Foreign Branch PE Income Not Taxable in India Under DTAAs; ITAT Mumbai Delivers Comprehensive Ruling in State Bank of India Appeals for AY 1997-98 & 1998-99
Background and Overview
The Mumbai Bench "G" of the Income Tax Appellate Tribunal adjudicated a set of cross-appeals filed by both the assessee and the Revenue arising from the orders of the Commissioner of Income Tax (Appeals)-5, Mumbai dated 28 January 2019. The appeals covered Assessment Years 1997-98 and 1998-99 and involved several interconnected legal and factual disputes. The consolidated outcome resulted in the assessee's appeals being partly allowed while the Revenue's appeals were dismissed.
The four appeals — ITA 2189/MUM/2019, ITA 2190/MUM/2019, ITA 2290/MUM/2019, and ITA 2291/MUM/2019 — were clubbed together given that they shared common issues. The Tribunal took up the assessee's appeal in ITA No. 2290/Mum/2019 for AY 1997-98 first, and thereafter applied the same findings to AY 1998-99.
The five core areas of dispute were:
- Disallowance under
Section 14Ain relation to exemption claimed underSection 10(15)(iv)(h) - Deduction claim for reversal of interest income on doubtful advances of ₹35,03,36,189/-
- Recovery of bad debts written off in earlier years amounting to ₹42,63,46,635/-
- Non-taxability of income earned through foreign branches constituting permanent establishments outside India
- Computation of interest on refunds under
Section 244A
Ground 1: Section 14A Disallowance Restricted to 1% of Exempt Income
Factual Matrix
During the assessment for AY 1997-98, the assessee had claimed exemption under Section 10(15)(iv)(h) of the Income Tax Act, 1961 amounting to Rs. 70.95 crores. The Assessing Officer, however, attributed proportionate interest expenditure of Rs. 25.43 crores as relating to this exempt income and accordingly restricted the exemption to Rs. 45.51 crores on a proportionate basis.
Before the CIT(A), the assessee could not furnish details establishing that borrowed funds had not been deployed in investments generating exempt income. Consequently, the CIT(A) confirmed the Assessing Officer's proportionate allocation and additionally upheld a disallowance at 2% of exempt income under Section 14A.
Arguments Before the Tribunal
The assessee's Authorised Representative contended that the controversy in the original assessment proceedings was confined solely to whether the exemption under Section 10(15)(iv)(h) was claimable on a gross or net basis. Reference was made to the Tribunal's earlier order in State Bank of India, ITA Nos. 1292/Mum/2001 and 1293/Mum/2001, dated 06/06/2002 covering AYs 1996-97 and 1997-98, wherein the exemption had been allowed on a gross basis — an order that attained finality as the Revenue did not appeal further.
It was further submitted that in the first round of appeal for the year under consideration, the Tribunal in ITA Nos. 3823-24/Mum/2005 (order dated 29/04/2016) had remanded the matter back to the Assessing Officer since the authorities had not had the benefit of case law on Section 14A at the time of the original assessment. In the remand proceedings, the Assessing Officer applied Rule 8D of the Income-tax Rules, 1962 to compute the disallowance, which was subsequently restricted by the CIT(A) to 1% of exempt income.
The Authorised Representative additionally relied on the Coordinate Bench decision in assessee's own case for AYs 2001-02 and 2002-03 in ITA Nos. 4408/Mum/2011, 4409/Mum/2011, 4656/Mum/2011, and 4655/Mum/2011 (order dated 12/07/2021), where the Tribunal had directed:
"Considered the rival submissions and perused the material on record. We notice that the provisions of rule 8D was introduced only from the assessment year 2008-09 and strictly the rules are not applicable in the current assessment year. However, following the findings of the Co-ordinate Bench decisions rendered in assessee's own case which has directed the Assessing Officer to estimate the disallowance under section 14A of the Act at one percent of the exempt income. Keeping in view the consistency maintained by the Tribunal in assessee's own case, we are also inclined to direct the Assessing Officer to estimate the expenditure under section 14A of the Act at the rate of one percent of the exempt income. We do not prefer to remit this issue to the Assessing Officer since the direction of the Co-ordinate Bench are very clear and it should be estimated at the rate of one percent of the exempt income. Thus, ground no.5, is allowed in terms indicated above."
The Departmental Representative, on the other hand, defended the CIT(A)'s order and noted that the question of gross-versus-net allowability of the exemption under Section 10(15)(iv)(h) had not been separately adjudicated by the CIT(A).
Tribunal's Decision
The Tribunal noted that the Assessing Officer had, without examining the gross-versus-net basis of the exemption, simply attributed proportionate interest expenditure and made a disallowance under Section 14A. Since Rule 8D was clearly inapplicable to AY 1997-98, and following the consistent view of Coordinate Benches in the assessee's own case, the Tribunal directed the Assessing Officer to restrict the disallowance under Section 14A to 1% of the exempt income.
The gross-versus-net basis of exemption under Section 10(15)(iv)(h) was not separately decided. Ground No. 1 was partly allowed.
Ground 2: Reversal of Previously Taxed Interest on Doubtful Advances — ₹35,03,36,189/-
Factual Background
During AY 1996-97, the assessee recognised interest income of ₹35,03,36,189/- on doubtful advances in conformity with RBI prudential norms and offered the same to tax under Section 43D of the Income Tax Act, 1961. In AY 1997-98, the corresponding advances were classified as non-performing assets, and accordingly the assessee reversed this interest income by debiting it to its Profit and Loss Account in compliance with paras 3.2.1 and 3.2.2 of the applicable RBI Guidelines on income recognition for non-performing assets.