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Tax Publishers DCIT v. Oman International Bank SAOG [ITA No. 4174/Mum/2014 and ITA No. 4330/Mum/2014 & Cross Objection No. 204/Mum/2015] : 2020 TaxPub(DT) 3680 (Mumbai-Tribunal) Disallowance under section 14A in the books of the foreign bank branch in India on interest paid by Head office -- Head office expenses of the foreign branch of a bank -- TDS disallowance on Nostro account expenses *Facts:* 1. Assessee was the foreign branch in India of an international bank. They were in receipt of interest income from their Head office for certain businesses and similarly had paid certain interest expense amounts to their head office. Both the income and the expenditure with their head office were claimed to be outside tax ambit on the principle of mutuality also applying Sumitomo Mitsui Banking Corporation Special bench decision. This was accepted by the tax authorities who then claimed that disallowance under section 14A be made on such exempted income. It was the plea of the assessee that the disallowance under section 14A be made on net basis meaning the interest income received and interest expense paid to the head office. Since the income from the head office was more no disallowance be done. This was not accepted by the Commissioner (Appeals), aggrieved assessee went in higher appeal. 2. Assessee claimed certain expenses spent by their head office for travel under section 37(1) citing that these being specific to their branches would not fall into the scope of section 44C Head office expenditure cap which is only for general expenses of the head office. This was accepted by Commissioner (Appeals) basing CIT v. Emirates Commercial Bank Ltd. (2003) 262 ITR 55 (Bom.) : 2003 TaxPub(DT) 1265 (Bom-HC) ruling it in favour of the assessee. Aggrieved revenue went in higher appeal. 3. Assessee had paid Nostro account expenses which were disallowed for non-deduction of TDS under section 195. This was reversed by Commissioner (Appeals). Revenue went in higher appeal. 1. Held against the assessee that the disallowance under section 14A cannot be done on net basis and thus remanded to assessing officer to compute the disallowance on gross basis. 2. Held in favour of the assessee that the travelling expenses will need to be allowed under section 37(1) and will not fall in the scope of section 44C cap. 3. Held in favour of the assessee that Nostro account charges were akin to bank charges not warranting any TDS thus no disallowance for non-deduction of TDS is warranted. *Editorial Note:* To have an elaborate view on head office expenditure under section 44C reference be made to the enclosed published article of the author (here enclosed add the link if possible). ANOTHER OPINION Head office expenditure under section 44C -- Some fine print I. Applicability 1. Section 44C is applicable only to a non-resident if a non-resident has profits from business or profession taxable in India. The extended reading of this section would also obviously mean that a PE/BC (Permanent Establishment or Business Connection) also would be entitled to be applicable to the allowance/cap of section 44C. 2. The section has been in the statue since 1-6-1976. Finance Act, 1993 omitted clause (b) of section 44C which was reading as under -- "(b) an amount equal to the average head office expenditure; or" 3. Section 44C (as amended by 1993) caps the spend of "Head office expenditure" to lower of the below two viz. -- (a) 5% of the adjusted total income (b) The amount of head office expenditure 'relevant' or attributable to the business or profession of the assessee in India. 4. What is "Head office expenditure" is also defined in the section as under -- "head office expenditure" means executive and general administration expenditure incurred by the assessee outside India, including expenditure incurred in respect of -- (a) rent, rates, taxes, repairs or insurance of any premises outside India used for the purposes of the business or profession; (b) salary, wages, annuity, pension, fees, bonus, commission, gratuity, perquisites or profits in lieu of or in addition to salary, whether paid or allowed to any employee or other person employed in, or managing the affairs of, any office outside India; (c) travelling by any employee or other person employed in, or managing the affairs of, any office outside India; and (d) such other matters connected with executive and general administration as may be prescribed. II. Rationale 5. The above section presupposes that for the income/profits taxable in India of a non-resident there might be expenditure incurred outside India attributable to such profits, by way of corporate controlling and management activities from outside India. Thus, a portion of these head office expenditures need to be allocated to the profits of the non-resident while computing the tax under the Income Tax Act, 1961. 6. Under Transfer pricing, levy of "management fee" by foreign entities on their Indian subsidiaries has been a hot topic of disallowance in the assessment of Indian subsidiaries in the recent times. The existence of section 44C is after all a corollary of the law itself permitting reasonable management fee allocable (to the Indian PE) in the hands of the non-resident. Hence if the law envisaged a fair management fee on the PE or on the taxable profit of the non-resident, it would not be incorrect for an Indian resident entity also receiving a fair/reasonable share of head office cost on its taxable share of profits in India. Then the aspect of arm's length pricing (ALP) will need to be applied only to justify the quantum of the charge/levy and not the principle of charging head office expenditure per se. Framed assessment orders citing that the ALP of the management fee stands as NIL in the opinion of the assessing officer thus are discriminatory in the hands of the Indian residents in principle. III. Whether section 44C overrides DTAA article 7 -- Final word yet to be decided 7. The above question is perhaps the most controversial/litigious question as regards this section. There are rulings either way. Whatsoever the end decision of these rulings are -- some fundamental aspects need to be read into the fine print of these decisions. 8. In the case of Mashreq Bank PSC v. Dy. DIT 2016 TaxPub(DT) 1119 (Mum-Trib) : (2016) 176 TTJ 0085 : (2016) 131 DTR 0001 one of the prime contentions was as to whether the DTAA clause/protocol overrides section 44C to that extent section 44C being discriminatory for a non-resident by capping head office expenditure especially if the DTAA Article-7 enables allowance of expenditure without imposing any cap @ 5% cap as per section 44C. The ITAT categorically confirmed that in matters of computation of income the course will be the domestic law and if there was no restriction imposed on the lines of section 44C then it will place a resident entity in the lines of discrimination which can never be the proposition of the Indian law -- "11. In a situation, therefore, in which a specific provision like the one in article 25(1) in India UAE tax treaty exists, there cannot be any occasion to ignore the limitations on deduction of expenses under the domestic tax legislation. That would be a case of, what can be termed as, reverse discrimination. Just as much a discrimination against a non-resident assessee is undesirable, a discrimination against the resident assessee is also not desirable. As is the underlying philosophy of the tax treaties, there should be a level paying ground for everyone, which must include domestic enterprises as well. When we put this to the learned counsel, it was submitted that it is not clear as to what was the language in the relevant DTAA and whether the Government of Canada has used different terminology in different tax treaties. Learned counsel also submitted that this 'reverse discrimination', as we term it, is not only permissible under the tax treaties, it is also permissible under the Income Tax Act. Our attention was then invited to the provisions of section 10(15) which provide for certain exemptions only to non-residents, as also the provisions of section 115A which provide for lower rates of taxes for certain category of incomes of the nonresidents. Learned counsel has also invited our attention to different phraseology employed in different treaties, and contended that a uniform meaning given to all these different expressions will make differentiation in expression meaningless. It is also contented that once a tax treaty is legally entered into by a Contracting State, it is duty of the Contracting State to apply the same in letter and in spirit. Our attention is invited to the CBDT Circular No. 333 which is also referred to by some of the Tribunal decisions cited by the learned counsel. Learned counsel submits that it cannot be open to a Contracting State to shy away from implementing a tax treaty on the ground that the consequences of its implementation could be contrary to the intentions of the treaty. We are thus urged to interpret the provisions of section 7(3) to mean that all the expenses, irrespective of the limitations under the domestic tax laws, incurred by the PE are to be allowed as deduction in computing the taxable profits of the PE. 12. We are not impressed with this line of reasoning either. As far as learned counsel's reference to exemptions available to non-resident taxpayers, under the Indian Income Tax Act, is concerned, it is important to bear in mind that an exemption for aliens essentially seeks to restrict host country's jurisdiction to tax, and it is well settled that, as has also been observed by Prof. Kees Van Road, "while nationality is virtually unconditionally employed as a ground of non-discrimination....... it is not related to the use of nationality as jurisdictional basis for income taxes..." [Non-discrimination in Income Tax Law--Prof. Kees Van Raad, at p. 15]. Therefore, non-taxability of any of an alien's income sourced in the host country cannot be viewed as discrimination in his favour. It is, therefore, too far-fetched to suggest that availability of certain tax exemptions to aliens shows that reverse discrimination is generally permissible under the scheme of Indian Income Tax Act. We reject this proposition. As far as learned counsel's reference to section 115A is concerned, this is also fallacious in as much as it does not take into the fact that the related incomes are taxed on gross basis in the hands of the non-residents taxpayers and net basis in the hands of the resident taxpayers." The key takeaways which emerge of the above ruling is -- (i) The Tribunal confirmed the aspect of reverse discrimination. By allowing full head expenditure to a non-resident, a resident is discriminated vis-a-vis a non-resident which could not be what the law or the sovereign wanted. (ii) Matter on method of computation etc. follow domestic law. Hence the capping of spend @ 5% is not discriminatory as per law nor can DTAA override the same. It is to be borne in mind that excessive expenditure for residents is capped or disallowed using various alternative provisions like section 40A(2) for instance. Thus the principle of arm's length spend is what is envisaged in domestic law as well at least implicitly. 9. The second clause in section 44C (clause (c) in the section now) also confirms allowability on fair principles of law applying ALP of such head office expenditure in the hands of the PE/attribution of profits of non-resident in India. 10. So put it simply, if the allocation of the head office expenditure is on fair/equitable arm's length principles section 44C cannot cap it (though the section does it indirectly in reality). 11. The contrary ruling in the case of DIT v. Credit Agricole Indosuez is under appeal on a SLP by the department on this topic refer 2018 TaxPub(DT) 3047 (SC). The outcome of this SLP is what might be the last nail on this coffin. 12. In ADIT (Intl. Taxn.) v. Dalma Energy LLC 2012 TaxPub(DT) 2139 (Ahd-Trib) : (2012) 136 ITD 0208 : (2012) 150 TTJ 0070 : (2012) 078DTR 0219 the ITAT again voiced the above principle of ALP/fair allocation by confirming that article 7 of the DTAA cannot override section 44C (as confirmed in Mashreq bank decision as well) -- (it is also to be remembered the decision of Dalma Energy was in the realm of pre-amended Indo UAE DTAA while the decision of Mashreq bank was post amended DTAA and on its protocol as well). In the words of the Tribunal -- "12.2 So the legal controversy is whether the administrative expenses be allowed to the extent attributable to run the business of P.E. or to be restricted under section 44C of the Act. The objective for the introduction of section 44C was to get over of the difficulty in scrutinizing and verifying claims in respect of general administrative expenses incurred by the foreign head office insofar as such expenses can be related to the business in India having regarded to the fact that foreign companies operating through branches in India, sometimes try to reduce the incidence in tax in India by inflating their claims in respect of head office expenses. On reading this section, an interpretation is possible that where an assessee does not have any business overseas and the entire operations are carried out in India only, the question of allocating a part of the expenditure to the business carried on in India cannot arise. But if there is overseas business and the expenditure is in the nature of head office expenditure, then naturally the expenditure which are not entirely for the PE in India but also pertains to the foreign enterprise head office, then should be restricted under the Act. 12.3 This interpretation is visible in the case of CIT v. Emirates Commercial Bank Ltd. (2003) 262 ITR 55 (Bom.) : 2003 TaxPub(DT) 1265 (Bom-HC), wherein the Hon'ble Court has finely elaborated the provisions of section 44C and thereupon opined that this section is applicable in the cases of those non-residents who carry on business in India through their branches. The said section was introduced to get over difficulties in scrutinizing claims in respect of general administrative expenses incurred by the foreign head office insofar as such expenses stand related to their business in India having regard to the fact that foreign companies operating through branches in India sometimes try to reduce incidence of tax in India by inflating their claims in respect of the head office expenses. Therefore, the expenditure which are covered under section 44C are those expenditure which are common in nature and found to be incurred by the head office and simultaneously by the branch. However, in that case, there was a concurrent finding of fact that the expenses were exclusively incurred for the branch office in India. Due to that reason, it was held that section 44C was not applicable on those facts. There was a decision of Hon'ble Calcutta High Court in the case of Rupenjuli Tea Co. Ltd. v. CIT (1990) 186 ITR 301 (Cal.) : 1990 TaxPub(DT) 0508 (Cal-HC) which can be said to be an order through which for the first time the applicability of the provisions of section 44C was addressed on the question that where the entire business operation of non-resident company if confined to India, then in that situation, provisions of section 44C would not be applicable and that the expenditure would not be disallowed. It was clarified that the language of section 44C clearly postulates that the general administrative expenses should be incurred not only in connection with the business in India but also business outside India. In other words, as per the Hon'ble Court, a part of the expenditure at least must not be attributable to the business operations carried on in India. But where an assessee does not have any business overseas and the entire operations are carried out by it in this country only, the question of allocating a part of expenditure to the business carried on in India cannot arise. 12.4 We have narrated few of the decisions of the Hon'ble Courts on this subject to give emphasis that the general principle of allowability of an expenditure cannot be overlooked and that the accepted principle is that only those expenditure can be allowed which are attributable to the business activity as well as laid out wholly and exclusively for the purposes of the business. Keeping this recognised principle in mind, in our considered opinion, in all these decisions the provisions of section 37(1) have also be simultaneously discussed by the Courts. This aspect is buttressed by the fact that while deciding the case of CIT v. Deutsche Bank A.G. (2006) 284 ITR 463 (Bom) : 2006 TaxPub(DT) 0011 (Bom-HC) the Hon'ble Bombay High Court has held that though the provisions of section 44C overrides the provisions of section 37 but in case the working of section 44C fails, then consequently if the expenditure is attributable to the business in India, then the assessee would become entitle for full deduction under section 37(1) of Income Tax Act. Rather, in the case of Metchem Canada Inc. (2006) 100 ITD 251 (Mum.) : 2006 TaxPub(DT) 0777 (Mum-Trib) the Tribunal has finally held that the head office expenses to the extent the same could be fairly allocable to the PE would be admissible as deduction under section 37(1) of Income Tax Act. This case has been relied upon by the appellant and, therefore in the light of the discussion made hereinabove, we are not accepting the view expressed by the learned Commissioner (Appeals) that the provisions of section 37(1) became redundant in view of the restrictions under section 44C of Income Tax Act. In our humble opinion, clause(c) of section 44C has also indicated the same principle that the amount of so much of the expenditure being in the nature of head office expenditure if attributable to the business of the assessee in India, then required to be considered for the allowance of the same, however subject to a ceiling of upper limit as prescribed under section 44C of Income Tax Act." IV. Nature of Spend envisaged by section 44C 13. The nature of expenditure under the scope of section 44C can be dealt as under -- (a) Expenditure incurred in India exclusively to the PE/non-resident's business in India -- fully allowable as it will be outside the scope of section 44C. (b) Expenditure incurred outside India exclusively to the PE/non-resident's business in India -- fully allowable as it will be outside the scope of section 44C (c) It is only common administrative/management overheads incurred by the head office which will fall in the scope of section 44C (d) Expenditure which is not falling in the description of "head office expenditure" again cannot be fit into section 44C. Nonetheless the correct approach of its deductibility will need to reviewed on ALP/fair allocation principles. 14. Courts have also held that for claiming head office expenditure manifestation of spend is a must but it is not necessary that the same has to be accounted for in the Indian books or a debit note/invoice also necessarily needs to flow to the Indian PE to that extent. 15. As for the cap of 5% does it restrict the expenditure attributable to a PE virtually? The answer to this question is akin to the chicken-egg conundrum. One may safely assume that it is better/safer for an assessee to first carve out the actual expenditure directly attributable to the PE in India then the quantum of head office expenditure may need to be evaluated to the 5% cap or on arm's length principles. At times it is quite possible that the nature of operations of the PE are too nascent to absorb the entire head office expenditure. In such circumstances it is open for the non-resident/PE entity to litigate under the DTAA on principles of non-discrimination (article-24) and on the scope of article-7 as well. Having said if we review the court ruling, they have time and again established the tenet that the manner of computation of tax etc. shall follow domestic law, the 5% cap thus may come as an obstacle in some genuine cases. In such circumstances the aspect of discrimination by not allowing arm's length principle of expense by capping at 5% is certainly a bone to pick. Another ground is also that by capping the spend @ 5% the law is envisaging one to pay tax out of capital in such cases which is fundamentally incorrect principle of the tax law. These grounds need to stand test of judiciary however.

Tax Publishers

DCIT v. Oman International Bank SAOG [ITA No. 4174/Mum/2014 and ITA No. 4330/Mum/2014 & Cross Objection No. 204/Mum/2015] : 2020 TaxPub(DT) 3680 (Mumbai-Tribunal)

Disallowance under section 14A in the books of the foreign bank branch in India on interest paid by Head office -- Head office expenses of the foreign branch of a bank -- TDS disallowance on Nostro account expenses

Facts:

1. Assessee was the foreign branch in India of an international bank. They were in receipt of interest income from their Head office for certain businesses and similarly had paid certain interest expense amounts to their head office. Both the income and the expenditure with their head office were claimed to be outside tax ambit on the principle of mutuality also applying Sumitomo Mitsui Banking Corporation Special bench decision. This was accepted by the tax authorities who then claimed that disallowance under section 14A be made on such exempted income. It was the plea of the assessee that the disallowance under section 14A be made on net basis meaning the interest income received and interest expense paid to the head office. Since the income from the head office was more no disallowance be done. This was not accepted by the Commissioner (Appeals), aggrieved assessee went in higher appeal.

2. Assessee claimed certain expenses spent by their head office for travel under section 37(1) citing that these being specific to their branches would not fall into the scope of section 44C Head office expenditure cap which is only for general expenses of the head office. This was accepted by Commissioner (Appeals) basing CIT v. Emirates Commercial Bank Ltd. (2003) 262 ITR 55 (Bom.) : 2003 TaxPub(DT) 1265 (Bom-HC) ruling it in favour of the assessee. Aggrieved revenue went in higher appeal.

3. Assessee had paid Nostro account expenses which were disallowed for non-deduction of TDS under section 195. This was reversed by Commissioner (Appeals). Revenue went in higher appeal.

1. Held against the assessee that the disallowance under section 14A cannot be done on net basis and thus remanded to assessing officer to compute the disallowance on gross basis.

2. Held in favour of the assessee that the travelling expenses will need to be allowed under section 37(1) and will not fall in the scope of section 44C cap.

3. Held in favour of the assessee that Nostro account charges were akin to bank charges not warranting any TDS thus no disallowance for non-deduction of TDS is warranted.

Editorial Note: To have an elaborate view on head office expenditure under section 44C reference be made to the enclosed published article of the author (here enclosed add the link if possible).

ANOTHER OPINION

Head office expenditure under section 44C -- Some fine print

I. Applicability

1. Section 44C is applicable only to a non-resident if a non-resident has profits from business or profession taxable in India. The extended reading of this section would also obviously mean that a PE/BC (Permanent Establishment or Business Connection) also would be entitled to be applicable to the allowance/cap of section 44C.

2. The section has been in the statue since 1-6-1976. Finance Act, 1993 omitted clause (b) of section 44C which was reading as under --

"(b) an amount equal to the average head office expenditure; or"

3. Section 44C (as amended by 1993) caps the spend of "Head office expenditure" to lower of the below two viz. --

(a) 5% of the adjusted total income

(b) The amount of head office expenditure 'relevant' or attributable to the business or profession of the assessee in India.

4. What is "Head office expenditure" is also defined in the section as under --

"head office expenditure" means executive and general administration expenditure incurred by the assessee outside India, including expenditure incurred in respect of --

(a) rent, rates, taxes, repairs or insurance of any premises outside India used for the purposes of the business or profession;

(b) salary, wages, annuity, pension, fees, bonus, commission, gratuity, perquisites or profits in lieu of or in addition to salary, whether paid or allowed to any employee or other person employed in, or managing the affairs of, any office outside India;

(d) such other matters connected with executive and general administration as may be prescribed.

II. Rationale

5. The above section presupposes that for the income/profits taxable in India of a non-resident there might be expenditure incurred outside India attributable to such profits, by way of corporate controlling and management activities from outside India. Thus, a portion of these head office expenditures need to be allocated to the profits of the non-resident while computing the tax under the Income Tax Act, 1961.

6. Under Transfer pricing, levy of "management fee" by foreign entities on their Indian subsidiaries has been a hot topic of disallowance in the assessment of Indian subsidiaries in the recent times. The existence of section 44C is after all a corollary of the law itself permitting reasonable management fee allocable (to the Indian PE) in the hands of the non-resident. Hence if the law envisaged a fair management fee on the PE or on the taxable profit of the non-resident, it would not be incorrect for an Indian resident entity also receiving a fair/reasonable share of head office cost on its taxable share of profits in India. Then the aspect of arm's length pricing (ALP) will need to be applied only to justify the quantum of the charge/levy and not the principle of charging head office expenditure per se. Framed assessment orders citing that the ALP of the management fee stands as NIL in the opinion of the assessing officer thus are discriminatory in the hands of the Indian residents in principle.

III. Whether section 44C overrides DTAA article 7 -- Final word yet to be decided

7. The above question is perhaps the most controversial/litigious question as regards this section. There are rulings either way. Whatsoever the end decision of these rulings are -- some fundamental aspects need to be read into the fine print of these decisions.

8. In the case of Mashreq Bank PSC v. Dy. DIT 2016 TaxPub(DT) 1119 (Mum-Trib) : (2016) 176 TTJ 0085 : (2016) 131 DTR 0001 one of the prime contentions was as to whether the DTAA clause/protocol overrides section 44C to that extent section 44C being discriminatory for a non-resident by capping head office expenditure especially if the DTAA Article-7 enables allowance of expenditure without imposing any cap @ 5% cap as per section 44C. The ITAT categorically confirmed that in matters of computation of income the course will be the domestic law and if there was no restriction imposed on the lines of section 44C then it will place a resident entity in the lines of discrimination which can never be the proposition of the Indian law --

"11. In a situation, therefore, in which a specific provision like the one in article 25(1) in India UAE tax treaty exists, there cannot be any occasion to ignore the limitations on deduction of expenses under the domestic tax legislation. That would be a case of, what can be termed as, reverse discrimination. Just as much a discrimination against a non-resident assessee is undesirable, a discrimination against the resident assessee is also not desirable. As is the underlying philosophy of the tax treaties, there should be a level paying ground for everyone, which must include domestic enterprises as well. When we put this to the learned counsel, it was submitted that it is not clear as to what was the language in the relevant DTAA and whether the Government of Canada has used different terminology in different tax treaties. Learned counsel also submitted that this 'reverse discrimination', as we term it, is not only permissible under the tax treaties, it is also permissible under the Income Tax Act. Our attention was then invited to the provisions of section 10(15) which provide for certain exemptions only to non-residents, as also the provisions of section 115A which provide for lower rates of taxes for certain category of incomes of the nonresidents. Learned counsel has also invited our attention to different phraseology employed in different treaties, and contended that a uniform meaning given to all these different expressions will make differentiation in expression meaningless. It is also contented that once a tax treaty is legally entered into by a Contracting State, it is duty of the Contracting State to apply the same in letter and in spirit. Our attention is invited to the CBDT Circular No. 333 which is also referred to by some of the Tribunal decisions cited by the learned counsel. Learned counsel submits that it cannot be open to a Contracting State to shy away from implementing a tax treaty on the ground that the consequences of its implementation could be contrary to the intentions of the treaty. We are thus urged to interpret the provisions of section 7(3) to mean that all the expenses, irrespective of the limitations under the domestic tax laws, incurred by the PE are to be allowed as deduction in computing the taxable profits of the PE.

12. We are not impressed with this line of reasoning either. As far as learned counsel's reference to exemptions available to non-resident taxpayers, under the Indian Income Tax Act, is concerned, it is important to bear in mind that an exemption for aliens essentially seeks to restrict host country's jurisdiction to tax, and it is well settled that, as has also been observed by Prof. Kees Van Road, "while nationality is virtually unconditionally employed as a ground of non-discrimination....... it is not related to the use of nationality as jurisdictional basis for income taxes..." [Non-discrimination in Income Tax Law--Prof. Kees Van Raad, at p. 15]. Therefore, non-taxability of any of an alien's income sourced in the host country cannot be viewed as discrimination in his favour. It is, therefore, too far-fetched to suggest that availability of certain tax exemptions to aliens shows that reverse discrimination is generally permissible under the scheme of Indian Income Tax Act. We reject this proposition. As far as learned counsel's reference to section 115A is concerned, this is also fallacious in as much as it does not take into the fact that the related incomes are taxed on gross basis in the hands of the non-residents taxpayers and net basis in the hands of the resident taxpayers."

The key takeaways which emerge of the above ruling is --

(i) The Tribunal confirmed the aspect of reverse discrimination. By allowing full head expenditure to a non-resident, a resident is discriminated vis-a-vis a non-resident which could not be what the law or the sovereign wanted.

(ii) Matter on method of computation etc. follow domestic law.

Hence the capping of spend @ 5% is not discriminatory as per law nor can DTAA override the same. It is to be borne in mind that excessive expenditure for residents is capped or disallowed using various alternative provisions like section 40A(2) for instance. Thus the principle of arm's length spend is what is envisaged in domestic law as well at least implicitly.

9. The second clause in section 44C (clause (c) in the section now) also confirms allowability on fair principles of law applying ALP of such head office expenditure in the hands of the PE/attribution of profits of non-resident in India.

10. So put it simply, if the allocation of the head office expenditure is on fair/equitable arm's length principles section 44C cannot cap it (though the section does it indirectly in reality).

11. The contrary ruling in the case of DIT v. Credit Agricole Indosuez is under appeal on a SLP by the department on this topic refer 2018 TaxPub(DT) 3047 (SC). The outcome of this SLP is what might be the last nail on this coffin.

12. In ADIT (Intl. Taxn.) v. Dalma Energy LLC 2012 TaxPub(DT) 2139 (Ahd-Trib) : (2012) 136 ITD 0208 : (2012) 150 TTJ 0070 : (2012) 078DTR 0219 the ITAT again voiced the above principle of ALP/fair allocation by confirming that article 7 of the DTAA cannot override section 44C (as confirmed in Mashreq bank decision as well) -- (it is also to be remembered the decision of Dalma Energy was in the realm of pre-amended Indo UAE DTAA while the decision of Mashreq bank was post amended DTAA and on its protocol as well). In the words of the Tribunal --

"12.2 So the legal controversy is whether the administrative expenses be allowed to the extent attributable to run the business of P.E. or to be restricted under section 44C of the Act. The objective for the introduction of section 44C was to get over of the difficulty in scrutinizing and verifying claims in respect of general administrative expenses incurred by the foreign head office insofar as such expenses can be related to the business in India having regarded to the fact that foreign companies operating through branches in India, sometimes try to reduce the incidence in tax in India by inflating their claims in respect of head office expenses. On reading this section, an interpretation is possible that where an assessee does not have any business overseas and the entire operations are carried out in India only, the question of allocating a part of the expenditure to the business carried on in India cannot arise. But if there is overseas business and the expenditure is in the nature of head office expenditure, then naturally the expenditure which are not entirely for the PE in India but also pertains to the foreign enterprise head office, then should be restricted under the Act.

12.3 This interpretation is visible in the case of CIT v. Emirates Commercial Bank Ltd. (2003) 262 ITR 55 (Bom.) : 2003 TaxPub(DT) 1265 (Bom-HC), wherein the Hon'ble Court has finely elaborated the provisions of section 44C and thereupon opined that this section is applicable in the cases of those non-residents who carry on business in India through their branches. The said section was introduced to get over difficulties in scrutinizing claims in respect of general administrative expenses incurred by the foreign head office insofar as such expenses stand related to their business in India having regard to the fact that foreign companies operating through branches in India sometimes try to reduce incidence of tax in India by inflating their claims in respect of the head office expenses. Therefore, the expenditure which are covered under section 44C are those expenditure which are common in nature and found to be incurred by the head office and simultaneously by the branch. However, in that case, there was a concurrent finding of fact that the expenses were exclusively incurred for the branch office in India. Due to that reason, it was held that section 44C was not applicable on those facts. There was a decision of Hon'ble Calcutta High Court in the case of Rupenjuli Tea Co. Ltd. v. CIT (1990) 186 ITR 301 (Cal.) : 1990 TaxPub(DT) 0508 (Cal-HC) which can be said to be an order through which for the first time the applicability of the provisions of section 44C was addressed on the question that where the entire business operation of non-resident company if confined to India, then in that situation, provisions of section 44C would not be applicable and that the expenditure would not be disallowed. It was clarified that the language of section 44C clearly postulates that the general administrative expenses should be incurred not only in connection with the business in India but also business outside India. In other words, as per the Hon'ble Court, a part of the expenditure at least must not be attributable to the business operations carried on in India. But where an assessee does not have any business overseas and the entire operations are carried out by it in this country only, the question of allocating a part of expenditure to the business carried on in India cannot arise.

12.4 We have narrated few of the decisions of the Hon'ble Courts on this subject to give emphasis that the general principle of allowability of an expenditure cannot be overlooked and that the accepted principle is that only those expenditure can be allowed which are attributable to the business activity as well as laid out wholly and exclusively for the purposes of the business. Keeping this recognised principle in mind, in our considered opinion, in all these decisions the provisions of section 37(1) have also be simultaneously discussed by the Courts. This aspect is buttressed by the fact that while deciding the case of CIT v. Deutsche Bank A.G. (2006) 284 ITR 463 (Bom) : 2006 TaxPub(DT) 0011 (Bom-HC) the Hon'ble Bombay High Court has held that though the provisions of section 44C overrides the provisions of section 37 but in case the working of section 44C fails, then consequently if the expenditure is attributable to the business in India, then the assessee would become entitle for full deduction under section 37(1) of Income Tax Act. Rather, in the case of Metchem Canada Inc. (2006) 100 ITD 251 (Mum.) : 2006 TaxPub(DT) 0777 (Mum-Trib) the Tribunal has finally held that the head office expenses to the extent the same could be fairly allocable to the PE would be admissible as deduction under section 37(1) of Income Tax Act. This case has been relied upon by the appellant and, therefore in the light of the discussion made hereinabove, we are not accepting the view expressed by the learned Commissioner (Appeals) that the provisions of section 37(1) became redundant in view of the restrictions under section 44C of Income Tax Act. In our humble opinion, clause(c) of section 44C has also indicated the same principle that the amount of so much of the expenditure being in the nature of head office expenditure if attributable to the business of the assessee in India, then required to be considered for the allowance of the same, however subject to a ceiling of upper limit as prescribed under section 44C of Income Tax Act."

IV. Nature of Spend envisaged by section 44C

13. The nature of expenditure under the scope of section 44C can be dealt as under --

(a) Expenditure incurred in India exclusively to the PE/non-resident's business in India -- fully allowable as it will be outside the scope of section 44C.

(b) Expenditure incurred outside India exclusively to the PE/non-resident's business in India -- fully allowable as it will be outside the scope of section 44C

(c) It is only common administrative/management overheads incurred by the head office which will fall in the scope of section 44C

(d) Expenditure which is not falling in the description of "head office expenditure" again cannot be fit into section 44C. Nonetheless the correct approach of its deductibility will need to reviewed on ALP/fair allocation principles.

14. Courts have also held that for claiming head office expenditure manifestation of spend is a must but it is not necessary that the same has to be accounted for in the Indian books or a debit note/invoice also necessarily needs to flow to the Indian PE to that extent.

15. As for the cap of 5% does it restrict the expenditure attributable to a PE virtually? The answer to this question is akin to the chicken-egg conundrum. One may safely assume that it is better/safer for an assessee to first carve out the actual expenditure directly attributable to the PE in India then the quantum of head office expenditure may need to be evaluated to the 5% cap or on arm's length principles. At times it is quite possible that the nature of operations of the PE are too nascent to absorb the entire head office expenditure. In such circumstances it is open for the non-resident/PE entity to litigate under the DTAA on principles of non-discrimination (article-24) and on the scope of article-7 as well. Having said if we review the court ruling, they have time and again established the tenet that the manner of computation of tax etc. shall follow domestic law, the 5% cap thus may come as an obstacle in some genuine cases. In such circumstances the aspect of discrimination by not allowing arm's length principle of expense by capping at 5% is certainly a bone to pick. Another ground is also that by capping the spend @ 5% the law is envisaging one to pay tax out of capital in such cases which is fundamentally incorrect principle of the tax law. These grounds need to stand test of judiciary however.