INDIA BUSINESS WORLD - NOVEMBER 2005
THE MONTH THAT WAS

(KOLKATA) INCOME TAX APPELLATE TRIBUNAL - INTEREST ELEMENT CANNOT BE TAX DEDUCTIBLE BY MNC BANKS

MNC banks in India will have to redo their arithmetic. Many of them may see a rise in their cost of operations thanks to a recent tax tribunal ruling which threatens to unsettle existing rules and even arrangements under treaties that India had entered with some of the countries. Foreign banks in India operate through branches. These entities regularly borrow dollar funds from their head office and branches abroad. The cross-border funding, which helps them meet dollar demands of Indian corporate clients, is often a way of life for several banks.

To do this, the branches of foreign banks pay interest to the head office (or other branches) on the money borrowed. The interest paid is considered as a `deductible': in other words, the branches deduct the interest (among other things) from their earnings to arrive at the taxable income.

A special bench (Kolkata) of the Income Tax Appellate Tribunal has now upturned this. It has ruled that this interest element cannot be tax deductible. This would cause foreign banks a greater tax outgo and even impact their pricing structure. The bench has ruled out tax deductibility of interest as well as withholding tax on the interest received by head office. This is very different from what the revenue authorities (CBDT) say. According to them, the interest is deductible as long as the withholding tax is applicable. The tribunal gave its ruling against a plea made by Dutch bank ABN Amro. The bank is expected to move Kolkata High Court to challenge the order. The bone of contention is that while the revenue authorities are willing to consider the branch and head office of foreign banks as separate entities, the tribunal interpretation is that these are parts of the same organisation.