ITAT Resolves Conflicting Views and Allows Full Deduction of PE Expenses under the Pre-Amended Article 7(3) of the India-UAE DTAA

Introduction

In a significant ruling, the Income Tax Appellate Tribunal, Mumbai (‘ITAT’), in Mashreq Bank Psc v. Deputy Commissioner of Income Tax (International Taxation)[i], addressed a long-standing interpretational conflict between the provisions of the Income-tax Act, 1961 (‘IT Act’) and the India-UAE Double Taxation Avoidance Agreement (‘DTAA’). The dispute centred on the deductibility of head office expenses and specific expenses incurred outside India for the Indian branches of a UAE-based banking entity.

In this judgment, rendered by a Special Bench, the ITAT settled the legal question of whether a. 7(3) of the DTAA, as it stood prior to its amendment effective from 01.04.2008, permitted full deduction of such expenses, notwithstanding the limitations prescribed under s. 44C of the IT Act. This ruling marks a watershed moment in treaty interpretation jurisprudence, particularly in affirming the doctrine that express treaty provisions override domestic law under s. 90(2) of the IT Act.

Brief Facts

• The assessee was a non-resident banking company incorporated in the UAE, operating in India through its branches in Mumbai and New Delhi, which constituted permanent establishments (‘PE’) of the assessee in India. For assessment year (‘AY’) 2002-03, the assessee initially filed its return of income on 31.10.2002, declaring book profits under s. 115JB of the IT Act and nil business income after setting off carried-forward losses. Subsequently, a revised return was filed on 01.12.2003, declaring a total loss of Rs. 17.78 crore.

• In this revised return, the assessee stated that it had not claimed any deduction for head office expenses due to the loss but reserved the right to claim a 5% deduction under s. 44C. Alternatively, it claimed that under a. 7(3) of the DTAA, all expenses incurred for the purpose of the business of the PE, including executive and administrative expenses, were fully deductible and not subject to s. 44C limits.

• The Assessing Officer (‘AO’), relying on earlier assessments, disallowed the head office expenses and allowed only 5% of the average adjusted total income under s. 44C. Additionally, the AO disallowed Rs. 3.58 lakh incurred outside India (for SWIFT expenses[ii] and Globus accounting software), holding that these fell within general and administrative expenses governed by s. 44C. The Commissioner of Income Tax (Appeals) [‘CIT(A)’] upheld the AO’s decision, prompting the assessee to appeal to the ITAT.

• A Division Bench of the ITAT initially heard the appeal and partly allowed it. However, the issue regarding the head office expense deduction was decided against the assessee. The assessee then filed a miscellaneous application for recall, citing that the ITAT had overlooked its own earlier rulings in the assessee’s favour for AYs 1998–99 and 2001–02. The ITAT accepted this plea and recalled its earlier order only with respect to Ground No. 1 (head office expenses) and Ground No. 4 (specific outside-India expenses for the Indian PE).

• In light of conflicting ITAT decisions in the assessee’s own cases for different years, the Revenue requested the constitution of a Special Bench. The Hon’ble President of the ITAT accepted the request and constituted a Special Bench to adjudicate these issues afresh. The key issues before the Special Bench were:

i.  Whether the full deduction of Rs. 1.78 crore allocated to Indian branches should be allowed under a. 7(3) of the DTAA.

ii.  Whether expenses of Rs. 3.58 lakh incurred outside India for Indian branches should be disallowed under s. 44C or allowed under s. 37 of the IT Act.

Held

• The Special Bench decided both grounds in favour of the assessee. It held that for AY 2002-03, the deduction of head office expenses was fully allowable under a. 7(3) of the DTAA, as it stood prior to its amendment effective from 01.04.2008. The ITAT also allowed the deduction of SWIFT and software maintenance charges, holding that these were specifically attributable to the Indian PE and did not fall within the ambit of ‘head office expenditure’ under s. 44C of the IT Act.

• The Tribunal acknowledged two conflicting lines of decisions on the interpretation of a. 7(3) and its interplay with s. 44C. The first view favoured the assessee and interpreted a. 7(3) as an express treaty provision overriding domestic law restrictions, including those in s. 44C. The second view, previously adopted in the assessee’s own case for AY 1996-97, held that a. 25(1) of the DTAA does not exclude domestic law unless expressly stated, and therefore s. 44C continues to apply.

• The ITAT interpreted a. 7(3) of the unamended DTAA (prior to 01.04.2008) as permitting the deduction of all expenses incurred for the PE, including executive and general administrative expenses, irrespective of where they were incurred. The Tribunal emphasized that the interpretation of a. 25(1), titled ‘Elimination of Double Taxation’, must be holistic and clarified that it does not control or override a. 7(3), nor can it be interpreted to introduce domestic limitations by implication.

• Relying on s. 90(2) of the IT Act, which accords primacy to the treaty if it is more beneficial to the assessee, the ITAT concluded that a. 7(3), being an express provision, prevails over s. 44C. It emphasized that reading restrictions from domestic law into a treaty provision without a textual basis would defeat the intent and language of the DTAA. The ITAT rejected the Revenue’s argument that the phrase ‘unless there is an express provision to the contrary’ in a. 25(1) meant that a. 7(3) must explicitly exclude domestic limitations. It held that the language of a. 7(3) is clear and unconditional, allowing all expenses without limitation.

• Although the ITAT acknowledged international commentaries such as the OECD and UN Model Conventions as persuasive, it stressed that these cannot override the clear text of the treaty, especially where the language is unambiguous.

• On the 2007 Protocol amending a. 7(3) to include the phrase ‘in accordance with the domestic laws of the PE’s jurisdiction’, the Tribunal observed that:

  • The amendment was prospective in nature, effective from 01.04.2008, and there was no indication from the contracting states of any retrospective intent.

  • If s. 44C was already applicable through a. 25(1), then the amendment to a. 7(3) would have been redundant – an interpretation that cannot be accepted.

• On Ground No. 4, concerning Rs. 3.58 lakh towards SWIFT and software maintenance charges, the ITAT found that:

  • These were incurred on a specific, user-based metric for Indian branches.

  • As such, they were not general head office expenses and fell outside the scope of s. 44C of the IT Act.

  • Relying on decisions in CIT v. Emirates Commercial Bank Ltd.[iii], DIT (IT)I v. Credit Agricole Indosuez[iv], DIT (IT) -I v. American Express Bank Ltd.[v], and the relevant CBDT Circular[vi], the ITAT held that expenses specifically incurred by the head office on behalf of Indian branches are allowable under s. 37 of the IT Act, and s. 44C does not apply to such direct expenses.

Our Analysis

This Special Bench ruling by the ITAT provides authoritative clarity in the recurring dispute concerning the interplay between domestic statutory limits and treaty provisions in cross-border taxation, especially for non-resident banking institutions operating through Indian PEs. The ruling reinforces the principle that, in the absence of an explicit reference to domestic limitations within the treaty itself, treaty provisions must be interpreted independently and in accordance with their text and purpose. By doing so, the ITAT has further delineated the boundaries between domestic law and international treaty obligations under s. 90(2) of the IT Act.

By rejecting the Revenue’s argument that a. 25(1) of the DTAA implicitly incorporates domestic limitations like s. 44C into the computation of PE profits under a. 7(3), the ITAT has reaffirmed that treaty amendments must be applied prospectively, in both letter and spirit.

This ruling aligns with internationally accepted principles of treaty interpretation under the Vienna Convention on the Law of Treaties. It is consistent with the Supreme Court’s decision in the landmark case of Azadi Bachao Andolan[vii], which emphasized that tax treaties are negotiated with the objective of promoting trade and investment by offering certainty and relief from double taxation.

This decision enhanced the clarity and certainty of tax compliance for multinational financial institutions for years prior to 2008. It reiterates that expenses directly attributable to the Indian PE must be allowed in full where expressly permitted under the treaty, supporting principles of fair profit attribution and non-retrospective taxation.

End Notes

[i] 2025 SCC OnLine ITAT 1038 dated 06.02.2025.

[ii] SWIFT stands for the Society for Worldwide Interbank Financial Telecommunication. SWIFT charges refer to costs incurred for using the SWIFT messaging network to execute cross-border financial transactions.

[iii] [Civil Appeal No. 1527 of 2006, dated 26-8-2008].

[iv] [2016] 69 taxmann.com 285/377 ITR 102 (Bombay).

[v]  [IT Appeal No. 1294 of 2013, dated 1-4-2015].

[vi] Circular no. 649 dated 31.02.1993.

[vii] Union of India v. Azadi Bachao Andolan [2003] 132 Taxman 373/263 ITR 706 (SC).

Authored by Prashant Singh, Advocate at Metalegal Advocates. The views expressed are personal and do not constitute legal opinions.