The Income Tax Appellate Tribunal (ITAT), Mumbai, on 8 October held that interest transactions between an Indian permanent establishment and its overseas Head Office or branches do not constitute taxable income under domestic law, as they represent transactions with oneself. Further that Section 14A of the Income Tax Act, 1961, cannot apply to such receipts.

A Bench comprising Judicial Member Beena Pillai and Accountant Member Bijayananda Pruseth partly allowed cross-appeals filed by American Express Bank Ltd. and the Revenue against the order of the Commissioner of Income Tax (Appeals) for Assessment Year 2000-01. It also allowed a foreign exchange forward contract revaluation loss and upheld the deduction of expenditure incurred under a voluntary retirement scheme, and held:

“Once the interest received from the Head Office/overseas branches is regarded as a receipt from self and consequently does not constitute 'income' under the domestic law, it cannot simultaneously be characterised as 'exempt income' so as to trigger s.14A.”

American Express Bank Ltd., a banking company incorporated in the United States, carried on banking business in India through branches that constituted its permanent establishment. The dispute over interest transactions between the Indian branches and the overseas Head Office arose from interest received on NOSTRO accounts.

The bank contended that the Head Office and its branches did not constitute separate legal entities under domestic law and that the interest represented a receipt from oneself. The CIT(A) accepted that net interest of Rs. 13.09 crore was not taxable but nevertheless disallowed interest expenditure and administrative expenses totalling Rs. 32.71 crore under Section 14A.

The Tribunal upheld the finding that interest arising from transactions between the Indian permanent establishment and the overseas Head Office or branches did not constitute taxable income. It directed the Assessing Officer to delete the Section 14A disallowance of Rs. 32.71 crore, holding that receipts arising from transactions with oneself do not constitute exempt income because they do not qualify as income in the first place.

It also considered the bank's claim of Rs. 6.98 crore for losses arising from the year-end revaluation of outstanding foreign exchange forward contracts. The bank followed the mercantile system of accounting and consistently revalued its unmatured contracts at the end of each accounting year. It offered gains to tax while claiming corresponding losses as expenditure. The Assessing Officer disallowed the loss on the ground that the contracts had not matured and the loss was notional.

Further, the Bench found that the bank's obligations under the outstanding contracts existed at the end of the financial year and that the bank had valued them using a consistent accounting method. It held that the loss was neither merely contingent nor notional and directed the Assessing Officer to delete the disallowance of Rs. 6.98 crore. It observed:

“Applying the above principles to the facts before us, we are unable to sustain the view that the impugned loss is merely contingent or notional. The obligation under the outstanding forward contracts existed as at the year end and its valuation is based on a consistently followed method by the assessee.”

Next, the Tribunal examined global system charges of Rs. 4.24 crore and Head Office expenditure of Rs. 2.76 crore. It held that the Assessing Officer must first determine the precise nature and character of the expenditure before deciding whether it qualified as Head Office expenditure under Section 44C.

It remanded the issues for fresh adjudication, including examination of the global system charges and the bank's contentions concerning tax deduction at source and royalty.

In the Revenue's appeal, it upheld the deletion of a separate Section 14A disallowance of Rs. 1 crore relating to exempt income. It noted that the bank had sufficient surplus interest-free funds to make its investments. It also upheld the allowance of Rs. 10.67 crore paid as broken-period interest on securities held in the course of banking business.

Moreover, the Bench rejected the Revenue's challenge to the deduction of Rs. 11.40 crore incurred under the voluntary retirement scheme. It found that the expenditure related to the existing workforce and the bank's business and that the bank had acquired neither a new asset nor a new source of income in the capital field.

Accordingly, the ITAT partly allowed both appeals.

Counsel for the Assessee: P.J. Pardiwala and Hiten Thakkar

Counsel for the Revenue: Kamlesh Makwana

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Case Title :  American Express Bank Ltd. v. DDIT (IT)-1(1) / JT DIT (IT)-1(1)Case Number :  ITA Nos. 5667/Mum/2004 and 9414/Mum/2004CITATION :  2026 LLBiz ITAT(MUM) 291
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