[Opinion] Set-Off Loss From Business of Permanent Establishment With Interest Income

Abhishek Worah – [2025] 175 taxmann.com 831 (Article)

1. Introduction

Globalisation has led to multinational enterprises doing business across the globe through their subsidiaries and branches. Double Taxation Avoidance Agreements (DTAA) between India and other countries enables the cross a Multinationals to assess their tax liability in India.

However, the tax computation mechanism can lead to disputes. One of such issues is whether any income taxable in the hands of a foreign company on gross basis can be set off against the business loss of its permanent establishment (PE) in India.

In a recent decision in the case of Abu Dhabi Commercial Bank the Income tax Appellate Tribunal (ITAT) Mumbai has held that a foreign company is allowed to set off the business loss of its PE in India with interest income (taxed on gross basis) under the India UAE DTAA.

This Article discusses various provisions of the decision of the ITAT and its impact. However first it is important to discuss the relevant provisions Income tax Act (ITA).

2. Relevant Provisions of the ITA

Under the ITA, the income of a company is taxable under various heads. These are income from house property, income from business, capital gains and income from other sources. The ITA provides detailed mechanism for computing income under each head (including relevant allowances and disallowances).

Section 71 of the ITA enables a taxpayer to set off loss under one head of income with his income under another head. Section 71(1) allows loss from any head of income (other than capital gain) in a year to be set off with income under another head. As per section 71(3) however, capital loss is not allowed to be set off against income under any other head. Thus, the business loss can be set off against the other income.

Section 90(1) allows the Government of India to enter into DTAA with government of a foreign country. As per the provisions of section 90(2) a non resident may choose to be governed by the provisions of the DTAA or ITA whichever are more beneficial for him.

3. Relevant Provisions of the India UAE DTAA

Article 11(1) provides that Interest arising in India and paid to tax resident of UAE is taxable in UAE. Article 11(2) provides that such interest may be taxable in India on gross basis at rate of 5% where interest is earned by a banking company.

Article 11(5) provides that Article 11 will not be applicable where resident of UAE carries on business in India has a PE in India and debt claim on which interest arises is effectively connected with such PE. In such cases Article 7 dealing with attribution of profits to PE will apply.

4. Facts of the case

The company was engaged in banking business. It was based in and tax resident of UAE with branches in India (which were its PE in India as per the DTAA).

In course of its business activity, the company advanced External Commercial Borrowing (ECB) loans to its Indian clients directly through its UAE head office without the involvement of Indian branches. The company filed its tax return in India where the interest on ECB loans (amounting to Rs 138 crore) was offered to tax at rate of 5% on gross basis under Article 11(2) of the India UAE DTAA. Further the Indian branches (PE) had suffered business loss (amounting to Rs 75 crore). While computing income the company set off the business losses of PE against the interest income and on the balance interest income of Rs.63 crore, the tax was computed at 5% in terms with Article 11(2) of DTAA.

The Assessing officer (AO) observed this loss set off. He held that under the DTAA where income is taxable on gross basis no deduction of any expenses and no set off of any loss was allowed. He also observed that since the DTAA did not provide for set off of loss, the company could not claim such benefit by referring to the ITA. Accordingly, the AO disallowed the claim of set off of business losses of PE against the interest income and computed tax liability at the applicable rate of 5% on the entire interest income in the draft assessment order.

The company filed its objections against the draft assessment order with the Dispute Resolution Panel (DRP). The DRP held as under:

• Since Article 11 does not allow any deduction/partial deduction, the meaning of the word “gross” as used in Article 11(2) of the DTAA would mean ‘the full amount of interest income’.
• There is no provision in the DTAA for inter-head adjustment. Once the interest income has been taxed as other income, the business loss of the PE, covered under Article 7(3), cannot be set off against the interest income.
• Once the company has chosen to be governed by DTAA provisions, it cannot invoke the provisions of the ITA for its taxation in India. Such ‘hybrid’ method is not allowed to be adopted.
• The ECB loans were advanced by the company in the course of its banking business activity. Therefore, the interest income was in the nature of business income and taxable at the base rate of 40% with surcharge and cess. However, such interest income has to be taxed on gross basis without allowing any deduction including set off of loss.
• Alternate claim of taxation under section 194LC of the Act, where ECB interest income was taxable at rate of 5% was rejected. It was held that the interest income tax taxable under section 115A at rate of 20%.

The AO passed the final assessment order as per directions of the DRP. The company filed appeal with ITAT against the same.

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