PE Loss Set Off Against ECB Interest Allowed: Abu Dhabi Commercial Bank v. DCIT 

Brief Facts: 

Abu Dhabi Commercial Bank (“Assessee”) is a UAE -headquartered bank and UAE tax resident with a Permanent Establishment (“PE”) in India, extended External Commercial Borrowings (“ECBs”) directly from its head office to Indian customers during AY 2019-20. These loans were not routed through the PE, generating interest income of INR 138.48 crore which was classified as “income from other sources” by the Assessee. Meanwhile, the Assesse’s PE reported current-year business losses. The Assessee set off these PE losses of Rs 75.33 crores against ECB interest of Rs 138.48 crores, offering net income of INR 63.15 crore, taxable at a concessional 5% rate under Article 11(2) of the India-UAE Double Taxation Avoidance Agreement (“India-UAE DTAA”) that is applicable to interest on bank loans, when the recipient is the beneficial owner of the interest. The Assessee contended that the interest earned on ECB loans advanced directly by its UAE head office to Indian borrowers was taxable at the rate of 5% under Article 11(2) of the India–UAE DTAA.¹, and that the expression “gross amount of interest” in Article 11(2) is left undefined within the DTAA and per common parlance such shall only be referred only to interest without deduction of expenses, not as interest without deduction of business losses. Therefore, PE losses in India could be set off against such interest income in accordance with domestic law before applying the treaty rate as Article 11(2) itself provides that interest is to be taxed “according to the laws” of the source Contracting Party (i.e India).Relying on Section 90(2) of the Income Tax Act, 1961 (“IT Act”), the Assessee also argued that it could apply domestic law for computation and the India- UAE DTAA treaty for the concessional rate, and rate and also pointed out that the return form permitted such inter-head adjustments 

The Assessee also claimed concessional taxation at rate of 5% under Section 115A(1)(a)(iiaa)² read with Section 194LC³ against the Dispute Resolution Panels (‘DRP’)  

The Revenue, on the other hand, argued that once the Assessee opted for the route provided under Article 11(2), interest earned had to be taxed on a gross basis without any deduction or set-off permitted. This entailed that the Assessee cannot set-off their PE’s losses as Article 11(2) only permitted calculation upon “gross” amount including PE losses, since the treaty. It was also averred that the DTAA did not contemplate inter-head adjustments and the term “gross” meant the full amount of interest. The Revenue further relied on CBDT Circular No. 333 dated 02 April 1982 and judicial precedents to contend that a hybrid approach using treaty provisions for rate while invoking domestic law for computation was impermissible. The DRP additionally reasoned that, being a banking entity, the ECB lending activity formed part of business operations and the interest constituted business income taxable under domestic provisions at higher rates; even assuming Section 115A applied, it would fall under Section 115A(1)(a)(ii) at 20% and not under Section 115A(1)(a)(iiaa). 

Issue for consideration: 

Whether PE business losses could set off against non-attributable ECB interest income before applying DTAA’s 5% on the amount of interest? 

ITAT Ruling and Reasoning: 

The ITAT ruled in favour of the Assessee, holding that PE losses were allowable to be set off against ECB interest income before applying the 5% rate under Article 11(2). It reasoned that Article 11(2) operates in two stages—first, the computation and taxability of interest must be determined “according to the laws” of the source State, meaning the Income-tax Act (including Chapter VI provisions permitting inter-head set-off under Section 71), and only thereafter is the treaty-specified rate  applied.  

The Tribunal also examined the meaning of “gross amount of interest” and, relying on the OECD Commentary (2017), held that “gross” refers to interest without deduction of expenses incurred to earn it, and does not prohibit set-off of losses where the treaty itself directs computation under domestic law; since the Assessee had not claimed any expenditure deduction, its computation was consistent with Article 11(2). On the alternative plea, the ITAT further held that the interest qualified for concessional taxation at 5% under Section 115A(1)(a)(iiaa), noting the CBDT press release dated 21 September 2012 clarification that separate Central Government approval was not necessary where ECB borrowings complied with RBI guidelines. 

Our thoughts: 

The Mumbai ITAT ruling delivers crucial clarity for non-resident banks under the India-UAE DTAA where current-year losses from Indian PEs can offset head-office interest income (such as from direct ECB lending), with treaty rates under Article 11(2) applied only after computing total income per IT Act provisions like Section 71 set-off—overriding Assessing Officers’ gross-basis taxation attempts. Key takeaways include: 

1. the mandatory sequence of domestic loss adjustments before treaty benefits,  

2. eligibility of routine PE operational losses against protected interest streams, and  

3. harmonious integration of DTAA with statutory mechanics.  

Multinationals with Indian PEs gain confidence in direct lending structures, enhancing tax efficiency and cash flows, provided they maintain robust segregated profit/loss records to substantiate audit defenses. 

The information contained in this document is not legal advice or legal opinion. The contents recorded in the said document are for informational purposes only and should not be used for commercial purposes. Acuity Law LLP disclaims all liability to any person for any loss or damage caused by errors or omissions, whether arising from negligence, accident, or any other cause. 

1. Article 11(2) of the India-UAE DTAA states that interest paid from one contracting state to a resident of the other can be taxed in the recipient’s state. However, the source state may also tax it under its domestic laws, subject to caps if the recipient is the beneficial owner: 5% on gross interest for loans from bona fide banks or similar financial institutions, and 12.5% in all other scenarios.  ↩︎
2. Section 115A(1)(a)(iia) of the IT Act ↩︎
3. Section 194LC of the IT Act  ↩︎