ITAT Mumbai ruling in DBS Bank Limited vs ADIT: Transfer pricing, forex hedging gains and DTAA interest issues

1. Background and scope of the decision

The Mumbai Bench of the Income Tax Appellate Tribunal (ITAT Mumbai) delivered a common order in the case of DBS Bank Limited Vs ADIT, dealing with cross-appeals for Assessment Years (AYs) 2010-11, 2011-12 and 2012-13. The appeals arose from orders passed by the CIT(A) – 55/56, Mumbai, dated 30/06/2016 and 28/09/2017.

DBS Bank Limited, a non-resident banking company incorporated in Singapore, operates in India through a branch that constitutes its Permanent Establishment (PE). Multiple issues were considered together, including:

• Allowability of interest paid by the Indian PE to its Head Office (HO) and overseas branches
• Transfer pricing (TP) adjustment on guarantee commission for bank guarantees issued in India on behalf of Associated Enterprises (AEs)
• Characterisation of gains from cancellation of foreign exchange forward contracts
• Tax rate applicable to interest received under Section 244A on income-tax refunds in the context of the India-Singapore Double Taxation Avoidance Agreement (DTAA)
• Levy of surcharge and cess where the DTAA prescribes a maximum tax rate

Both the assessee and the Revenue filed appeals for the three years, and as the disputes overlapped, the Tribunal consolidated the matters and issued a single order.

2. Interest paid by Indian PE to Head Office / overseas branches

2.1 Disallowance by AO and relief by CIT(A)

For AY 2010-11, the assessee originally filed a return declaring income of Rs.466,34,70,887 on 29/09/2010. During scrutiny proceedings under Section 143(2) and Section 142(1), a revised computation dated 22/08/2013 showed income at Rs.471,58,00,305.

Among various additions, the Assessing Officer (AO) disallowed:

• Interest paid to Head Office / overseas branches: Rs.17,55,90,087
• Interest on Nostro account: Rs.20,644
• Club membership expenditure: Rs.7,21,160
• Amount of Rs.58,32,98,553 from cancellation of foreign exchange forward contracts, taxed as “Income from Other Sources”

The CIT(A) deleted the disallowance of interest paid to the HO/overseas branches, relying on the assessee’s own earlier years and judicial precedents. The Revenue challenged this deletion before the Tribunal.

2.2 Tribunal’s approach on interest issue

The assessee’s Indian branch had paid interest (including Rs.1,63,73,490 in one of the earlier years referred to) to its HO and branches in Singapore, Hong Kong and London and claimed deduction under Section 36(1)(iii). It had also deducted tax at source on such payments.

The Tribunal noted that this controversy had already been addressed in:

• The assessee’s own earlier years, where ITAT had allowed the claim, and
• The Special Bench ruling in Sumitomo Mitsui Banking Corporation v. DCIT [2012] 19 taxmann.com 364 (Mum)(SB) / 136 ITD 66 (Mum)(SB)

In Sumitomo Mitsui Banking Corporation v. DCIT, the Special Bench held:

1. Under domestic law, interest paid by an Indian branch to its foreign HO is not taxable in India as it is a payment to “self”.
2. However, while computing profits attributable to a PE under Article 7(2) and Article 7(3) of the relevant DTAA (there, the Indo-Japanese treaty), such interest is to be treated as a deductible outgoing in determining PE profits.
3. Since the interest is not chargeable to tax in India in the hands of the foreign bank (being payment to self), no withholding obligation arises thereon.

The coordinate bench in the assessee’s own case for AYs 2003-04, 2005-06 and 2006-07 had already followed this ratio and allowed deduction of interest while denying taxability in the hands of the HO.

Relying on these precedents and noting the absence of any distinguishing facts, the Tribunal for AY 2010-11:

• Upheld the deletion of disallowance of interest paid to HO/overseas branches
• Dismissed the Revenue’s ground on this issue

Consequently, the assessee’s ground seeking exclusion of interest received from HO (on the principle that it is payment from self) was treated as academic for AY 2010-11 and not adjudicated separately.

3. Applicability of transfer pricing provisions to HO–PE dealings

The assessee argued that Chapter X transfer pricing provisions cannot apply to dealings between the foreign HO/overseas branches and its Indian PE because they are the same legal person and not distinct entities.

The Tribunal rejected this broad proposition. It relied on the Special Bench decision in TBEA Shenyang Transformer Group Company Ltd. v. DCIT 169 taxmann.com 145 (Ahmedabad)(SB), which held that:

Transactions between a foreign enterprise and its Indian PE can, subject to the statutory conditions under the Income Tax Act 1961, qualify as “international transactions” for transfer pricing purposes and can be benchmarked under Chapter X.

Accordingly, the Tribunal held that the mere fact that HO and PE form part of the same legal entity does not, in itself, bar application of transfer pricing provisions. The assessee’s general challenge to TP applicability was therefore dismissed.

4. Guarantee commission on bank guarantees issued on behalf of AE

4.1 Facts and TPO’s adjustment for AY 2010-11

During AY 2010-11, the Indian PE issued bank guarantees in India in favour of third-party beneficiaries at the request of its HO/overseas branches (Associated Enterprises). These guarantees were backed by counter-guarantees from the HO/overseas branches. For these transactions, the assessee charged a guarantee commission to its AE at 0.10%, subject to USD 75 minimum / USD 150 maximum, in line with the group’s Global Pricing Policy.

The Transfer Pricing Officer (TPO) treated commissions charged by the PE to unrelated Indian customers on standalone guarantees as an internal Comparable Uncontrolled Price (CUP).