in India. That is the core issue in this appeal before us. As far as the expression ‘income deemed to accrue or arise in India’ is concerned, section 9 of the Act elaborately deals with the same, but, as learned representatives agree, the expression ‘income accruing or arising in India’ is not defined anywhere in the Act, nor any judicial precedent is cited before us on the scope of this expression. We will, therefore, have to make our endeavour to find out the principles on the basis of which the income accruing or arising to a foreign enterprise in India can be determined.

• The very concept of computation of PE profits is created as a fiction of tax law in order to demarcate tax jurisdiction over the operations of a company in a country of which it is not a tax resident. Unless the PE is treated as a separate profit centre, it is not possible to ascertain the profits of the permanent establishment which, in turn, constitute profits accruing or arising to the foreign GE in India.

• As a first step to the computation of business profits accruing or arising in India to the German GE, therefore, we have to compute the profits of the Indian branch or Indian PE  of the German company.

• The proposition that intra organisation transactions are to be ignored for computing the business profits holds good only when profits of the organisation as whole are to be computed, or when these transactions are domestic transactions within one single enterprise and within one tax jurisdiction. These intra organisation transactions, which should more aptly be termed as ‘intra organisation dealings’, have a significant impact on the determination of profits of the organisational units – whether termed as permanent establishment, or by whatever other description.

• Cross border dealings within an enterprise, which necessarily concern at least two tax jurisdictions, however, need to be examined in a different perspective – the perspective of ascertaining profits taxable in each such jurisdiction as also the perspective of ascertaining the income eligible for exemption, when tax credit in GE domicile tax jurisdiction is by way of exemption,  in the GE domicile tax  jurisdiction. 

• The computation of profits in each PE state, i.e. each tax jurisdiction, thus has a dual role. On one hand, this computation decides the quantum of income on which source country can levy the tax, and, on the other hand, this computation also decides, generally speaking, the quantum of income for which tax credit is granted in the domicile country.

• It is necessary that the profits of the PE are computed as independent units.

• In order to arrive at the true profits of a branch or the PE, howsoever you term it, the intra organizations at the arms length price are to be taken into account. That is settled accounting position, so far as determination of profits of a PE are to be taken into account. No contrary accounting practice has been brought to our notice.

• Intra organisation interest income will have to be taken into account to arrive at the ‘income accruing or arising in India’.

• We have no treat the branches as hypothetically independent, and that is the underlying presumption in branch accounting methods in accountancy as well.

• Transfer pricing provisions cannot, and donot, introduce new incomes in the tax net, but only provide that incomes from international transactions are to be computed at arm’s length price. The fact that head office – branch office interest transactions are also to be computed as income on the basis of transfer pricing provisions, only confirms, as in our considered view is the correct legal position, that interest earned by the branch office from head office is a taxable event, so far as taxability of branch office is concerned.

• For the purposes of computing profits of a PE, the intra organization transactions are to be taken into account as long as these transactions are real and bonafide transactions. It is  not the assessee’s case that the interest income from the head office is without any consideration or without sufficient consideration. In other words, fact of or correctness of interest earnings from head office are not in dispute. Therefore, in our considered view, the interest earnings from the head office are to be taken into account for the purposes of computing profits arising in or accruing in India.

( Click here for full text of ruling AIT-2006-222-ITAT )