India tax: ITAT rules on deduction of salaries paid by foreign company

The Indian Income Tax Appellate Tribunal (ITAT) issued a decision on 6 March 2009 allowing a deduction for salaries paid by a foreign company to its expatriate employees working in an Indian branch office.

A T Kearney Ltd., UK (assessee), a company engaged in the business of providing management consulting services, carried on its business operations in India through a branch office. A T Kearney Ltd. seconded highly experienced personnel to train and develop local expertise to provide services to Indian clients in line with the assessee's global standards. The expatriate employees continued to draw their salaries from the overseas office. In computing the total income of the branch office (which was treated as a permanent establishment (PE)), the assessee claimed a deduction for the salaries paid to the expatriates by the overseas office. However, the Indian Assessing Officer disallowed the deduction for salaries on the grounds that the salaries were paid by the overseas company for its own benefit to have a global presence and, therefore, the expenses could not be considered to have been incurred by the Indian branch office. When the Commissioner of Income Tax (Appeals) overturned the disallowance of the salary deduction, the Indian authorities appealed to the ITAT.

The ITAT upheld the decision of the Commissioner, concluding that the salaries of the expatriate employees and expenses incurred for promoting and operating the business in India are attributable to the branch operations in India and, therefore, should be allowed as a deduction. Further, because the year at issue was the assessee's first year of doing business in India, it incurred significant expenses for business development/marketing, etc., and it offered considerable discounts to improve its relationship with clients, all of which contributed to heavy losses of the assessee. The business development and marketing costs were incurred to gain market share and contact clients, which are integral to the earning of income.

The ITAT reiterates in its decision that legitimate expenses incurred by a foreign company specifically and exclusively for an Indian PE will be allowed as deductible expenditure in computing the total income of that PE.