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A Favourable Tax Ruling for Foreign Banks from the Kolkata High Court

India
17 Mar 2011

The Kolkata High Court has ruled that interest paid by an Indian branch of a foreign bank to its overseas head office is tax deductible in the hands of the branch. The interest cannot be disallowed in the hands of the branch under section 40(a)(i) of the Income-tax Act, 1961 ('the Act'), on the basis that the branch did not withhold tax on the payment made to the head office, given that the interest was not liable to withholding tax in India since it was not taxable in the hands of the head office as per the provisions of the India-Netherlands tax treaty. Taxand India looks at the background of the case and the ruling made by the Kolkata High Court.

ABN AMRO Bank NV ('ABN'), which was acquired globally by the Royal Bank of Scotland ('RBS') in 2007-2008, is a bank incorporated in the Netherlands and is tax resident in the Netherlands. ABN, now operating under the RBS name, conducts banking operations in India through various branch offices ('Indian branch'). As part of its banking operations, the Indian branch received interest from its head office ('HO') / overseas offices, which the branch credited to its profit and loss account in India and offered to tax in India. The Indian branch also paid interest to its HO / overseas offices which it debited to its profit and loss account in India and claimed as a tax deductible expenditure. The Indian branch did not withhold tax on the interest paid to its HO, on the basis that it was not required to do so, as the interest did not represent income in the hands of the HO (given that the HO and branch were two parts of the same legal entity and a person cannot earn income from himself).

ABN did not offer to tax in India the interest income earned by the HO from the Indian branch, on the basis that the interest was not taxable in India under the India-Netherlands tax treaty. The Revenue authorities did not accept the above contention of ABN and disallowed the interest claim of its branch. The Kolkata Income-tax Appellate Tribunal (ITAT) ruled that one would need to examine the provisions of the local tax law to see the deductibility of the expenditure. Aggrieved by the ruling of the Kolkata ITAT, ABN appealed to the Kolkata High Court.

The Kolkata High Court indicated that to address this issue of tax deductibility of the interest paid by the Indian branch of ABN to its HO, there were principally two issues that needed to be considered in the appeal:

  • First, whether the interest paid was to be allowed as a tax deduction in computing the profits of the Indian branch?; and
  • Second, whether the Indian branch was required to withhold tax under section 195 of the Act, while paying the interest to the HO?

The Kolkata High Court ruled in favour of ABN on both the above questions of law. It has held that:

(i) the interest paid by the Indian branch of ABN to its HO was tax deductible in the hands of the branch while computing the profits of the branch
(ii) the branch was not required to withhold tax on the interest paid to the HO as the interest was not chargeable to tax in India under the provisions of the India-Netherlands tax treaty.

Taxand's Take


The ruling by the Kolkata High Court is welcomed and will be well received by foreign banks, which are litigating the issue of tax deductibility of interest paid by their Indian branches to their HO. What is particularly interesting is that the Kolkata High Court has held the principle that a branch and its HO are two separate entities for all purposes, while determining their tax liabilities under the provisions of a tax treaty. On balance, the ruling, though a positive one, does raise some fundamental issues as regards the taxability of transactions between Indian branches and their HO and how the provisions of the tax treaties and related withholding tax provisions ought to apply to such situations.

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Mukesh Butani
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Taxand's Take Author