Is Salary paid overseas to expatriates of foreign entities working in India by HO an allowable business expenditure?
A permanent establishment (PE) of a foreign entity is subject to Indian income tax on income that is attributable to the PE. In computing the profits of a PE, expenses which are incurred for the purposes of the business of the PE, there shall be allowed as deductions. Further, Article 7 provides that all actual expenses including executive and general administrative expenses regardless of where (or by whom) incurred should be allowed as deductible expenses, subject to Indian tax laws.
The provisions of section 44C of the Income tax Act, 1961, limits the deductibility of head office expenditure incurred outside India in computing the income of a PE in India. The deduction under section 44C of the Act is limited to 5% of the adjusted total income or the actual expenditure of the PE, whichever is lower.
According to Section 44C, in the case of an assessee, being a non-resident, no allowance shall be made, in computing the income chargeable under the head “Profits and gains of business or profession”, in respect of so much of the expenditure in the nature of head office expenditure as is in excess of the amount, which shall be the least of:
- an amount equal to five per cent of the adjusted total income; or
- the amount of so much of the expenditure in the nature of head office expenditure incurred by the assessee as is attributable to the business or profession of the assessee in India
The meaning of head office expenditure is quite wide and includes executive and general administrative expenses, including expenditure incurred in respect of:
- rent, rates, taxes, repairs or insurance of any premises outside India used for the purposes of the business or profession
- 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
- travelling by any employee or other person employed in, or managing the affairs of, any office outside India; and
- such other matters connected with executive and general administration as may be prescribed.
Section 37 of the Income Tax Act pertains to general allowability of business expenditure while computing Profits or Gains from Business or Profession. According to Section 37(1), any expenditure, not being expenditure of the nature described in sections 30 to 36 and not being in the nature of capital expenditure or personal expenses of the assessee, laid out or expended wholly and exclusively for the purposes of the business or profession shall be allowed in computing the income chargeable under the head “Profits and gains of business or profession”.
Le us refer to the case of MUFG Bank Ltd vs ACIT (International Taxation), Circle-2(2)(1), New Delhi, where the issue under consideration was whether, salary paid overseas to the expatriates of the foreign entity working in India by the head office is an allowable business expenditure under Section 37 or disallowable under Section 44C?
Basic Information of the Assessee:
- The assessee is a banking company incorporated in Japan and is a tax resident of Japan.
- The assessee is engaged in wholesale banking operations in India under a license from the RBI and is covered by The Banking Regulation Act, 1949.
- The assessee is carrying on mainly banking activities and limited to wholesale banking only. It is engaged in institutional banking, credit/landing and other facilities to the corporate.
Ground of Appeal:
- The ground of appeal was against the disallowance of salary paid to overseas expatriates (expatriate is basically a person who lives outside their native country) of the appellant working in India by the Head Office (HO) and Indian taxes paid thereon by the head office.
- The head office of the assessee was situated in Japan and had deputed certain employees to work in its branches situated in India.
- The sole responsibility of such expatriate employees while deputation in India was to exclusively manage the business operation of the branches of the assessee in India.
- According to the employment and remuneration policy of the assessee part of the salaries for the services rendered by the expatriate employees in India were paid to such expatriate employees outside India i.e. by the head office of the bank Japan and the balance amount was paid to such employees in India.
- It was claimed that entire salary including which was paid outside India was exclusively towards the services rendered by the employees for Indian operations of the bank while on reputation in India.
- Such salaries were accounted by debiting only that portion of salary paid to the expatriate employees which was paid in Indian rupees by the branches in India.
- Salary paid in the foreign currency by the head office was not routed through the profit and loss account of the Indian branches and such salaries accounted for at the head office level.
- The assessee bore the Indian tax payable on the salaries paid to the expatriate’s employees including the salary paid by the head office in Japan computed after grossing up of the salaries paid to such expatriate’s employees.
- Tax deduction u/s 192 of the income tax act was also carried out.
- Accordingly, in computing the taxable income of the assessee’s permanent establishment India for the impugned assessment year the assessee claimed deduction of Rs 484,153,799 in respect of salaries paid by the head office to the expatriate employees and taxes paid thereon but not debited in the books of PE in India.
- The claim of the assessee was as the sum paid represented expenditure incurred for the purpose of the business operation of the India of Indian branches of the assessee and therefore same were allowable as a deduction.
Order of Assessing Officer (AO)
- The AO held that these employees worked for head office as well as for its branch offices in India.
- There was no exclusivity of work and it could not be accepted that the services given by these employees were wholly and exclusively for the purpose of the branch office in India only.
- Under the circumstances he held that the part of the work which was done for the purpose of the permanent establishment’s business was remunerated by the permanent establishment and head office paid for the work pertaining to the head office or other branches.
- He placed reliance on the judgment of the Calcutta High Court in case of ABN Amro Bank NV versus Commissioner of income tax wherein the court held that for taxation purposes head office and PE are to be treated as separate entities.
- He further held that it was the duty of the assessee to substantiate any claim made by it by proper evidence for it is to be allowed as a deduction under the Act.
- He held that looking to the composite nature of employment there was no demarcation to show that the expenses incurred by the head office were incurred wholly and exposure for the purposes of the business of the permanent establishment.
- Therefore, he held that the salary paid to expatriate employees by the head offices should not allowed as a deduction u/s 37 for computing income of PE as the same was not incurred wholly and exclusively for the purposes of the business of the permanent establishment.
- He further held that in respect of expenses incurred by the head office deduction of 5% of the adjusted total income of its permanent establishment in India is allowed to the assessee as per the provisions of Section 44C as other income is at a be taxed at gross basis as per the provisions of the India Japan DTAA.
Submission by the assessee before the Tribunal
- The assessee submitted that expatriate employees deputed by the HO were working exclusively for the Indian branches.
- Therefore, the salary paid to expatriates was incurred wholly and exclusively for the purpose of carrying on the business of branches in India.
- Thus, the salary paid to expatriates was deductible as an expense under section 37(1) of the Act and not covered within the scope of “head office expenditure” under section 44C of the Act.
Reference to an older case by assessee
It was submitted that this issue was covered by the order of the High Court in A.Y. 2007-08 and 2008-09 wherein the High Court dismissed the appeal of the Department.
The HC had held that:
- The question urged concerned the payment of salaries to the expatriates.
- In deciding this issue in favour of the Assessee, the ITAT in the impugned order referred to and relied upon the decision of its coordinate bench at Kolkata in ABN Amro Bank vs. JCIT (2005).
- Further the ITAT followed the decision of the Bombay High Court in CIT vs. Emirates Commercial Bank Ltd. (2003), where the Bombay High Court approved the view taken by the ITAT.
- The ITAT agreed that the expenses have been incurred wholly and exclusively by the Indian branch and therefore no part of these expenses could be allocated to any other branch of the HO and that there was no dispute with regard to the non-applicability of section 44C.
- HC perused the order of the Bombay High Court in Emirates Commercial (supra) where on identical facts, the issue was decided in favour of the Assessee.
- This order of the Bombay High Court was affirmed by the Supreme Court by order in Commissioner of Income Tax v. M/s. Emirates Commercial Bank Ltd. which in turn referred to an order of the same date in Commissioner of Income Tax v. Deutsche Bank AG (CA No. 1544 of 2006)
- In that view of the matter, HC declined to frame a question on this issue.
Thus, it was submitted that above Judgment of the High Court was also followed by the Tribunal in A.Y. 2010-11, High Court in A.Y. 2010-11, Tribunal in A.Y. 2003-04, 2004-05 and by Tribunal in A.Y. 2013-14. Therefore, it was submitted that the issue was squarely covered in favour of the assessee
Submission by Respondent
The departmental representative supported the order of the AO and submitted that as AO had filed Special Leave Petition before the honourable Supreme Court to keep the issue alive the above disallowance has been made.
Order of Income Tax Appellate Tribunal (ITAT)
On careful consideration of the rival arguments ITAT found that in absence of any change drawn to their notice in the facts and circumstances of the case, respectfully following the decision of the honourable High Court and subsequently followed by the coordinate benches for assessment year 2013 – 14, ITAT directed the AO to delete the disallowance of salary paid overseas to the expatriates of the appellant working in India by the head office and the Indian taxes paid thereon by that office.
Accordingly, the appeal was allowed.
In simple words, salary paid overseas to the expatriates of the foreign entity working in India by the head office is an allowable business expenditure under Income Tax.