Brief Overview

The Supreme Court of India (SC) has pronounced a landmark judgment (the Ruling) in the case of American Express Limited and Oman International Bank (the Taxpayers), which will have a significant impact on non-residents operating in India through a branch structure. The SC has laid down guiding principles on the deductibility of ‘executive and general administrative expenses’ allocated to Indian branches by their overseas head offices (HOs) as provided under Section 44C of the Income-tax Act, 1961 (the Act). 

Background and Summary of the Ruling

• The taxpayers are non-resident banking companies with Indian branches that claimed deductions with respect to various head office (HO) expenses incurred outside India for their Indian branch operations. The expenses in question were not proportionate allocations, but expenses incurred specifically for the Indian branches. However, it appears that these expenses were neither debited to the profit and loss account of the Indian branches nor cash-settled.
• The taxpayers contended that, since these expenses were incurred ‘exclusively’ for their Indian branches, they were not covered by the overall limits prescribed under section 44C of the Act. Section 44C of the Act lays down a cap of 5% of adjusted total income on the deductibility of ‘head office expenditure’ (HO expenses), as defined.
• The contention of the taxpayers was upheld by the Bombay High Court (HC) based on several other rulings. The Indian Revenue Authorities (IRA) subsequently filed an appeal against the same before the Supreme Court (SC).
• On the IRA’s appeal, the Supreme Court overturned the HC’s order after considering the factual matrix and distinguishing the judicial precedents.

Key Principles Emerging from the Ruling

The SC has ruled that section 44C of the Act does not draw any distinction between ‘exclusive’ and ‘common’ head office expenses, and that all HO expenses falling within the category of executive and general administrative expenses, as defined therein are required to be covered under the ambit of section 44C of the Act. The key principles emerging from the ruling are indicated below:

1. Primacy of Section 44C: The SC reaffirmed that special provisions with a non‑obstante clause override the general provisions of deductibility provided in sections 28 to 43 of the Act.
2. Statutory Ceiling is Mandatory: Deduction of HO expenses is mandatorily subject to the quantitative limits prescribed, even if they are otherwise allowable business expenses.
3. Tripartite Test for “HO Expenditure” (Explanation to Section 44C of the Act): If an expenditure –
   • is incurred outside India,
   • pertains to executive or general administration, and
   • falls within the specific categories enumerated in the Explanation namely: rent, taxes, repairs or insurance of overseas premises; salaries of overseas staff and their travel; or such other matters connected with executive and general administration as may be prescribed:
     
     such expenditure would fall within the ambit of section 44C of the Act. This would not change even if the expenditure was incurred specifically for the operations of the Indian branches of the non-resident.
4. Common vs Exclusive Expenditure is Irrelevant: The SC expressly disapproved Bombay HC’s interpretation that section 44C of the Act applies only to ‘common’ allocable expenses. Further, the SC observed that the phrase ‘attributable to India’ is wide enough to encompass expenses incurred exclusively for India, which would merely constitute a species of expenses that are attributable to India.
5. Tax Treaty Deductions Would be Subject to Domestic Tax Law Limitations: The SC also negated the argument of full deductibility of expenses under Article 7 of the India – US Tax Treaty (Business profits of the PE), observing that the Article itself alludes that deductions remain subject to the limitations prescribed under the Indian domestic tax laws.
6. Determination of ‘HO expenditure’ is a Factual Exercise: The Supreme Court (SC) also observed that the determination of what constitutes ‘head office (HO) expenditure’ is a factual exercise and remanded the taxpayers’ matter back to the Assessing Officer for verification in light of the applicable facts.

A&M’s Key Takeaways

India-specific head office costs are likely to undergo closer scrutiny, warranting a rethink on the mechanism for allocation, recovery and documentation. The following may be considered:

1. Stricter Interpretation of HO Expenses: The Supreme Court’s ruling clarifies that expenses incurred solely by the head office for the branch are not, by that fact alone, excluded from the scope of section 44C of the Act. It also indicates that section 44C applies only to those costs that qualify as ‘HO expenses.’ Therefore, any expenditure other than such ‘HO expenses’, that is incurred by the HO on behalf of the Indian branch should continue to be deductible, provided it is incurred wholly and exclusively for the branch’s ‘business or profession’. The ruling also suggests that what constitutes ‘HO expenses’ must be interpreted strictly.
2. Requirement of P&L Debit and Recovery Debatable: Another interesting aspect arising from the ruling is that, although the Indian Revenue Authorities (IRA) argued that the Indian branches had neither debited the expenses in their books of account nor paid for the expenses under consideration, and that such expenses should therefore not be allowed as a deduction, the ruling does not delve into this aspect. This leaves the issue open for debate.
3. Monitor India-specific HO costs: Costs incurred overseas exclusively for India (e.g., India-focused leadership time, HO staff dedicated to Indian operations, India-only travel or direct support functions) may no longer be automatically deductible merely because they are not ‘shared’ with other jurisdictions. Such costs may be subject to the overall cap of 5%, thereby impacting the profitability of the Indian branch and elevate tax costs, especially for India-heavy HO support models. This may also require a reset of budgeting and profitability forecasts for Indian operations.
4. Expense Taxonomy must be Sharpened, Not Broadened: Expense deductions would require a shift from attribution-based logic towards a sharper statutory characterization. Functional, operational, or direct service-oriented costs that do not squarely qualify as HO expenses may need to be identified early and ring-fenced, supported by robust documentation.
5. Historical Positions Carry Elevated Controversy Risk: Business groups that have historically relied on the principle laid out in the Emirates Commercial Bank ruling (i.e., no cap on exclusive expense) could face a risk of re-opening, adjustments, or sustained litigation pressure. Therefore, a proactive health check of open years to assess the litigation exposure and developing a robust defense strategy may be considered.
6. Alignment Across Tax Functions is Critical: A coordinated and consistent review across all functions (i.e., Direct tax, Transfer Pricing, Finance and Management teams) becomes critical to avoid contradictory narratives.

The ruling provides clarity on the scope of deduction for HO expenses as envisaged under section 44C of the Act and establishes that no distinction exists between ‘common’ and ‘exclusive’ HO expenses. However, the SC does not categorically interpret the term ‘executive and general administrative expenses’ or provide specific examples, thereby, leaving room for varied interpretation and debate on characterization of HO expenditures. For non-resident entities operating in India, this Ruling underscores the importance of accurate classification, robust documentation, and strict governance of HO expenses for tax certainty and mitigating the risk of disallowance or tax disputes.