Interest received by non-resident from its PE is not taxable as per DTAA due to non-applicability of separate entity approach

Facts of the Case:

• The Assessee (Credit Suisse AG) is a foreign company incorporated in Switzerland and is a tax resident of Switzerland. Credit Suisse Mumbai Branch (“CSMB”) is a branch of the Assessee registered with the Reserve Bank of India and undertaking banking operations in India. CSMB constitutes a fixed place of Permanent Establishment (“PE”) of the Asessee in India as per Article 5 of India-Swiss DTAA. Also, the Assessee is having singapore branch which is registered with the Securities and Exchange Board of India (“SEBI”) and conducts portfolio investments in Indian securities.
• The CSMB has procured loan from Singapore and London branch of the Assessee. During the year under consideration, the Assessee paid interest on loan to both the foreign branches and same was not offered to tax by the Singapore branch on the basis that the Assessee and branches are one and same enterprises by placing reliance upon the decision of Hon’ble Tribunal in Sumitomo Mitsui Banking Corporation vs DDIT. (2012)145 TTJ 649 (Mum). The Assessee claimed the deduction of interest on loan while computing the business profits of the CSMB.
• However, the Assessing Officer (“AO”) is of the view that interest paid by the PE to the foreign branches is an interest deemed to accrue arise in India and is liable to be taxed in India by referring to explanation under section 9(1)(v) of the Income Tax Act, 1961 (“the Act”) which clarifies that in case of non-resident engaged in the business of banking, any interest paid by the PE of such non-resident in India to the head office outside India shall be deemed to accrue arise in India and shall be chargeable to tax and PE in India shall be deemed to be a person separate and independent of the non-resident.

Issues before the Hon’ble Tribunal

Whether fiction of hypothetical independence or a separate entity approach for the purpose of computing the profits attributable to the PE can be extended for the computation of profits of the head office or overseas branch?

Decision of the Tribunal:

• The Tribunal held as per the provisions of Section 90(2) of the Act, the Assessee can avail the taxability as per DTAA or the Act whichever is more beneficial. Accordingly, even though the interest paid by the PE to overseas branch are covered under explanation to section 9(1)(v) of the Act and liable for tax in the hands of overseas branch however since the Assessee has opted for the benefit of DTAA, the aforementioned explanation of the Act will not lead to taxation of the interest received by the overseas branch under the provisions of DTAA.
• The Tribunal also held that by applying the separate entity approach, interest paid by the PE to the head office or overseas branch on money lent to the PE shall be allowed as deduction as per Article 7(3) of the India-Switzerland DTAA. However, separate entity approach comes into play only for computing the profits attributable to the PE which shall be taxable in the source country as per Article 7(2) of the India- Switzeland DTAA.
• Further, by extending the separate entity approach for computing the profit of head office or overseas branch for bringing to tax the interest received by the overseas branch from the Indian PE is flawed because interest income of non-resident shall be taxed under Article 12 of DTAA only when such non-resident is not having any PE in India wherein case PE is established in India then the provisions of Article 7 only shall apply and since Article 7 deals with taxability of only such profits which are attributable to PE of such non-resident. Therefore, in present case interest received by overseas branch from CSMB are not liable for tax in India in the hands of the Assessee.

SW Point of View:

Hon’ble ITAT has clarified that fiction of hypothetical independence or separate entity approach is not applicable for the computation of profit of the head office or overseas branch and same shall be applicable only for computation of profits attributable to PE of non-resident.

Lakshay Prakash Jonwal, Direct Tax Associate, SW India