Article 24(2) does not entitle a foreign company’s Indian PE to domestic-company tax rates.

The appellant, a Netherlands-incorporated non-resident banking company, carried on banking operations in India through a branch treated as a permanent establishment (PE) under the Income-tax Act, 1961 and the India–Netherlands DTAA.

For AY 2004–05, it claimed taxation at the rate applicable to domestic companies under Article 24(2) of the DTAA, deduction of interest paid by the Indian PE to its overseas head office and branches, higher depreciation for automated teller machines (ATMs) as “computers,” and deduction of the full lease rentals paid for motor vehicles used by its employees.

The Assessing Officer applied the higher foreign-company tax rate, disallowed the interest deduction for failure to deduct tax at source, treated the principal component of the vehicle lease rentals as capital expenditure, and restricted the depreciation claim on ATMs.

The CIT(A) and Tribunal substantially upheld the Revenue’s position, although consequential depreciation was directed in relation to the vehicles.

The assessee challenged the Tribunal’s order under Section 260A of the Act on six substantial questions of law.

1. Whether the appellant was entitled to be taxed at the rate applicable to a domestic company under Section 90 of the Act and Article 24(2) of the India–Netherlands DTAA, rather than at the higher rate applicable to a foreign company.

2. Whether interest paid by the Indian PE to its overseas head office and foreign branches was allowable as a deduction in computing the PE’s taxable profits, despite non-compliance with the TDS provisions.

3. Whether, if the interest paid to the head office and foreign branches was treated as a non-deductible payment to self, corresponding interest received by the Indian PE from those entities was required to be excluded from its taxable income.

4. Whether an ATM qualified as a “computer” under item 2B of Appendix I to the Income-tax Rules and was therefore eligible for the higher depreciation rate.

5. Whether the vehicle leasing arrangement was a hiring arrangement and the lease rentals were allowable as revenue expenditure, rather than being treated as a financing or hire-purchase transaction.

6. Whether the principal component of the vehicle lease rentals amounting to Rs. 3,00,39,208 was capital expenditure.

The Court applied Sections 2(22A) and 2(23A) of the Income-tax Act, which distinguish domestic and foreign companies for tax purposes, and Section 90, including its Explanation inserted retrospectively by the Finance Act, 2001, which provides that charging a higher rate of tax on a foreign company does not constitute less favourable treatment.

Article 24(2) of the India–Netherlands DTAA prohibits discriminatory taxation only where enterprises are in the same circumstances, while Article 7 permits attribution of profits to a PE by treating it as a separate and distinct enterprise.

Section 40(a)(i), read with Section 195, disallows specified payments made outside India where applicable tax has not been deducted or paid at source.

The Court also relied on CBDT Circular No. 740 concerning the tax treatment of interest remitted by an Indian branch of a foreign bank, CBDT Circular No. 333 concerning the precedence of treaty provisions where applicable, and CBDT Circular No. 2 of 2001, which clarifies that accounting standards relating to leases do not determine the allowability or character of expenditure under the Act.

For depreciation, the Court applied the functional classification of assets under item 2B of Appendix I and held that ATMs fall within the broad category of computers.

The Court held that the appellant did not satisfy the statutory definition of a domestic company and that the retrospective Explanation to Section 90 validly clarified that the higher rate applicable to foreign companies was not discriminatory; additionally, a foreign company taxed only on Indian-source income and a domestic company taxed on global income were not in the same circumstances for Article 24(2) purposes.

Regarding interest, the Court applied the separate-entity fiction under Article 7: since the PE relied on that fiction to claim the interest as a business deduction, the remittance to the head office attracted Section 195 and the deduction was disallowable under Section 40(a)(i) for failure to deduct tax at source.

The same separate-entity treatment required interest received by the PE from the head office or foreign branches to be included in its taxable profits; the disallowance was based on TDS non-compliance and not on the proposition that the PE and head office were legally incapable of having an interest transaction.

On depreciation, the Court found that an ATM performs electronic data processing, uses software and communicates with banking servers, and is functionally comparable to a computer; it therefore qualified for the higher depreciation rate.

In relation to the vehicles, the Court held that accounting treatment under AS-19 could not determine tax liability. The substance of the agreement was hiring of vehicles for business purposes, with no evidence that the assessee acquired ownership; consequently, the lease rentals were revenue expenditure.

The Court also relied on the Revenue’s consistent treatment of the rentals as revenue expenditure in the preceding years and, alternatively, noted the assessee’s entitlement to consequential depreciation if capitalisation were upheld.

Questions 1, 2 and 3 were answered in the affirmative, against the assessee and in favour of the Revenue: the higher foreign-company tax rate applied, the interest deduction was disallowed for failure to comply with TDS provisions, and interest received by the PE remained taxable.

Questions 4, 5 and 6 were answered in the negative, against the Revenue and in favour of the assessee: ATMs were eligible for depreciation as computers, the entire vehicle lease rentals were allowable as revenue expenditure, and the principal component was not required to be treated as capital expenditure.

The impugned Tribunal order was modified accordingly, and the Assessing Officer was directed to pass a consequential order for AY 2004–05.

There was no order as to costs.