M/S. BESIX KIER DABHOL S.A, MUMBAI V. THE DDIT ( IT) 3(2), MUMBAI

ITA 4249/MUM/2007

• Counselvise Citation: [2010] 135 COUNSELVISE.COM (IT) 3731 (ITAT-MUMBAI)
• Duration Of Justice: 3 year(s) 5 month(s) 5 day(s)
• Appeal Type: Income Tax Appeal
• Pronouncement Date: 10-11-2010
• Appeal Filed By: Assessee
• Order Result: Allowed
• Bench Allotted: L
• Next Hearing Date: 19-10-2010
• Assessment Year: 2002-2003
• Appeal Filed On: 05-06-2007
• Result in Favour of: Assessee
• Court: TRIBUNAL
• Assessee Lawyers: NARENDRA SINGH
• Keywords: Residential status; Search and seizure; Double taxation relief; Deemed to accrue or arise in india; Permanent establishment; Competent authority
• Section: 5(2); 37

Judgement Text

ITA NO.: 4249/MUM/07 ASSESSMENT YEAR: 2002 - 03 PAGE 1 OF 28 IN THE INCOME TAX APPELLATE TRIBUNAL MUMBAI L BENCH, MUMBAI [CORAM : N V VASUDEVAN JM, AND PRAMOD KUMAR AM] ITA NO.: 4249 /MUM/ 0 7 ASSESSMENT YEAR: 2002 - 03 BESIX KIER DABHOL , SA .. APPELLANT VS. DEPUTY DIRECTOR OF INCOME TAX - (INTER NATIONAL TAXATION) CIRCLE 3 ( 2 ), MUMBAI 400 020 .. RESPONDENT APPEARANCES: S UNIL M LALA , FOR THE APPELLANT NARENDRA SINGH , FOR THE RESPONDENT O R D E R PER PRAMOD KUMAR: 1. THE SHORT ISSUE THAT WE ARE REQUIRED TO ADJUDICATE IN THIS APPEAL IS WHETHER OR NOT THE COMMISSIONER (APPEALS) WAS JUSTIFIED IN SUSTAINING THE DISALLOWANCE OF INTEREST PAID BY THE ASSESSEE TO ITS SHAREHOLDERS, I.E. N. V. BESIX SA BELGIUM, AND KIER INTERNATIONAL (INVESTMENTS) LTD, UK, AGGREGATING TO RS 5,73,90,51 9. THE ASSESSMENT YEAR INVOLVED IS 2002 - 03. ITA NO.: 4249/MUM/07 ASSESSMENT YEAR: 2002 - 03 PAGE 2 OF 28 2. THE MATERIAL FACTS GIVING RISE TO THIS DISPUTE BEFORE US ARE LIKE THIS. THE ASSESSEE BEFORE US IS A COMPANY REGISTERED UNDER THE LAWS OF KINGDOM OF BELGIUM. IT IS AN ADMITTED POSITION THAT THE SOLE BUSINESS O F THE ASSESSEE COMPANY IS TO CARRY OUT THE PROJECT OF CONSTRUCTION OF FUEL JETTY AND A BACKWATER NEAR DABHOL, INDIA, PURSUANT TO A CONTRACT ENTERED INTO BY THE COMPANY WITH LINGTEC CONSTRUCTORS LP ON 27 TH NOVEMBER 1998. THE ASSESSEE COMPANY HAD AN ISSUED AND FULLY PAID UP CAPITAL , AT THE RELEVANT POINT OF TIME, OF BEF (BELGIAN FRANCS) 2,500,000 DIVIDED INTO 2,500 SHARES OF BEF 1,000 EACH. OUT OF TH IS EQUITY CAPITAL OF 2,500 EQUITY SHARES, 60% EQUITY SHARES, I.E. 1,500 SHARES, WERE HELD BY N V BESIX SA, B ELGIUM, AND THE REMAINING 40% EQUITY SHARES, I.E. 1000 SHARES, WERE HELD BY KIER INTERNATIONAL (INVESTMENTS) LIMITED, UNITED KINGDOM. THESE TWO SHAREHOLDERS THUS OWN THE EQUITY SHARES IN THE RATIO OF 60:40. THE TOTAL SHARE CAPITAL WAS TH US APPROXIMATELY U S $ 83,334 OR RS 38,20,00 0 (A PPROXIMATE AMOUNT BASED ON INPUTS FROM WWW.COINMILL.COM/BEF_CALCULATOR.HTML ) . THE ASSESSEE ALSO RAISED THE CAPITAL BY RESORTING TO BORROWINGS FROM THE SHAREHOLDERS, RS 57,09,18,579 FROM NA BESIX SA AND RS 37,01,55,921 FROM KIER INTERNATIONAL (INVESTMENTS) LIMITED, WHICH WAS IN THE SAME RATIO IN WHICH EQUITY WAS HELD BY THE SHAREHOLDERS I.E. 60 : 40. THIS DEBT, AS STATED BY THE ASSESSEE, WAS RAISED BY THE PERMANENT ES TABLISHMENT DIRECTLY FROM THE SHAREHOLDERS, AND NOT ROUTED THROUGH THE ASSESSEE COMPANYS HEAD OFFICE. THE ASSESSEE THUS HAD AN EQUITY CAPITAL OF RS 38 LAKHS APPROXIMATELY, AND A DEBT CAPITAL OF RS 9,410 LAKHS APPROXIMATELY. THE DEBT EQUITY RATIO THUS WOR KED OUT TO 248:1. ITA NO.: 4249/MUM/07 ASSESSMENT YEAR: 2002 - 03 PAGE 3 OF 28 3. IT WAS IN THIS BACKDROP THAT THE ASSESSEE CLAIMED DEDUCTION OF INTEREST ON THESE BORROWINGS FROM THE SHAREHOLDERS, I.E. BORROWING OF RS 57,09,18,579 FROM NA BESIX SA AND RS 37,01,55,921 FROM KIER INTERNATIONAL (INVESTMENTS) LIMITED. HOWEVER, THIS CLAIM CAME UP FOR SCRUTINY OF THE ASSESSING OFFICER, AND THE ASSESSING OFFICER NOTED THE ABOVE FACTS, AS ALSO THE POSITION THAT THE RESERVE BANK OF INDIAS APPROVAL DATED 3 RD NOVEMBER 1998, TO ASSESSEES INDIA PROJECT OFFICE WAS SUBJECT TO, I NTER ALIA, THE CONDITIONS THAT (I) THE INDIAN PROJECT OFFICE WILL MEET ALL ITS EXPENSES IN INDIA ONLY OUT OF INWARD REMITTANCES RECEIVED FROM HEAD OFFICE; AND THAT (II) THE INDIAN PROJECT OFFICE WILL NOT BORROW OR LEND FROM/ TO ANY PERSON IN INDIA WITHOU T SPECIFIC PERMISSION OF THE RESERVE BANK OF INDIA. THE ASSESS ING OFFICER THEN REQUIRED THE ASSESSEE TO SHOW CAUSE AS TO WHY SUCH INTEREST DEDUCTION NOT BE DECLINED SINCE, IN VIEW OF THE PROVISIONS OF ARTICLE 7 (3) (B) OF INDIA BELGIUM DOUB LE TAXATION AVO IDANCE AGREEMENT - WHICH WILL APPLY ON THE FACTS OF THIS CASE, INTEREST ON MONIES LENT BY THE HEAD OFFICE TO BRANCHES WAS NOT ALLOWABLE DEDUCTION. THE ASSESSEES CONTENTION WAS THAT THE BORROWINGS WERE FROM THE SHAREHOLDER COMPANIES AND NOT FROM THE HEAD OFFICE, AND THAT, FOR THIS REASON, DISALLOWANCE UNDER ARTICLE 7(B) WILL NOT COME INTO PLAY. IT WAS ALSO SUBMITTED THAT THE ASSESSEE HAD BORROWED THE MONIES FROM THE OUTSIDERS, EVEN IF SUCH OUTSIDERS HAPPENED TO THE SHAREHOLDERS, THAT INTEREST HAS BEEN PAI D ON THESE BORROWINGS, AND THAT, UNDER THE INDO BELGIUM TAX TREATY, NEITHER THE R E IS ANY RESTRICTIONS ON PAYING INTEREST ON LOANS, NOR ANY REQUIREMENTS IN RESPECT OF DEBT EQUITY RATIO. ITA NO.: 4249/MUM/07 ASSESSMENT YEAR: 2002 - 03 PAGE 4 OF 28 4. NONE OF THESE SUBMISSIONS, HOWEVER, IMPRESSED THE ASSESSING OFFI CE R. THE ASSESSING OFFICER WAS OF THE VIEW THAT THE PAYMENTS MADE BY A BRANCH OFFICE TO THE HEAD OFFICE, UNDER THE INDIAN INCOME TAX ACT 1961, DONOT CONSTITUTE ADMISSIBLE DEDUCTIONS AS THESE PAYMENTS ARE FROM SELF TO SELF. IT WAS ALSO NOTED THAT IN TERMS O F THE PROVISIONS OF ARTICLE 7 (3) (B) INTEREST PAYMENTS FROM BRANCH TO HEAD OFFICE, AS THESE PAYMENTS DE FACTO ARE, NOT DEDUCTIBLE IN COMPUTATION OF PROFITS OF THE PERMANENT ESTABLISHMENT. HE THEN REFERRED TO THE OECD MODEL CONVENTION COMMENTARY WHICH, INTE R ALIA, STATES THAT BAN ON DEDUCTIONS FOR INTERNAL DEBTS AND RECEIVABLES SHOULD CONTINUE GENERALLY, SUBJECT TO SPECIAL PROBLEMS OF BANKS. A REFERENCE WAS ALSO MADE TO KLAUS VOGELS OFT QUOTED COMMENTARY KLAUS VOGEL ON DOUBLE TAXATION CONVENTION WHICH OBSERVES THAT IT IS UNDISPUTED THE HEAD OFFICE CANNOT CHARGE INTEREST FOR PROVIDING ITS PERMANENT ESTABLISHMENT WITH THE NECESSARY ALLOTMENT OF CAPITAL AND OTHER ASSETS. THE ASSESSING OFFICER ALSO REFERRED TO OECD DISCUSSION DRAFT ON ATTRIBUTION OF P ROFITS TO PERMANENT ESTABLISHMENT WHICH, BROADLY SPEAKING, RECOGNIZED THE FACT THAT A PE RMANENT ESTABLISHMENT CANNOT BE FUNDED SOLELY BY DEBT CAPITAL. IT WAS FURTHER OBSERVED THAT THE RESERVE BANK GUIDELINES ALSO RECOGNIZE THAT EXPENSES OF THE INDIAN OFF ICE ARE TO BE MET OUT OF CAPITAL INFUSION OR REMITTANCE FROM HEAD OFFICE, EXCEPT IN THE CASE OF BANKS WHERE ALSO SOME LIMITATIONS HAVE BEEN PLACED. THE ASSESSING OFFICER THUS CONCLUDED AS FOLLOWS: IN VIEW OF THE ABOVE DISCUSSIONS, IT IS EVIDENT THAT, A S PER THE PROVISIONS OF INCOME TAX ACT, PROVISIONS OF THE DOUBLE TAXATION ITA NO.: 4249/MUM/07 ASSESSMENT YEAR: 2002 - 03 PAGE 5 OF 28 AVOIDANCE AGREEMENT BETWEEN INDIA AND BELGIUM, PRESENT INTERNATIONAL CONSENSUS IN THIS REGARD AND ALSO IN VIEW OF SPECIFIC GUIDELINES OF RESERVE BANK OF INDIA, THE INTEREST PAID BY T HE PERMANENT ESTABLISHMENT TO ITS HEAD OFFICE, WHICH HAS AN EFFECT OF REDUCING THE TAXABLE INCOME OF THE PE IN THE SOURCE COUNTRY, CANNOT BE ALLOWED AS DEDUCTION. 5. THE ASSESSING OFFICER PROCEEDED TO OBSERVE THAT THE SITUATION WILL NOT CHANGE JUST BECAU SE THE LOAN HAS BEEN TAKEN BY THE ASSESSEE DIRECTLY FROM THE SHAREHOLDERS, INSTEAD OF ROUTING THE SAME THROUGH THE ASSESSEE COMPANY. IT WAS NOTED THAT THE ASSESSEE COMPANY HAS NO RESERVES, NO PROVISIONS, NO FINANCIAL DEBTS, NO FINANCIAL ASSETS, NO ASSETS I N ANY PART OF ASSETS ANYWHERE IN THE WORLD EXCEPT IN INDIA, THAT IT HAS A DEBT EQUITY RATIO OF 428 :1 WHEREAS DEBT EQUITY RATIO OF SHAREHOLDER COMPANIES HAVE NOT BEEN FURNISHED BY THE ASSESSEE, THAT THE RATIO OF BORROWINGS IS THE SAME AS OF THE EQUITY CAPI TAL, AND THAT, IN VIEW OF THESE FACTS, THE INTEREST PAYMENTS BY THE ASSESSEE TO NA BESIX SA AND KIER INTERNATIONAL (INVESTMENTS) LTD CANNOT BE ALLOWED AS DEDUCTION. AGGRIEVED, ASSESSEE CARRIED THE MATTER IN APPEAL BEFORE THE CIT(A) BUT WITHOUT ANY SUCCESS. THE CIT(A) UPHELD THE DISALLOWANCE UNDER THE PROVISIONS OF ARTICLE 7(3)(B) AND HE ALSO HELD THAT THE INTEREST PAYMENT, HAVING BEEN MADE IN VIOLATION OF THE RESERVE BANK OF INDIA GUIDELINES, IS ANYWAY NOT ALLOWABLE AS A DEDUCTION IN VIEW OF THE SPECIFIC PR OVISIONS OF EXPLANATION TO SECTION 37 OF THE ACT. NOT ONLY THAT THE DISALLOWANCE WAS CONFIRMED, BUT ALSO FURTHER FORTIFIED BY THE CIT(A). THE ASSESSEE IS AGGRIEVED OF THE STAND SO TAKEN BY THE CIT(A) AND IS IN FURTHER APPEAL BEFORE US. ITA NO.: 4249/MUM/07 ASSESSMENT YEAR: 2002 - 03 PAGE 6 OF 28 6 . WE HAVE HEARD TH E RIVAL CONTENTIONS AT CONSIDERABLE LENGTH, PERUSED THE MATERIAL ON RECORD AND DULY CONSIDERED FACTUAL MATRIX OF THE CASE, AS ALSO THE APPLICABLE LEGAL POSITION. 7. LET US FIRST TAKE A LOOK AT THE CAPITA L STRUCTURE OF THE ASSESSEE COMPANY WHICH IS, IN TER MS OF A DIAGRAM, AS FOLLOWS: 8 . IT IS IMPORTANT TO BEAR IN MIND THE FACT THAT THE ASSESSABLE UNIT BEFORE US IS THE ASSESSE E COMPANY I.E. BESIX KIER DABHOL SA, AND NOT ITS INDIAN PE - AS IS THE ASSUMPTION ON WHICH THE ASSESSING OFFICER HAS PROCEEDED, EVEN THOUGH TAX LIABILITY OF THE ASSESSEE COMPANY IS CONFINED TO SUCH PROFITS AS MAY BE ITA NO.: 4249/MUM/07 ASSESSMENT YEAR: 2002 - 03 PAGE 7 OF 28 ATTRIBUTED TO ITS PERMANENT ESTABLISHMENT IN INDIA. A COORDINATE BENCH OF THIS TRIBUNAL, IN THE CASE OF DRESDNER BANK VS . ADD ITIONA L COMMISSIONER OF INCOME TAX (108 ITD 495) HA D AN O CCASION TO DEAL WITH THIS ISSUE, AND S PEAKING THROUGH ONE OF US, I.E. ACCOUNTANT MEMBER, THE COORDINATE BENCH EXPLAINED THE SCHEME OF THE ACT AS FOLLOWS: UNDER SECTION 4 OF THE ACT, IT IS TOTAL INCOME OF EV ERY PERSON WHICH IS TAXABLE. SECTION 2 (31), IN TURN, DEFINES PERSON AS INCLUDING A COMPANY, WHICH IN TERMS OF THE PROVISIONS OF SECTION 2(23A), INCLUDES A FOREIGN COMPANY AS WELL. SECTION 6(4) OF THE ACT LAYS DOWN THAT A COMPANY, UNLESS IT IS AN INDIAN COMPANY OR UNLESS IT IS CONTROLLED OR MANAGED ENTIRELY FROM INDIA, CANNOT BE SAID TO BE RESIDENT IN INDIA. A FOREIGN COMPANY, WHICH IS NOT WHOLLY CONTROLLED OR MANAGED IN INDIA, IS THEREFORE A NON - RESIDENT SO FAR AS RESIDENTIAL STATUS UNDER THE ACT IS CONCERNED. SECTION 5(2) FURTHER LAYS DO WN THAT AS FAR AS A NON - RESIDENT ASSESSEE IS CONCERNED SCOPE OF TOTAL INCOME OF SUCH AN ASSESSEE IS CONFINED TO ( I ) AN INCOME WHICH ACCRUES OR ARISES IN INDIA OR IS DEEMED TO ACCRUE OR ARISE IN INDIA AND ( II ) AN INCOME WHICH IS RECEIVED OR IS DEEMED TO BE RECEIVED BY OR ON BEHALF OF SUCH FOREIGN COMPANY. THIS ELEMENTARY ANALYSIS MAKES IT CLEAR THAT UNDER THE INCOME - TAX ACT, SO FAR AS FOREIGN COMPANIES ARE CONCERNED, TAXABLE UNIT IS A FOREIGN COMPANY AND NOT ITS BRANCH OR PERMANENT ESTABLISHMENT IN INDIA , EVEN THOUGH THE TAXABILITY OF SUCH FOREIGN COMPANIES IS CONFINED TO ( I ) AN INCOME WHICH ACCRUES OR ARISES IN INDIA OR IS DEEMED TO ACCRUE OR ARISE IN INDIA, AND ( II ) AN INCOME WHICH IS RECEIVED OR IS DEEMED TO BE RECEIVED BY OR ON BEHALF OF SUCH FORE IGN COMPANY . IT IS IMPORTANT TO BEAR IN MIND THAT, IN TERMS OF THE PROVISIONS OF THE INDIAN INCOME - TAX ACT, WHILE THE TAXABLE SUBJECT IS THE FOREIGN GE, IT IS TAXABLE ONLY IN RESPECT OF THE INCOME, INCLUDING BUSINESS PROFITS, WHICH ACCRUES OR ARISES TO TH AT FOREIGN GE IN INDIA. THE INDIAN INCOME - TAX ACT DOES NOT PROVIDE FOR ANY SPECIAL MECHANISM FOR TAXATION OF PE OF A FOREIGN ENTERPRISE, EXCEPT TAXATION ON PRESUMPTIVE BASIS FOR CERTAIN TYPES OF INCOME.. THEREFORE, ASCERTAINMENT OF A FOREIGN GES TAXABL E BUSINESS PROFITS IN INDIA INVOLVES AN ARTIFICIAL DIVISION OF THE OVERALL PROFITS OF THE GE - BETWEEN PROFITS EARNED IN INDIA AND PROFITS EARNED OUTSIDE INDIA. INDIAN INCOME - TAX ACT CAN ONLY BE CONCERNED WITH THE PROFITS EARNED IN INDIA, AND, THEREFORE, A METHOD IS TO BE FOUND TO ASCERTAIN PROFITS ACCRUING OR ARISING IN INDIA. . THE VERY CONCEPT OF ITA NO.: 4249/MUM/07 ASSESSMENT YEAR: 2002 - 03 PAGE 8 OF 28 COMPUTATION OF PE PROFITS IS CREATED AS A FICTION OF TAX LAW IN ORDER TO DEMARCATE TAX JURISDICTION OVER THE OPERATIONS OF A COMPANY IN A COUNTRY OF WHICH IT IS NOT A TAX RESIDENT. UNLESS THE PE IS TREATED AS A SEPARATE PROFIT CENTRE, IT IS NOT POSSIBLE TO ASCERTAIN THE PROFITS OF THE PERMANENT ESTABLISHMENT WHICH, IN TURN, CONSTITUTE PROFITS ACCRUING OR ARISING TO THE FOREIGN GE IN INDIA. 9 . THIS APPROACH WAS APPROVED BY A SUBSEQUENT DECISION OF HONBLE SUPREME COURT IN THE CASE OF CIT VS . HYUNDAI HEAVY IND. LTD (291 ITR 482) WHEREIN THEIR LORDSHIPS HAVE HELD THAT UNDER THE INCOME TAX AC T , A TAXABLE UNIT IS A FOREIGN COMPANY AND NOT ITS BRANCH OR PE IN INDI A, THOUGH ITS TAXABILITY IS RESTRICTED TO INCOMES WHICH ACCRUES OR ARISE OR IS DEEMED TO ACCRUE OR ARISE IN INDIA. THE IR LORDSHIPS HAVE FURTHER HELD THAT UNDER THE ACT, WHILE THE TAXABLE SUBJECT IS THE FOREIGN GENERAL ENTERPRISE (FOR SHORT, GE), IT IS TAXABLE ONLY IN RESPECT OF THE INCOME INCLUDING BUSINESS PROFITS, WHICH ACCRUES OR ARISES TO THAT FOREIGN GE IN INDIA. 10. THE SCHEME OF TAXABILITY OF A NON - RESIDENT IN RESPECT OF HIS OPERATIONS IN INDIA BY WAY OF 'ITS BRANCH( S ) OR THROUGH SOME OTHER FORM OF ITS PRESENCE IN INDIA SUCH AS OFFICE, PROJECT SITE, FACTORY, SALES OUTLET ETC.' IS THUS LIKE THIS. ITS TAXABILITY IN INDIA IN RESPECT OF PROFITS OF SUCH PE IS LIMITED TO ONLY SUCH PROFITS AS ACCRUE OR ARISE IN INDIA, OR ARE DEEMED TO ACCRUE OR ARI SE IN INDIA. AS REGARDS THE INCOME ACCRUING OR ARISING IN INDIA, AS OBSERVED BY THE HON'BLE SUPREME COURT, 'AN INCOME WHICH ACCRUES OR ARISES TO A FOREIGN ENTERPRISE IN INDIA CAN BE ONLY SUCH PORTION OF INCOME ACCRUING OR ARISING TO SUCH A FOREIGN ENTERPRI SE AS IS ATTRIBUTABLE TO ITS BUSINESS CARRIED ITA NO.: 4249/MUM/07 ASSESSMENT YEAR: 2002 - 03 PAGE 9 OF 28 OUT IN INDIA' AND 'SINCE THERE IS NO SPECIFIC PROVISION UNDER THE ACT TO COMPUTE PROFITS ACCRUING IN INDIA IN THE HANDS OF THE FOREIGN ENTITIES, THE PROFITS ATTRIBUTABLE TO THE INDIAN PE OF FOREIGN ENTERPRISE A RE REQUIRED TO BE COMPUTED UNDER NORMAL ACCOUNTING PRINCIPLES AND IN TERMS OF THE GENERAL PROVISIONS OF THE IT ACT'. 11. VIEWED IN THIS PERSPECTIVE, IN TERMS OF THE PROVISIONS OF THE INDIAN INCOME TAX ACT, THE PROFIT OF THE ASSESSEE COMPANY THAT ARE LIA BLE TO BE TAXED IN INDIA ARE SUCH PROFITS OF THE ASSESSEE COMPANY AS ARE ATTRIBUTA BLE TO ITS OPERATIONS IN INDIA. SINCE THE ONLY BUSINESS CARRIED OUT BY THE ASSESSEE IS PROJECT IN INDIA, ITS ENTIRE PROFITS ARE TAXABLE IN INDIA AND ALL ITS EXPENSES, WHICH A RE INCURRED TO EARN ONLY INDIAN INCOME, ARE DEDUCTIBLE IN ASCERTAINMENT OF ITS TAXABLE INCOME. THEREFORE, IRRESPECTIVE OF WHETHER THE INTEREST IS PAID BY THE HEAD OFFICE OR BY THE INDIAN PE, SO FAR AS ITS DEDUCTIBILITY UNDER THE INDIAN INCOME TAX ACT, 1961 , THIS MODE OF BORROWING IS TAX NEUTRAL. BROADLY, MATERIALLY IDENTICAL IS THE POSITION UNDER THE PROVISIONS OF THE INDIA BELGIUM DOUBLE TAXATION AVOIDANCE AGREEMENT. THERE IS NO DISPUTE THAT THE ASSESSEE COMPANY HAS A PE IN INDIA , WHICH IN FACT IS ITS RAI SON D'ETRE . ARTICLE 7 OF INDIA BELGIUM DOUBLE TAXATION AVOIDANCE AGREEMENT (228 ITR STATUES 79) , WHICH IS RELEVANT FOR THE PURPOSE OF COMPUTING PROFITS ATTRIBUTABLE TO A PERMANENT ESTABLISHMENT, IS AS FOLLOWS: ITA NO.: 4249/MUM/07 ASSESSMENT YEAR: 2002 - 03 PAGE 10 OF 28 ARTICLE 7 : BUSINESS PROFITS 1. THE PROF ITS OF AN ENTERPRISE OF A CONTRACTING STATE SHALL BE TAXABLE ONLY IN THAT STATE UNLESS THE ENTERPRISE CARRIES ON BUSINESS IN THE OTHER CONTRACTING STATE THROUGH A PERMANENT ESTABLISHMENT SITUATED THEREIN. IF THE ENTERPRISE CARRIES ON BUSINESS AS AFORESAID, THE PROFITS OF THE ENTERPRISE MAY BE TAXED IN THE OTHER STATE BUT ONLY SO MUCH OF THEM AS IS ATTRIBUTABLE TO ( A ) THAT PERMANENT ESTABLISHMENT; ( B ) SALES IN THAT OTHER STATE OF GOODS OR MERCHANDISE OF THE SAME OR SIMILAR KIND AS THOSE SOLD THROUGH THAT PER MANENT ESTABLISHMENT; OR ( C ) OTHER BUSINESS ACTIVITIES CARRIED ON IN THAT OTHER STATE OF THE SAME OR SIMILAR KIND AS THOSE EFFECTED THROUGH THAT PERMANENT ESTABLISHMENT. 2. WHERE AN ENTERPRISE OF A CONTRACTING STATE CARRIES ON BUSINESS IN THE OTHER CONTRA CTING STATE THROUGH A PERMANENT ESTABLISHMENT SITUATED THEREIN, THERE SHALL BE ATTRIBUTED TO SUCH PERMANENT ESTABLISHMENT THE PROFITS WHICH IT MIGHT BE EXPECTED TO DERIVE IF IT WERE AN INDEPENDENT ENTERPRISE ENGAGED IN THE SAME OR SIMILAR ACTIVITIES UNDER THE SAME OR SIMILAR CONDITIONS AND DEALING AT ARMS LENGTH WITH THE ENTERPRISE OF WHICH IT IS A PERMANENT ESTABLISHMENT. 3. ( A ) IN THE DETERMINATION OF THE PROFITS OF A PERMANENT ESTABLISHMENT, THERE SHALL BE ALLOWED AS DEDUCTIONS EXPENSES WHICH ARE INCUR RED FOR THE PURPOSES OF THE BUSINESS OF THE PERMANENT ESTABLISHMENT INCLUDING EXECUTIVE AND GENERAL ADMINISTRATIVE EXPENSES SO INCURRED, WHETHER IN THE STATE IN WHICH THE PERMANENT ESTABLISHMENT IS SITUATED OR ELSEWHERE, SUBJECT TO THE LIMITATIONS OF THE T AXATION LAWS OF THAT STATE : ITA NO.: 4249/MUM/07 ASSESSMENT YEAR: 2002 - 03 PAGE 11 OF 28 PROVIDED THAT WHERE THE LAW OF THE STATE IN WHICH THE PERMANENT ESTABLISHMENT IS SITUATED IMPOSES A RESTRICTION ON THE AMOUNT OF THE EXECUTIVE AND GENERAL ADMINISTRATIVE EXPENSES WHICH MAY BE ALLOWED, AND THAT RESTRICTION IS R ELAXED OR OVERRIDDEN BY ANY CONVENTION OR AGREEMENT BETWEEN THAT STATE AND A THIRD STATE WHICH IS A MEMBER OF THE OECD WHICH ENTERS INTO FORCE AFTER THE DATE OF ENTRY INTO FORCE OF THIS AGREEMENT, THE COMPETENT AUTHORITY OF THAT STATE SHALL NOTIFY THE COMP ETENT AUTHORITY OF THE OTHER CONTRACTING STATE OF THE TERMS OF THE CORRESPONDING PARAGRAPH IN THE CONVENTION OR AGREEMENT WITH THAT THIRD STATE IMMEDIATELY AFTER THE ENTRY INTO FORCE OF THAT CONVENTION OR AGREEMENT AND, IF THE COMPETENT AUTHORITY OF THE OT HER CONTRACTING STATE SO REQUESTS, THE PROVISIONS OF THIS SUB - PARAGRAPH SHALL BE AMENDED BY PROTOCOL TO REFLECT SUCH TERMS . ( B ) HOWEVER, NO SUCH DEDUCTION SHALL BE ALLOWED IN RESPECT OF AMOUNTS, IF ANY, PAID (OTHERWISE THAN TOWARDS REIMBURSEMENT OF ACTUAL EXPENSES) BY THE PERMANENT ESTABLISHMENT TO THE HEAD OFFICE OF THE ENTERPRISE OR ANY OF ITS OTHER OFFICES, BY WAY OF ROYALTIES, FEES OR OTHER SIMILAR PAYMENTS IN RETURN FOR THE USE OF PATENTS OR OTHER RIGHTS, OR BY WAY OF COMMISSION OR OTHER CHARGES FOR S PECIFIC SERVICES PERFORMED OR FOR MANAGEMENT, OR, EXCEPT IN THE CASE OF A BANKING ENTERPRISE, BY WAY OF INTEREST ON MONEYS LENT TO THE PERMANENT ESTABLISHMENT. LIKEWISE, NO ACCOUNT SHALL BE TAKEN, IN THE DETERMINATION OF THE PROFITS OF A PERMANENT ESTABLIS HMENT, FOR AMOUNTS CHARGED (OTHERWISE THAN TOWARDS REIMBURSEMENT OF ACTUAL EXPENSES), BY THE PERMANENT ESTABLISHMENT TO THE HEAD OFFICE OF THE ENTERPRISE OR ANY OF ITS OTHER OFFICES, BY WAY OF ROYALTIES, FEES OR OTHER SIMILAR PAYMENTS IN RETURN FOR THE USE OF PATENTS OR OTHER RIGHTS, OR BY WAY OF COMMISSION OR OTHER CHARGES FOR SPECIFIC SERVICES PERFORMED OR FOR MANAGEMENT, OR, EXCEPT IN THE CASE OF A BANKING ENTERPRISE, BY ITA NO.: 4249/MUM/07 ASSESSMENT YEAR: 2002 - 03 PAGE 12 OF 28 WAY OF INTEREST ON MONEYS LENT TO THE HEAD OFFICE OF THE ENTERPRISE OR ANY OF ITS OT HER OFFICES. 4. INSOFAR AS IT HAS BEEN CUSTOMARY IN A CONTRACTING STATE TO DETERMINE THE PROFITS TO BE ATTRIBUTED TO A PERMANENT ESTABLISHMENT ON THE BASIS OF AN APPORTIONMENT OF THE TOTAL PROFITS OF THE ENTERPRISE TO ITS VARIOUS PARTS, NOTHING IN PARAGRA PH 2 OR PARAGRAPH 3 SHALL PRECLUDE SUCH CONTRACTING STATE FROM DETERMINING THE PROFITS TO BE TAXED BY SUCH AN APPORTIONMENT AS MAY BE CUSTOMARY; THE METHOD OF APPORTIONMENT ADOPTED SHALL, HOWEVER, BE SUCH THAT THE RESULT SHALL BE IN ACCORDANCE WITH THE PRI NCIPLES LAID DOWN IN THIS ARTICLE. 5. NO PROFITS SHALL BE ATTRIBUTED TO A PERMANENT ESTABLISHMENT BY REASON OF THE MERE PURCHASE BY THAT PERMANENT ESTABLISHMENT OF GOODS OR MERCHANDISE FOR THE PURPOSE OF EXPORT TO THE ENTERPRISE OF WHICH IT IS THE PERMANE NT ESTABLISHMENT. 6. FOR THE PURPOSES OF THE PRECEDING PARAGRAPHS, THE PROFITS TO BE ATTRIBUTED TO THE PERMANENT ESTABLISHMENT SHALL BE DETERMINED BY THE SAME METHOD YEAR BY YEAR UNLESS THERE IS GOOD AND SUFFICIENT REASON TO THE CONTRARY. 7. WHERE PROFIT S INCLUDE ITEMS OF INCOME WHICH ARE DEALT WITH SEPARATELY IN OTHER ARTICLES OF THIS AGREEMENT, THEN THE PROVISIONS OF THOSE ARTICLES SHALL NOT BE AFFECTED BY THE PROVISIONS OF THIS ARTICLE. 1 2 . A PLAIN READING OF THE ABOVE TREATY PROVISION SHOWS THAT THE PROFITS WHICH CAN BE BROUGHT TO TAX IN THE SOURCE STATE, I.E. INDIA IN THE PRESENT CASE, ITA NO.: 4249/MUM/07 ASSESSMENT YEAR: 2002 - 03 PAGE 13 OF 28 INCLUDE SUCH PROFITS AS ATTRIBUTABLE TO THE PERMANENT ESTABLISHMENT , AND THAT IN DETERMINATION OF THE PROFITS OF A PERMANENT ESTABLISHMENT, ALL EXPENSES INCURRED FOR THE BUSINESS OF THE PE - WHETHER IN THE SOURCE COUNTRY OR OUTSIDE, ARE TO BE ALLOWED AS DEDUCTION SUBJECT TO THE LIMITATIONS PLACED BY THE LAWS OF THE STATE IN WHICH PE IS SITUATED AND CERTAIN SPECIFIC LIMITATIONS SET OUT IN ARTICLE 7 ITSELF. 13. ONE OF THESE LIMITATIONS IN ARTICLE 7 IS THAT EXCEPT IN THE CASE OF BANKING COMPANIES, INTEREST PAID TO THE HEAD OFFICE IS NOT TO BE ALLOWED AS A DEDUCTION UNLESS IT IS TOWARDS REIMBURSEMENT OF ACTUAL EXPENSES. THE SCHEME OF THE TREATY PROVIDES THAT NOTIONAL I NTRA ORGANIZATION DEDUCTIONS ARE NOT TO BE ALLOWED UNLESS THESE ARE BACKED BY A CORRESPONDING THIRD PARTY OUTGO, AND, TO THAT EXTENT, DEDUCTION ON THE BASIS OF HYPOTHETICAL INDEPENDENCE ARE RESTRICTED. THAT LIMITATION DOES NOT, HOWEVER, AFFECT THE ASSESSEE . IT IS BEYOND DISPUTE THAT THE ENTIRE BORROWINGS ARE FOR THE PURPOSES OF BUSINESS OF THE PE, WHICH IN FACT IS THE ONLY BUSINESS CARRIED ON BY THE ASSESSEE, AND, THAT THE INTEREST CLAIMED AS DEDUCTION HAS BEEN PAID BY THE ASSESSEE TO AN OUTSIDE PARTY I.E. SHAREHOLDERS. WHILE ON THIS ASPECT OF THE MATTER, IT IS NECESSARY TO BEAR IN MIND THE FACT THAT A COMPANY AND ITS SHAREHOLD ERS HAVE SEPARATE EXISTENCE, THAT THE CONTRACTS BETWEEN A COMPANY AND ITS SHAREHOLDERS ARE JUST AS ENFORCEABLE AS CONTRACTS WITH ANY INDEPENDENT PERSON [ LEE V S. LEES AIR FARMING LTD (1960) 3 AER 420] , AND THAT, THEREFORE, INTEREST PAID TO THE SHAREHOLDER CAN ONLY BE TREATED AS INTEREST PAID TO INDEPENDENT OUTSIDER PARTIES. ITA NO.: 4249/MUM/07 ASSESSMENT YEAR: 2002 - 03 PAGE 14 OF 28 14. IN VIEW OF THIS DISCUSSION , WHETHER THE INTEREST EXPE NSE IS INCURRED IN INDIA BY THE PE OR IN BELGIUM BY THE GE, THIS ARRANGEMENT IS ALSO WHOLLY T AX NEUTRAL SO FAR AS THE PROVISIONS OF THE INDIA BELGIUM TAX TREATY ARE CONCERNED. DURING THE COURSE OF HEARING BEFORE US, AS ALSO IN THE PROCEEDINGS BEFORE AUTHOR ITIES BELOW, A LOT OF A DISCUSSIONS HAVE TAKEN PLACE ON WHETHER THE BORROWINGS FROM THE SHAREHOLDERS IS DIRECTLY BY THE PE OR BY THE ASSESSEE COMPANYS HEAD OFFICE. FRANKLY, IN OUR CONSIDERED VIEW AND FOR THE REASONS STATED ABOVE, THIS IS A NONISSUE INASMU CH AS WHETHER THE BORROWING IS BY THE PE OR THE GE, IT IS TAX NEUTRAL SO FAR AS INDIAN TAX POSITION IS CONCERNED. 15. AS WE HAVE SEEN IN THE PRECEDING DISCUSSIONS, PROFIT OF THE ASSESSEE COMPANY THAT ARE LIABLE TO BE TAXED IN INDIA ARE SUCH PROFITS OF THE ASSESSEE COMPANY AS ARE ATTRIBUTABLE TO ITS OPERATIONS IN INDIA, AND SINCE THE ONLY BUSINESS CARRIED ON BY THE ASSESSEE IS OPERATIONS IN INDIA, ITS ENTIRE PROFITS ARE TAXABLE IN INDIA. AS REGARDS THE LIMITATION PLACED, UNDER ARTICLE 7 (3)(B), ON DEDUCT IBILITY OF INTEREST PAID TO HEAD OFFICE, AS WE HAVE SEEN ABOVE, THAT LIMITATION IS RELEVANT ONLY WHEN THE INTEREST PAYMENT IS AN INTERNAL AND NOTIONAL CHARGE . 16. THAT LEAVES US WITH THE OBJECTIONS RAISED BY THE REVENUE AUTHORITIES, BASED ON THE LIMITA TIONS PLACED BY THE DOMESTIC TAX LEGISLATION OF THE SOURCE COUNTRY I.E. PROVISIONS OF THE INDIAN INCOME TAX ACT, TO DEDUCTIBILITY OF INTEREST PAID TO JOINT VENTURE PARTNERS . THE OBJECTION IS TWO ITA NO.: 4249/MUM/07 ASSESSMENT YEAR: 2002 - 03 PAGE 15 OF 28 FOLD FIRST, THAT A PAYMENT OF INTEREST IS A PAYMENT FROM SE LF TO SELF AS THE PAYMENT IS BEING MADE TO A JOINT VENTURE PARTNER, AND SECOND, THAT THE AMOUNT IS DISALLOWABLE UNDER EXPLANATION TO SECTION 37 WHICH DEBARS DEDUCTIBILITY OF A NY EXPENDITURE INCURRED BY AN ASSESSEE FOR ANY PURPOSE WHICH IS AN OFFENCE OR WHICH IS PROHIBITED BY LAW SHALL NOT BE DEEMED TO HAVE BEEN INCURRED FOR THE PURPOSE OF BUSINESS OR PROFESSION AND NO DEDUCTION OR ALLOWANCE SHALL BE MADE IN RESPECT OF SUCH EXPENDITURE . AS REGARDS THE FIRST OBJECTION, AS WE HAVE DISCUSSED ABOVE IN THE CO NTEXT OF PROVISIONS OF ARTICLE 7(3)(B), THE PAYMENT OF INTEREST MADE TO THE JOINT VENTURE PARTNERS IS TO BE TREATED AS PAYMENT MADE TO INDEPENDENT PARTIES AND THE MERE FACT THAT THOSE COMPANIES ARE SHAREHOLDERS IN THE ASSESSEE COMPANY DOES NOT VITIATE THAT STATUS. AS REGARDS THE SECOND OBJECTION, AS LEARNED COUNSEL FOR THE ASSESSEE RIGHTLY POINTS, THAT LIMITATION, EVEN IF APPLICABLE, COMES INTO PLAY IN RESPECT OF DEDUCTIONS CLAIMED UNDER SECTION 37, WHEREAS THE PRESENT DEDUCTION IN RESPECT OF INTEREST ON BO RROWINGS IS COVERED BY THE SPECIFIC PROVISIONS OF SECTION 36(1)(III) WHICH PERMITS DEDUCTION IN RESPECT OF THE AMOUNT OF THE INTEREST PAID IN RESPECT OF CAPITAL BORROWED FOR THE PURPOSES OF THE BUSINESS OR PROFESSION. IT IS, THEREFORE, NOT EVEN NECESSARY TO EXAMINE WHETHER OR NOT THE INTEREST PAID BY THE ASSESSEE COMPANY WAS IN VIOLATION OF RESERVE BANK OF INDIA GUIDELINES. 17. THE ABOVE OBJECTIONS RAISED BY THE REVENUE AUTHORITIE S ARE, THUS, NOT SUSTAINABLE IN LAW. THE AMOUNT PAID BY THE ASSESSEE, TOWARDS INTEREST ON ITA NO.: 4249/MUM/07 ASSESSMENT YEAR: 2002 - 03 PAGE 16 OF 28 BORROWINGS FOR THE PURPOSE OF BUSINESS OF THE ASSESSEE, IS THUS DEDUCTIBLE IN COMPUTATION OF PROFITS OF THE ASSESSEE WHICH ARE EXIGIBLE TO TAX IN INDIA. THERE IS ONE MORE OBJECTION TO THIS DEDUCTION, AND THIS OBJECTION IS ON THE CONCEPT UAL PLANE RATHER THAN ON PE PROFIT DETERMINATION MECHANISM IN DOMESTIC LAW OR IN THE TAX TREATY. 1 8 . THAT TA KES US TO OBJECTION OF THE REVENUE AUTHORITIES TO THE EFFECT THAT THE BORROWINGS BY THE ASSESSEE , ON WHICH INTEREST HAS BEEN CLAIMED AS DEDUCTION , ARE IN FACT PART OF THE CAPITAL OF THE ASSESSEE WHICH IS BROUGHT IN THE GARB OF BORROWINGS PURELY ON TAX CONSIDERATIONS. OUR ATTENTION IS POINTED OUT TO THE FACT THE RATIO OF DEBT TO THE EQUITY IS 248: 1 WHICH IS UNUSUALLY HIGH BY ANY STANDARD AND THAT S UCH A HIGHLY GEARED COMPANY ONLY SHOWS THAT EQUITY IS BROUGHT IN THE GARB OF DEBT, AND IT IS CONTENDED THAT SINCE WHAT IS TERMED AS BORROWING BY THE COMPANY IS D E FACTO MINIMUM REQUIRED CAPITAL TO CARRY OUT THE BUSINESS IN INDIA, INTEREST CANNOT BE ALLOWED AS A DEDUCTION ON THE SAME. IN OTHER WORDS, REVENUES OBJECTION IS THAT THE ASSESSEE COMPANY IS SO THINLY CAPITALIZED THAT ITS DEBT CAPITAL IS REQUIRED TO RECHARACTERIZED AS EQUITY CAPITAL FOR THE PURPOSE OF EXAMINING CLAIM OF DEDUCTION FOR INTEREST ON SU CH DEBT CAPITAL. 19. THIN CAPITALIZATION REFERS TO A SITUATION IN WHICH CAPITAL OF A BUSINESS IS MADE UP OF GREATER PORTION OF DEBT THAN EQUITY, AND ITS SUCH GEARING OR ITA NO.: 4249/MUM/07 ASSESSMENT YEAR: 2002 - 03 PAGE 17 OF 28 LEVERAGE RATIO I.E. DEBT EQUITY RATIO, IS TOO HIGH. THE TAX TREATMENT BEING GIVEN TO THE EQUITY CAPITAL AND DEBT CAPITAL BEING FUNDAMENTALLY DIFFERENT, IT IS OFTEN MORE ADVANTAGEOUS IN INTERNATIONAL CONTEXT TO ARRANGE FINANCING OF A COMPANY BY LOAN RATHER THAN BY EQUITY. IT DOES AFFECT THE LEGITIMATE TAX REVENUES OF THE SOURCE COUNT RY IN W HICH BUSINESS IS CARRIED OUT BECAUSE WHILE DIVIDENDS AND INTEREST ARE GENERALLY TAXABLE AT THE SAME RATE IN THE HANDS OF THE RECIPIENT IN THE SOURCE COUNTRY , E.G. UNDER INDIA BELGIUM TAX TREATY WHT RATE ON INTEREST, OTHER THAN BA NK INTEREST, AS ALSO DIVIDE ND IS AT UNIFORM 15% , INTEREST IS TAX DEDUCTIBLE AND THAT RESULTS IN LOWER CORPORATE TAXES IN RESPECT OF PE PROFITS. THESE TAX BENEFITS COULD BE FURTHER OPTIMIZED BY HYBRID FINANCING INSTRUMENTS SUCH AS PROFIT PARTICIPATING LOANS, CONVERTIBLE LOANS OR WHER E INSTRUMENT IS TREATED AS DEBT IN THE SOURCE COUNTRY OF THE INCOME (I.E. RESULTING IN TAX DEDUCTIBLE INTEREST) AND AS EQUITY IN THE RESIDENCE COUNTRY OF THE LENDER ( I.E. WHERE LENDER MAY CLAIM THE PARTICIPATION EXEMPTION OF INTEREST INCOME BECAUSE OF ITS CHARACTERIZATION AS DISTRIBUTION OF PROFITS). THAT IS HOW TAX CONSIDERATIONS AT TIMES DO RESULT IN A COMPANY BEING TOO THINLY CAPITALIZED, OR, TO PUT IT DIFFERENTLY, FINANCED BY A DISPROPORTIONATE RATIO OF DEBTS. IN ORDER TO PROTECT THEMSELVES AGAINST S UCH EROSION IN THEIR LEGITIMATE TAX BASE, SEVERAL TAX JURISDICTIONS ENACT RULES TO COUNTER THIS VULNERABILITY AND THESE RULES ARE TERMED AS THIN CAPITALIZATION RULES. 20. I T IS FOR THIS BACKGROUND THAT MANY JURISDICTIONS TAKE SEVERAL LEGISLATIVE ANTI A BUSE MEASURES INCLUDING LIMIT ING DEDUCTION ON INTEREST WHEN THE ITA NO.: 4249/MUM/07 ASSESSMENT YEAR: 2002 - 03 PAGE 18 OF 28 COMPANY IS CONSIDERED TO BE TOO HIGHLY GEARED UNDER APPLICABLE TAX REGULATIONS . INDIA HAS WOKEN UP NOW TO NEUTRALIZE THIS KIND OF MANOEUVRING AND THE DIRECT TAXES CODE BILL, 2010, DOES SEEK TO PROVIDE A LEGISLATIVE FRAMEWORK FOR REMEDIAL MEASURES TO COUNTER EROSION OF TAX BASE BY THIN CAPITALIZATION. UNDER SECTION 123 (1)(F) OF THE PROPOSED DIRECT TAXES CODE BILL, 2010 ( BILL NO. 11 OF 2010 AS INTRODUCED IN THE PARLIAMENT ON 30 TH AUGUST 2010 ) A S A PART OF THE GENERAL ANTI AVOIDANCE RULE , A NY ARRANGEMENT ENTERED INTO BY A PERSON MAY BE DECLARED AS AN IMPERMISSIBLE AVOIDANCE ARRANGEMENT AND THE CONSEQUENCES, UNDER THIS CODE, OF THE ARRANGEMENT MAY BE DETERMINED BY RECHARACTERISING ANY EQUITY INTO DEBT OR VICE VERSA. THAT IS THE FIRST STEP TAKEN BY THE INDIAS TAX ADMINISTRATION IN THE DIRECTION OF HAVING FORMAL THIN CAPITALIZATION RULES IN INDIA. HOWEVER, IT IS NOT IN DISPUTE THAT AS AT THE MATERIAL POINT OF TIME, INDIA DID NOT HAV E ANY THIN CAPI TALIZATION RULES, NOR DOES IT HAVE ANY THIN CAPITALIZATION RULES EVEN AT PRESENT. 21. INTERESTINGLY, HOWEVER, THI N CAPITALIZATION RULES DO EXIST IN BELGIUM WHICH PERHAPS EXPLAIN S , FOR THE REASONS WE SHALL NOW SET OUT, THE PECULIAR CAPITAL STRUCTURE MAY HA VE BEEN ADOPTED BY THE ASSESSEE. AS PER THE COUNTRY SURVEY REPORT ON BELGIUM, AS PUBLISHED BY THE INTERNATIONAL BUREAU OF FISCAL DOCUMENTATION, AMSTERDAM, ( BASED ON INFORMATION AS ON 19 TH DECEMBER 1995) BELGIUM APPLIES TWO SETS OF THIN CAPITALIZATION RULE S. FIRSTLY, A 1:1 DEBT/EQUITY RATIO APPLIES TO LOANS GRANTED BY INDIVIDUAL DIRECTORS, SHAREHOLDERS AND NON - RESIDENT CORPORATE DIRECTORS TO THEIR COMPANY (ART. ITA NO.: 4249/MUM/07 ASSESSMENT YEAR: 2002 - 03 PAGE 19 OF 28 198(10) IR/WIB). INTEREST RELATING TO DEBT IN EXCESS OF THIS RATIO IS RECHARACTERIZED INTO A NON - DEDUCTIBLE DIVIDEND. FURTHERMORE, THE INTEREST RATE MAY NOT EXCEED THE MARKET RATE. SECONDLY, A 7:1 DEBT/EQUITY RATIO APPLIES TO DEBT IF THE CREDITOR (RESIDENT OR NON - RESIDENT) IS EXEMPT OR TAXED AT A REDUCED RATE IN RESPECT OF THE INTEREST PAID ON THE DEB T. INTEREST RELATING TO DEBT IN EXCESS OF THIS RATIO IS CONSIDERED A NON - DEDUCTIBLE BUSINESS EXPENSE (ART. 198(11) IR/WIB). IN A 2008 IBFD PUBLICATION INTERNATIONAL TAX PLANNING AND PREVENTION OF ABUSE ( BY DR LUC DE BROE ; ISBN 978 - 90 - 8722 - 035 - 08; @ PAGE 502), THESE THIN CAPITALIZATION RULES ARE SUMMED UP AS FOLLOWS: BELGIUM HAS FIVE DOMESTIC LAW PROVISIONS THAT ARE RELEVANT FOR THE DISCUSSION OF THIN CAPITALIZATION, I.E. ART 26 BITC; ART 54 BITC; ART 198 11 BITC, ART 18 4 BITC AND THE BELGIAN GAAR. AR TICLE 26,54 AND 198 BELONG TO THE FIRST GROUP OF AFOREMENTIONED RULES. THE DEDUCTION OF INTEREST IS DENIED IF THE STATUTORY CONDITIONS FOR DEDUCTIBILITY ARE NOT SATISFIED. ARTS 26 AND 54 ARE NOT CONCERNED WITH THE QUESTION WHETHER THE BORROWER IS UNDERCAPI TALIZED BUT ONLY WHETHER THE INTEREST CHARGED IS AT ARMS LENGTH . EXCESSIVE INTEREST ( I.E. INTEREST CHARGED ABOVE THE PREVAILING MARKET CONDITIONS) IS NOT DEDUCTIBLE. ARTICLE 198, 11 IS CONCERNED WITH UNDERCAPITALIZED COMPANIES. INTEREST IS NOT DEDUCTIBL E IF THE STATUTORY 7:1 DEBT/ EQUITY RATIO IS EXCEEDED. ARTICLE 18, 4 BITC BELONGS TO SECOND GROUP OF AFOREMENTIONED RULES; IT RECHARACTERIZES CERTAIN INTEREST PAYMENTS INTO DIVIDENDS BOTH FOR CORPORATE TAX PURPOSES OF DEBTOR AND FOR WITHHOLDING TAX PURPO SES, WHILE CURIOUSLY IT DOES NOT RECHARACTERIZE DEBT INTO EQUITY (NEITHER FOR CORPORATE TAX, NOR FOR CAPITAL DUTY PURPOSES). IN CERTAIN CIRCUMSTANCES, THE BELGIAN GAAR MAY HAVE THE ITA NO.: 4249/MUM/07 ASSESSMENT YEAR: 2002 - 03 PAGE 20 OF 28 POTENTIAL TO RECHARACTERIZE PURPORTED DEBT INTO EQUITY. IN THAT CASE, IT A LSO BELONGS TO THE SECOND SET OF RULES. 22. IT IS THUS ONLY UNDER THE BELGIAN TAX LAWS, WHICH INTER ALIA RESTRICT THE INTEREST DEDUCTIONS ONLY TO THE EXTENT OF DEBT CAPITAL RATIO OF 1:7 IN SHARP CONTRAST TO THE DEBT RATIO IN THE PRESENT CASE WHICH IS 1:2 48, THAT THE MODE OF BORROWINGS, I.E. VIA GE OR VIA PE, MAY HAVE SOME TAX IMPLICATION EVEN THOUGH AT SOMEWHAT SUPERFICIAL LEVEL . THAT PERHAPS EXPLAINS AS TO WHY THE BORROWINGS ARE CLAIMED TO HAVE BEEN RESORTED TO BY THE INDIAN PE AND NOT THE BELGIAN GE DIRECTLY. IF THESE BORROWINGS WERE RESORTED TO BY THE BELGIAN GE DIRECTLY , PRIMA FACIE THE THIN CAPITALIZATION RULES WOULD HAVE RESTRICTED THE INTEREST DISALLOWANCE IN EXCESS OF BORROWINGS EXCEEDING SEVEN TIMES THE EQUITY CAPITAL, WHEREAS IN THE PRESENT C ASE BORROWINGS ARE TWO HUNDRED FORTY EIGHT TIMES THE EQUITY CAPITAL. AS THE CAPITAL IS STRUCTURED NOW, AND THE BORROWINGS HAVING BEEN RESORTED BY THE INDIAN PE DIRECTLY, IT COULD POSSIBLY BE SAID, OR AT LEAST ARGUED, THAT THERE IS NO DEBT CAPITAL IN THE AS SESSEE COMPANY - I.E. THE BELGIAN ENTITY, AND THIS DEBT CAPITAL IS CONFINED TO BORROWING DIRECTLY BY THE PE. BE THAT AS IT MAY, IT CANNOT BE OPEN TO US TO APPLY THESE THIN CAPITALIZATION RULES IN THE HANDS OF THE ASSESSEE COMPANY WHILE COMPUTING ITS TAXABL E INCOME IN INDIA, BECAUSE SO FAR AS TAXABILITY IN INDIA IS CONCERNED, THE LIMITATIONS TO BE PLACED ON DEDUCTION OF EXPENSES HAS TO BE LIMITATION UNDER THE LAWS OF THE STATE IN WHICH PE IS SITUATED I.E. INDIA. IT MAY BE USEFUL TO RECALL THAT IN TERMS OF TH E PROVISIONS OF ARTICLE 7 (3)(B) OF INDO BELGIAN TAX TREATY, IN THE DETERMINATION OF THE PROFITS OF A PERMANENT ITA NO.: 4249/MUM/07 ASSESSMENT YEAR: 2002 - 03 PAGE 21 OF 28 ESTABLISHMENT, THERE SHALL BE ALLOWED AS DEDUCTIONS EXPENSES WHICH ARE INCURRED FOR THE PURPOSES OF THE BUSINESS OF THE PERMANENT ESTABLISHMEN T INCLUDING EXECUTIVE AND GENERAL ADMINISTRATIVE EXPENSES SO INCURRED, WHETHER IN THE STATE IN WHICH THE PERMANENT ESTABLISHMENT IS SITUATED OR ELSEWHERE, SUBJECT TO THE LIMITATIONS OF THE TAXATION LAWS OF THAT STATE. ADMITTEDLY, THERE ARE NO LIMITATIONS ON DEDUCTION OF INTEREST EXPENSES ON BORROWINGS, WHICH CAN BE ATTRIBUTED TO THIN CAPITALIZATION RULES, IN INDIA. 2 3. THE QUESTION THEN ARISES WHETHER EVEN IN THE ABSENCE OF ANY SPECIFIC THIN CAPITALIZATION RULES IN INDIA, IT COULD BE OPEN TO THE REVENUE AUTHORITIES TO RECHARACTERIZE THE DEBT CAPITAL AS EQUITY CAPITAL, AND, ACCORDINGLY, DISREGARD THE INTEREST PAYMENTS AS TAX DEDUCTIBLES. 2 4. WE FIND GUIDANCE FROM HONBLE SUPREME COURTS JUDGMENT IN THE CASE OF UNION OF INDIA VS AZADI B ACHAO ANDOLAN ( 26 3 ITR 706) WHEREIN THEIR LORDSHIPS HAVE, INTER ALIA, OBSERVED AS FOLLOWS: 111. IN PARA 3.3.1, AFTER NOTICING THE GROWING PRACTICE AMONGST CERTAIN ENTITIES, WHO ARE NOT RESIDENTS OF EITHER OF THE TWO CONTRACTING STATES, TO TRY AND AVAIL OF THE BENEFICIAL P ROVISIONS OF THE DTAAS AND INDULGE IN WHAT IS POPULARLY KNOWN AS TREATY SHOPPING, THE REPORT SAYS : 3.3.1 .THERE IS A NEED TO INCORPORATE SUITABLE PROVISIONS IN THE CHAPTER ON INTERPRETATION OF DTAAS, TO DEAL WITH TREATY ITA NO.: 4249/MUM/07 ASSESSMENT YEAR: 2002 - 03 PAGE 22 OF 28 SHOPPING, CONDUIT COMPANIES AN D THIN CAPITALIZATION. THESE MAY BE BASED ON UN/OECD MODEL OR OTHER BEST GLOBAL PRACTICES. 112. IN PARA 3.3.2, THE WORKING GROUP RECOMMENDED INTRODUCTION OF ANTI - ABUSE PROVISIONS IN THE DOMESTIC LAW. 113. FINALLY, IN PARAGRAPH 3.3.3 IT IS STATED THE WO RKING GROUP RECOMMENDS THAT IN FUTURE NEGOTIATIONS, PROVISIONS RELATING TO ANTI - ABUSE/LIMITATION OF BENEFIT MAY BE INCORPORATED IN THE DTAAS ALSO. 114. WE ARE AFRAID THAT THE WEIGHTY RECOMMENDATIONS OF THE WORKING GROUP ON NON - RESIDENT TAXATION ARE AGAIN ABOUT WHAT THE LAW OUGHT TO BE, AND A POINTER TO THE PARLIAMENT AND THE EXECUTIVE FOR INCORPORATING SUITABLE LIMITATION PROVISIONS IN THE TREATY ITSELF OR BY DOMESTIC LEGISLATION. THIS PER SE DOES NOT RENDER AN ATTEMPT BY RESIDENT OF A THIRD PARTY TO TAKE ADVANTAGE OF THE EXISTING PROVISIONS OF THE DTAC ILLEGAL . (EMPHASIS BY UNDERLINING SUPPLIED BY US) 25. IT IS THUS CLEAR THAT MERELY BECAUSE A SUITABLE LIMITATION PROVISION IN THE TREATY OR THE DOMESTIC LEGISLATION IS CONSIDERED DESIRABLE, AND ATTEMPT A RE BEING MADE TO LEGISLATE T HE ANTI ABUSE PROVISIONS SUBSEQUENTLY, IT WOULD NOT RENDER THE EFFORT TO TAKE ADVANTAGE OF EXISTING PROVISION OF THE TREATY ILLEGAL. WE ARE THUS UNABLE TO ACCEPT THE PLEA OF THE REVENUE AUTHORITIES, AND WE UPHOLD THE CLAIM OF D EDUCTION OF INTEREST, IN RESPECT OF CAPITAL BORROWED FROM THE SHAREHOLDERS OR JOINT VENTURE PARTNERS, BY THE ASSESSEE. ITA NO.: 4249/MUM/07 ASSESSMENT YEAR: 2002 - 03 PAGE 23 OF 28 26. EVEN OTHERWISE, I T IS ALSO IMPORTANT TO BEAR IN MIND THE FACT THAT, AS THE LAW STANDS NOW UNDER SECTION 90 OF THE INDIAN INCOME TA X ACT, THE PROVISIONS OF A TAX TREATY OVERRIDE THE PROVISIONS OF THE INDIAN INCOME TAX ACT EXCEPT TO THE EXTENT THE LATTER ARE BENEFICIAL TO THE ASSESSEE , AND THIS TREATY OVERRIDE IS UNQUALIFIED SAVE AND EXCEPT FOR CLARIFICATION THAT CHARGE OF TAX IN RE SPECT OF A FOREIGN COMPANY AT A RATE HIGHER THAN THE RATE AT WHICH DOMESTIC COMPANY IS CHARGEABLE, SHALL NOT BE REGARDED AS LESS FAVOURABLE CHARGE OR LEVY IN RESPECT OF SUCH FOREIGN COMPANY. JUST IN CASE THERE WERE ANY DOUBTS ON THIS FUNDAMENTAL LEGAL POS ITION, THE CENTRAL BOARD OF DIRECT TAXES, VIDE CIRCULAR NO. 33 DATED 2 ND APRIL 1982 [ (1982) 137 ITR (ST.) 1] , HAS SET THE SAME AT REST. THIS CIRCULAR DEALS WITH THE QUESTION AS TO WHAT THE ASSESSING OFFICERS WILL DO WHEN THEY FIND THAT THE PROVISIONS OF T HE DOUBLE TAXATION AVOIDANCE AGREEMENT ARE NOT IN CONFORMITY WITH THE PROVISIONS OF THE INCOME - TAX ACT, 1961. THEN IT WAS LAID DOWN BY THE BOARD IN THE SAID CIRCULAR AS FOLLOWS : THE CORRECT LEGAL POSITION IS THAT WHERE A SPECIFIC PROVISION IS MADE IN TH E DOUBLE TAXATION AVOIDANCE AGREEMEN T, THAT PROVISION WILL PREVAIL OVER THE GENERAL PROVISIONS CONTAINED IN THE INCOME - TAX ACT, 1961. IN FACT THE DOUBLE TAXATION AVOIDA NCE AGREEMENTS WHICH HAVE BEEN ENTERED INTO BY THE CENTRAL GOVERNMENT UNDER SECTION 90 OF THE INCOME - TAX ACT, 1961, ALSO PROVIDE THAT THE LAWS IN FORCE IN EITHER COUNTRY WILL CONTINUE TO GOVERN THE ASSESSMENT AND TAXATION OF INCOME IN THE RESPECTIVE COUNTRY EXCEPT WHERE PROVISIONS TO THE CONTRARY HAVE BEEN MADE IN THE AGREEMENT. ITA NO.: 4249/MUM/07 ASSESSMENT YEAR: 2002 - 03 PAGE 24 OF 28 27. IN THE CASE OF UCO BANK VS CIT (237 ITR 889), THEIR LORDSHIPS OF HONBLE SUPREME COURT HAD AN OCCASION TO SURVEY THE JUDICIAL PRECEDENTS ON THE QUESTION OF BINDING NATURE OF THE CBDT CIRCULARS. AFTER ELABORATELY DEALING WITH HONBLE SUPREME COURTS JUDGMENTS IN THE CASES OF NAVNEET JHAVERI VS KK SEN, AAC (56 ITR 198) AND K P VARGHESE VS ITO (131 ITR 597), THEIR LORDSHIP CONCLUDED THAT THE CBDT CIRCULARS INTER ALIA , CAN TONE DOWN THE RIGOUR OF THE LAW AND SUCH BENEVOLENT CIRCULAR ARE BINDING ON THE FIELD AUTHORIT IES. IT CANNOT THEREFORE BE OPEN TO A REVENUE AUTHORITY TO DISREGARD THE CBDT CIRCULAR EVEN IF IT DEVIATES FROM THE LAW AS LONG AS IT IS BENEFICIAL TO THE ASSESSEE. THUS, WHERE A DOUBLE TAXATION AVOIDANCE AGREEMENT PROVIDED FOR A PARTICULAR MODE OF COM PUTATION OF INCOME, THE SAME SHOULD BE FOLLOWED, IRRESPECTIVE OF THE PROVISIONS IN THE INCOME - TAX ACT. WHERE THERE IS NO SPECIFIC PROVISION IN THE AGREEMENT, IT IS THE BASIC LAW, I.E., THE INCOME - TAX ACT, THAT WILL GOVERN THE TAXATION OF INCOME. WHEN NO SU CH LIMITATION OF BENEFITS OR ANTI ABUSE PROVISIONS ARE SET OUT IN THE TAX TREATY, IT CANNOT BE OPEN TO THE REVENUE AUTHORITIES TO APPLY THE ANTI ABUSE PROVISIONS BASED ON THE JUDGE MADE LAW IN INDIA WHICH IS ESSENTIALLY TO BE TREATED AS A PART OF THE IN COME TAX ACT AS IT IS BASED ON THE INTERPRETATION OF PROVISIONS UNDER THE INCOME TAX ACT, AND APPLY THE SAME. AS OBSERVED BY THIS TRIBUNAL, IN THE CASE OF MOTOROLA INC VS DCIT (95 ITD SB 269), A TAX TREATY IS AN ALTERNATIVE TAX REGIME. IT HAS TO BE TREATE D AS A COMPLETE CODE IN ITSELF, IN THAT SENSE. THERE ARE THUS NO LEGALLY SUSTAINABLE MERITS IN LEARNED DEPARTMENTAL REPRESENTATIVES PASSIONATE PLEA FOR INVOKING PRINCIPLES LAID DOWN BY HONBLE SUPREME COURT IN MCDOWELL & CO LTD VS COMMERCIAL TAX OFFICER ITA NO.: 4249/MUM/07 ASSESSMENT YEAR: 2002 - 03 PAGE 25 OF 28 (154 ITR 148), WHICH, INTER ALIA, HOLDS THAT COLOURABLE DEVICES CANNOT BE PART OF TAX PLANNING AND IT IS WRONG TO ENCOURAGE OR ENTERTAIN THE BELIEF THAT IT IS HONOURABLE TO AVOID THE PAYMENT OF TAX BY RESTORING TO DUBIOUS METHODS AND THAT IT IS THE OBL IGATION OF EVERY CITIZEN TO PAY THE TAXES HONESTLY WITHOUT RESORTING TO SUBTERFUGE. IT IS THUS NOT EVEN NECESSARY TO EXAMINE WHETHER OR NOT THE FINANCE STRUCTURE IN QUESTION CONSTITUTED COLOURABLE DEVICE OR SORT OF SUBTERFUGE. AS LONG AS FINANCE STRUCTURE ADOPTED BY THE ASSESSEE WAS NOT SPECIFICALLY PROHIBITED BY THE APPLICABLE TAX TREATY PROVISIONS, AND AS LONG AS THERE WAS NO SPECIFIC ANTI ABUSE PROVISION TO DEAL WITH THE SAME IN THE TAX TREATY ITSELF , THE EFFECT OF THE FINANCE STRUCTURE COULD NOT BE IGN ORED. 28. IT IS INTERESTING TO TAKE NOTE OF THE PARADIGM SHIFT WITH REGARD TO THE TREATY OVERRIDE, AS INTRODUCED IN SECTION 129(9) OF THE DIRECT TAXES CODE BILL 2010, WHICH PROVIDES THAT NOTWITHSTANDING THE TREATY OVERRIDE PROVISIONS IN SECTION 129(8) [ WHICH ARE IN PARI MATERIA WITH SECTION 90(2) OF THE INDIAN INCOME TAX ACT, 1961] THE PROVISIONS OF THE DIRECT TAXES CODE RELATING ( A ) GENERAL ANTI - AVOIDANCE RULE UNDER SECTION 123;( B ) LEVY OF BRANCH PROFIT TAX UNDER SECTION 111; OR( C ) CONTROL FOREIGN C OMPANY RULES REFERRED TO IN THE TWENTIETH SCHEDULE, SHALL APPLY TO THE ASSESSEE REFERRED TO IN SUB - SECTION ( 8 ), WHETHER OR NOT SUCH PROVISIONS ARE BENEFICIAL TO HIM. THE TREATY OVERRIDE IS THUS QUITE RESTRICTED IN SCOPE IN THIS NEW PARADIGM. UNLIKE IN TH E PROPOSED CODE AND IN SHARP CONTRAST TO THIS PARADIGM , THE TREATY OVERRIDE IN THE INCOME TAX ACT, 1961, SAVE AND EXCEPT FOR THE HIGHER ITA NO.: 4249/MUM/07 ASSESSMENT YEAR: 2002 - 03 PAGE 26 OF 28 TAX RATE BEING PERMITTED FOR THE FOREIGN COMPANIES, IS UNQUALIFIED . IN THE SCHEME OF THINGS, AS IT EXISTS IN THE INDIAN INCOME TAX ACT, 1961, THE TREATY OVERRIDE OVER DOMESTIC LAW IS MUCH WIDER IN SCOPE. WE CAN NOT INTERPRET THE TREATY PROVISIONS IN SUCH A MANNER SO AS TO CURTAIL, DILUTE OR OTHERWISE TINKER WITH THIS COMPREHENSIVE TREATY OVERRIDE OVER THE DOMESTIC TAX LAW . 2 9. IT IS ALSO IMPORTANT TO BEAR IN MIND THAT WHEN THERE ARE NO THIN CAPITALIZATION RULES VIS - - VIS DOMESTIC THIN CAPITALIZATION SITUATIONS, AND IN THE LIGHT OF THE SECTION 90(2) AS IT EXISTS AT PRESENT, ANY ATTEMPTS TO NEUTRALIZE THIN CAPITALIZATION V IS - - VIS PES OF BELGIAN ENTERPRISE WILL BE CLEARLY CONTRARY TO THE SCHEME OF NON DISCRIMINATION ENVISAGED BY ARTICLE 24 (5) WHICH PROVIDES THAT, ENTERPRISES OF A CONTRACTING STATE, THE CAPITAL OF WHICH IS WHOLLY OR PARTLY - OWNED OR CONTROLLED, DIRECTLY OR INDIRECTLY, BY ONE OR MORE RESIDENTS OF THE OTHER CONTRACTING STATE, SHALL NOT BE SUBJECTED IN THE FIRST - MENTIONED CONTRACTING STATE TO ANY TAXATION OR ANY REQUIREMENT CONNECTED THEREWITH WHICH IS OTHER , OR MORE BURDENSOME , THAN THE TAXATION AND CONNECTED REQUIREMENT TO WHICH OTHER SIMILAR ENTERPRISES OF THAT FIRST - MENTIONED STATE ARE OR MAY BE SUBJECTED IN THE SAME CIRCUMSTANCES AND UNDER THE SAME CONDITIONS. IN THIS VIEW OF THE MATTER, IT CANNOT BE OPEN TO THE REVENUE AUTHORITIES TO PUT ANY LIMITATION O N DEDUCTION OF INTEREST, IN RESPECT OF FUNDS BORROWED BY THE PE, WHILE COMPUTING INCOME IN ACCORDANCE WITH THE PROVISIONS OF ARTICLE 7 OF INDO BELGIUM TAX TREATY, WHEN NO SUCH LIMITATIONS ARE PLACED ON THE DOMESTIC ENTERPRISE. ITA NO.: 4249/MUM/07 ASSESSMENT YEAR: 2002 - 03 PAGE 27 OF 28 30. FOR THE REASONS SET OUT ABOVE, WE ARE OF THE CONSIDERED VIEW THAT THE ASSESSE IS INDEED JUSTIFIED IN CLAIMING DEDUCTION ON ACCOUNT OF INTEREST PAID ON BORROWINGS FROM ITS SHAREHOLDERS/ JOINT VENTURE COMPANIES. THE INTERNATIONAL CONSENSUS THAT THE ASSESSING OFFICER HAS REFERRED TO IS FOR THE NEED OF THIN CAPITALIZATION RULES, BUT THEN JUST BECAUSE IT IS DESIRABLE TO CURB THIN CAPITALIZATION, THE ASSESSING OFFICER CANNOT DISALLOW THE INTEREST PAID ON DEBT CAPITAL IN THE CASES OF THINLY CAPITALIZED COMPANIES. THE ASSESSING OFFICER WAS CLEARLY AHEAD O F HIS TIMES IN DISALLOWING THE EXPENSES BASED ON HIS NOTIONS OF THIN CAPITALIZATION RULES, WHEN SUCH RULES HAD NOT EVEN REACHED THE DRAWING BOARD STAGE IN INDIA . LEARNED COMMISSIONER (APPEALS) ALSO DID NOT FOLLOW THE CORRECT LEGAL POSIT ION BY LEANING UPON RESTRICTION PLACED IN EXPLANATION TO SECTION 37 OF THE ACT, WHICH IS NOT APPLICABLE IN RESPECT OF DEDUCTION ON INTEREST UNDER SECTION 36(1)(III), AND IN LEANING UPON RESTRICTION PLACED IN ARTICLE 7(3)(B) ON INTRA ORGANIZATION NOTIONAL PAYMENT OF INTEREST ON CAPITAL, WHEREAS THE INTEREST PAYMENT IN THE PRESENT CASE DID NOT CONSTITUTE AN INTRA ORGANIZATION TRANSACTION AT ALL. EVEN IF THESE INTEREST PAYMENT S WE RE TO BE TREATED AS INTRA ORGANIZATION TRANSACTIONS BY TREATING THE SAME A S PAYMENT S MADE TO THE GE, AND NOT TO THE JOINT VENTURE PARTNERS, THESE PAYMENTS CANNOT BE VIEWED AS NOTIONAL PAYMENTS BECAUSE IN SUCH A SITUATION THE GE WILL HAVE CORRESPONDING LIABILITY TO PAY THE SAME TO THE JOINT VENTURE PARTNERS. WE HAVE ALSO NOTED THAT T HE INTEREST PAID BY THE ASSESSEE MAY HAVE BEEN CONTRARY TO THE SPIRIT, IF NOT LETTER, OF THE RESERVE BANK OF INDIA GUIDELINES, BUT THEN THIS FACT, BY ITSELF AND PARTICULARLY IN VIEW OF EXPLANATION TO SECTION 37 BEING CONFINED TO THE AMOUNTS ADMISSIB LE AS ITA NO.: 4249/MUM/07 ASSESSMENT YEAR: 2002 - 03 PAGE 28 OF 28 DEDUCTION UNDER SECTION 37 , DOES NOT RENDER THE INTEREST PAID BY THE ASSESSEE AS NOT DEDUCTIBLE , AND IT IS NOT EVEN NECESSARY TO EXAMINE THE SCOPE OF EXPLANATION TO SECTION 37. IT IS ALSO QUITE POSSIBLE THAT TAX CONSIDERATIONS MAY HAVE PLAYED A ROLE IN ASSESSEES PLANNING THE CAPITAL STRUCTURE, BUT AN ELEMENT OF PLANNING IN STRUCTURING CAPITAL DOES NOT TRANSFORM A TAX DEDUCTIBLE EXPENSE OF INTEREST INTO AN EXPENSE THAT IS NON TAX DEDUCTIBLE . IN VIEW OF THESE DISCUSSIONS, IT IS CLEAR THAT THE IM PUGNED DISALLOWANCE IS INDEED CONTRARY TO THE SCHEME OF THE LAW AS IT EXISTS ; THE GRIEVANCE OF THE TAXPAYER DESERVES TO BE UPHELD. WE, THEREFORE , DIRECT THE ASSESSING OFFICER TO DELETE THE IMPUGNED DISALLOWANCE. 31. IN THE RESULT, THE APPEAL IS ALLOWED . PRONOUN CED IN THE OPEN COURT TODAY ON 10 TH DAY OF NOVEMBER, 2010 . SD/XX SD/XX ( N V VASUDEVAN) (PRAMOD KUMAR) JUDICIAL MEMBER ACCOUNTANT MEMBER MUMBAI; 10 TH DAY OF NOVEMBER , 2010 . COPY FORWARDED TO : 1. THE APPELLANT 2. THE RESPONDENT 3. THE DIRECTOR OF INTERNATIONAL TAXATION , MUMBAI 4. THE COMMISSIONER (APPEALS) , MUMBAI 5 . DEPARTMENTAL REPRE SENTATIVE, L BENCH, MUMBAI 6. GUARD FILE TRUE COPY BY ORDER ETC. ASSISTANT REGISTRAR INCOME TAX APPELLATE TRIBUNAL MUMBAI BENCHES , MUMBAI