The Mumbai Bench of Income Tax Appellate Tribunal ( ITAT ) allowed Abu Dhabi Commercial Bank to set off losses of its Indian Permanent Establishment (PE) against interest income earned on External Commercial Borrowing (ECB) loans and upheld the concessional tax rate of 5% under the India-UAE tax treaty.

Abu Dhabi Commercial Bank,appellant-assessee,was a tax resident of the U.A.E. and had two branches in India,one in Mumbai and the other in Bangalore. During the relevant year, it advanced ECB loans directly to Indian clients through its U.A.E. head office, without involving its Indian branches. As a result, it earned interest income of ₹138.48 crore from Indian customers.

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The assessee filed its return of income on 04.01.2021, declaring ₹63.15 crore as taxable income. It claimed the benefit of Article 11(2) of the India-U.A.E. Double Taxation Avoidance Agreement (DTAA), offering the interest income to tax at a concessional rate of 5% on gross basis. However, it had first set off ₹75.32 crore of business losses from its Indian PE against the interest income before computing tax.

The Assessing Officer (AO) rejected the set-off, holding that Article 11(2) allowed taxation of gross interest income and did not permit any deduction or loss adjustment. He relied on CBDT Circular No. 333 and judicial precedents to conclude that when a DTAA specifies a method of taxation, it overrides the Income Tax Act. Accordingly, he taxed the entire ₹138.48 crore at 5%, without allowing any set-off.

Before the Dispute Resolution Panel (DRP), the assessee argued in support of the set-off and also made an alternative claim that the interest income was taxable at 5% under section 115A(1)(a)(iiaa) read with section 194LC of the Act. The DRP upheld the AO’s view and observed that the word “gross” in Article 11(2) meant the full amount of interest without any deductions.

The DRP also held that business losses of the PE could not be adjusted against interest income taxed under a different head. It stated that the appellant could not mix DTAA and domestic law provisions.

Since the ECB loans were part of the assessee’s banking business, the DRP noted that the interest income was in the nature of business income and would otherwise attract 40% tax under domestic law. The alternative claim under section 115A was also rejected due to lack of required government approval under section 194LC.

Based on the DRP’s directions, the AO passed the final assessment order, which was challenged by the assessee before the tribunal.

The two member bench comprising Saktijit Dey ( Vice President ) and Padmavathy S( Accountant Member) noted that the assessee had earned ₹138.48 crore as interest on ECB loans given directly by its UAE head office to Indian customers, with no role played by the Indian PE. The taxpayer had offered this income under the head 'Income from Other Sources' and claimed a concessional tax rate of 5% under both Section 115A(1)(a)(iiaa) and Article 11(2) of the India-UAE DTAA.

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The dispute was about whether the assessee could set off the PE’s business loss against this interest income. The department argued that since Article 11(2) used the word “gross,” no deductions or set-offs were allowed. However, the tribunal held that “gross” only restricted deductions for expenses, not set-off of losses permitted under domestic law.

The appellate tribunal clarified that under Article 11(2), income must first be computed under the Income Tax Act, which allows inter-head set-off of losses under Section 71. Since the taxpayer had not claimed any expenses, the interest income remained “gross,” and the set-off of loss was valid.

On the alternative claim under Section 115A(1)(a)(iiaa), the ITAT referred to a CBDT press release that waived the need for individual loan approvals, provided the ECB complied with RBI guidelines. As there was no allegation of non-compliance, the tribunal held that the taxpayer was also eligible for the 5% concessional rate under Section 115A.

In short,the appeal was allowed.

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