ABN AMRO BANK (ROYAL BANK OF SCOTLAND) VS TAXATION OFFICER III, AUDIT DIVISION LARGE TAXPAYER UNIT, KARACHI, 2011 PTD-KARACHI-HIGH-COURT-SINDH 438 (2010)

Income Tax Ordinance (XLIX of 2001)---

----Ss. 2(40), 11(6), 101(3) & 105---Pakistan Branch of a non-resident Banking company---Interest/profit on debt on money lent by or to Pakistan Branch to or by Head Office and other branches of such company located outside Pakistan, taxation of---Scope---Doctrine of mutuality would not and could not apply to a situation to which S.105(1)(a) of Income Tax Ordinance, 2001 attracted---Provisions of Ss.101(3) and 105 must be read together and consistently---Pakistan Branch was a permanent establishment in Pakistan of non-resident banking company---Pakistan Branch would be regarded as a distinct and separate person and while dealing with Head Office or other branches of its company located outside Pakistan would be regarded as doing business wholly independently---Business income of a non-resident person attributable directly or indirectly to permanent establishment in Pakistan would be regarded Pakistan-source income---Profit on debt paid to or payable by Pakistan Branch in respect of its dealings with Head Office' and other branches of non-resident banking company would be regarded its income and a deductible expense respectively---Principles.

Sharkey (Inspector of Taxes) v. Wernher (1956) AC 58; CIT v. The Lyallpur Cooperative Bank Ltd. 1959 PTD 639; (1983) 47 Tax 67(sic); (1996) 74 Tax 239(sic); PTCL 1996 St. 1045; National Westminster Bank PLC v. United States (2008) 512 F. 3d 1347 and National Westminster Bank PLC v. United States (1999) 44 Fed. Cl. 120 ref.

Dr. Ikramul Haq for Applicant.

Jawaid Farooqui for Respondents.

ORDER

MUNIB AKHTAR, J.---This Income Tax Reference Application was admitted to regular hearing on 6-3-2009, to consider the following two questions proposed by the applicant, and said to be questions of law arising out of the impugned order dated 20-5-2008:--

(a) Whether Division Bench of I.T.A.T. was correct in law to follow a conflicting decision in another case ignoring its earlier favourable judgments in the case of taxpayer without referring the matter to a larger bench.

(b) Whether the Tribunal was correct to confirm taxation of interest income received from Head Office and branches located outside Pakistan disregarding the principle of mutuality.

2. The income sought to be taxed in the present case arose in the Tax Year, 2003, the first year to which the Income Tax Ordinance, 2001 ("2001 Ordinance") was applicable. The applicant (hereinafter "the Bank") was, at the relevant time, a banking company registered and headquartered in the Netherlands, and had a license to do banking business in Pakistan. It did so through a number of branches in the country (hereinafter collectively referred to as "the Pakistan Branch"), which were assessed and taxed as a non-resident banking company. In other words, the Bank's banking business in Pakistan was not done through a separate legal entity, but through branches owned and operated by the Bank itself. (It may be noted in passing that in or around 2007, the Pakistan Branch was sold to a British banking company, the Royal Bank of Scotland; this does not however, have any bearing on the present proceedings). The Pakistan Branch had inter-branch banking dealings with its head office and other branches of the Bank in other jurisdictions (hereinafter collectively referred to as "the Other Branches"). For present purposes, it suffices to note that such dealings led to the Pakistan Branch having, from time to time over the Tax Year in question, funds lying with or made available to the Other Branches and vice versa. In line with common banking practice, the Pakistan Branch paid interest/profit to the Other Branches in respect of their funds lying with or made available to it, and received interest/profit from the Other Branches in respect of its funds lying with or made available to them. The key question, and this is a question of general importance to foreign banks doing banking business in Pakistan through branches, is whether the interest/profit paid to the Pakistan Branch on its funds lying with or made available to the Other Branches constituted taxable income, and correspondingly, whether the interest/profits paid to the Other Branches on their funds lying with or made available to the Pakistan Branch constituted a deductible expense under the 2001 Ordinance.

3. When the Bank (i.e., the Pakistan Branch) filed its return for the Tax Year, 2003 (which was a deemed assessment order) it did not offer the interest/profits received .by it from the Other Branches as income liable to tax. The amount involved was Rs.80,594,504. (The Pakistan Branch also did not apparently claim any deduction in respect of the interest/profits paid by it to the Other Branches, but this element does not appear to be germane for the tax year in question.) The taxation officer however, amended the assessment by bringing the aforesaid amount to tax. The Bank's appeal to the CIT (Appeals) succeeded, against which the Department preferred an appeal to the Income Tax Appellate Tribunal. The Tribunal, by means of its impugned order dated 20-5-2008, set aside the order of the CIT (Appeals) and restored the assessment order of the taxation officer. The Tribunal held as follows:

"We are of the considered opinion that the respondent operating with seven branches in Pakistan is one taxable entity under the Pakistan Tax Laws and its head office and foreign branches are separate taxable entities under the tax laws of the respective countries where those are located and operating and their income is not taxable in Pakistan. Accordingly, the doctrine of mutuality does not apply between the Pakistan taxable entity and the foreign country taxable entity (ies). Therefore, we are in full agreement with the findings of our learned brothers given in their order dated 16-8-2000 in I.T.A. No. 2623/KB of 1992-93 (Assessment year 1991-02) in the case of Messrs Standard Chartered Bank, Karachi. Accordingly, the Departmental appeal is accepted on the issue under appeal, the learned CIT(A)'s impugned order is vacated and that of the Taxation Officer/ Additional Commissioner is restored."

Being aggrieved by this decision, the Bank has filed the present reference application.

4. Although learned counsel for the applicant assailed the impugned order in several different ways, the essence of his grievance can be stated quite shortly. It is simply this a person cannot trade with or profit from himself, and hence any putative "gains" from such "trade" cannot be brought to tax under income tax law. The Pakistan Branch and the Other Branches constituted but one legal entity (i.e., the Bank). Any interest/profits paid or received as a result of inter-branch dealings were mere book entries of, and within, the same legal entity, and did not therefore generate or constitute income or expense for anyone, including the Pakistan Branch. Learned counsel invoked the doctrine of mutuality to submit that for a receipt to constitute income, the payer and the recipient had to be legally distinct. Where the same legal entity dealt with its own funds, simply (as it were) shifting them from one point (i.e., branch) to another, any amounts shown in the books of the various branches as payable/paid to or receivable/received from each other were (from a tax point of view) only notional and internal to the legal entity (i.e., the Bank). Learned counsel submitted that when the Bank itself was taxed on its global operations (presumably in the Netherlands), the various inter-branch entries/dealings would get netted off, and hence disappear from the final reckoning. Learned counsel referred also to Sharkey (Inspector of Taxes) v. Wernher (1956) AC 58, a decision of the House of Lords, to stress the point that a person could not trade with himself, and that any profits or gains that could be brought to tax had to be actual commercial profits. He submitted that the inter-branch dealings failed the test on both counts, and hence the taxation officer and the Tribunal had both erred in their conclusion that the interest/profit received by the Pakistan Branch from the Other Branches was liable to tax. He also referred to the provisions of the 2001 Ordinance to contend that the amount in question was not income, relying in particular on sections 11(6) and 101(3). He further submitted that section 101(7), which specifies when profit on debt is to be regarded as Pakistan-source income, did not apply in the facts and circumstances of the present case. He also contended that the scope of section 105(1)(a) was limited only to the extent of operations attributable directly or indirectly in Pakistan. All of these provisions are examined in detail herein below.

5. The foregoing submissions were made by learned counsel in relation to the second question, which is of course the main question requiring determination. As regards the first question, he submitted that the Tribunal had itself, in earlier cases involving the applicant and other banking companies similarly placed, held that receipts of the nature now brought to tax did not constitute income. He submitted that if the Bench hearing the case felt impelled to deviate from the earlier decisions, it ought to have asked that a larger Bench be constituted, which could then deal with the matter and resolve any conflict. He submitted that the Department itself had taken a contrary view in earlier years, and contended that this flip-flop was neither justified in law nor conducive to the proper administration of justice. He therefore prayed that both the questions be answered in favour of the applicant and against the Department.

6. Learned counsel appearing for the Department contended that the doctrine of mutuality had no application in the facts and circumstances of the present case. His case was that that doctrine required the existence of a "common fund" for it to be applicable, and submitted that admittedly there was no such fund in the present case. He placed reliance on CIT v. The Lyallpur Cooperative Bank Ltd. 1959 PTD 639. Insofar as the first question was concerned, he submitted that there was nothing in law preventing the Tribunal from reaching the decision that it did in the impugned order, which was in any case the correct and proper conclusion at law. He also noted that many of the earlier Tribunal decisions referred to by learned counsel for the applicant were under reference before the High Court, and submitted that the point involved required an authoritative adjudication and determination which could only come at the level of the Superior Courts. He accordingly prayed that the questions raised be answered against the applicant and in favour of the Department.

7. We have heard learned counsel for the parties, examined the record with their assistance, and considered the case-law relied upon by them. We first take up the second question for consideration since it is the substantive issue, and by far the more important of the two questions raised before us. With the utmost respect to the Tribunal, and the submissions of learned counsel for the applicant, we are of the view that the proper resolution of the question raised does not lie in determining whether or not the doctrine of mutuality is applicable. Whatever may have been the previous state of the law, the question before us has to be addressed in terms of the 2001 Ordinance. As we explain shortly, section 105 of the 2001 Ordinance provides a complete answer to the second question. Section 105 had no equivalent in either the Income Tax Ordinance, 1979 or the Income Tax Act, 1922. Whether or not the doctrine of mutuality was applicable in similar cases that arose under those statutes is not a point that we need to decide here. We are concerned with the Tax Year 2003, the first year to which the 2001 Ordinance was applicable. In our view therefore, the reference to the doctrine of mutuality in the question proposed merely draws attention away from the real issue at hand, and we therefore reframe the second question by deleting the words "disregarding the principle of mutuality" therefrom. (The second question was in any case a complete question even without referring to the doctrine of mutuality.) Having identified the core issue requiring resolution, we turn to consider the relevant provisions of section 105.

8. Subsection (1) of section 105 provides as follows (emphasis supplied):--

105. Taxation of a permanent establishment in Pakistan of a non-resident person.---(1) The following principles shall apply in determining the income of a permanent establishment in Pakistan of a non-resident person chargeable to tax under the head "Income from Business", namely:

(a) The profit of the permanent establishment shall be computed on the basis that it is a distinct and separate person engaged in the same or similar activities under the same or similar conditions and dealing wholly independently with the non-resident person of which it is a permanent establishment;

(b) subject to this Ordinance, there shall be allowed as deductions any expenses incurred for the purposes of the business activities of the permanent establishment including executive and administrative expenses so incurred, whether in Pakistan or elsewhere;

(d)no deduction shall be allowed for amounts paid or payable by the permanent establishment to its head office or to another permanent establishment of the non-resident person (other than towards reimbursement of actual expenses incurred by the non-resident person to third parties) by way of:

(i)royalties, fees or other similar payments for the use of any tangible or intangible asset by the permanent establishment;

(ii)compensation for any services including management services _ performed for the permanent establishment; or

(iii)profit on debt on moneys lent to the permanent establishment, except in connection with a banking business; and

(d) no account shall be taken in the determination of the income of a permanent establishment of amounts charged by the permanent establishment to the head office or to another permanent establishment of the non-resident person (other than towards reimbursement of actual expenses incurred by the permanent establishment to third parties) byway of:

(i)royalties, fees or other similar payments for the use of any tangible or intangible asset;

(ii)compensation for any services including management services performed by he permanent establishment; or

(iii)profit on debt on moneys lent by the permanent establishment, except in connection with a banking business.

Section 105 was enacted with a very specific category in mind. It lays down the principles in accordance with which the income of a permanent establishment in Pakistan of a non-resident person is to computed under the head "Income from Business". It is common ground that the Pakistan Branch is a permanent establishment in Pakistan of a non-resident person. It is also not in dispute that its income is taxable under the head "Income from Business". Hence, the principles specified in section 105(1) are fully attracted to its case, and must therefore be applied when computing its income and the tax payable by it, unless there is anything to the contrary, either expressly or by necessary implication, in any other provision of the 2001 Ordinance.

9. The general rule or principle is laid down in clause (a) of subsection (1). It has three elements. Firstly, the permanent establishment must be regarded as a distinct and separate person. Secondly, it is to be regarded as being engaged in the same or similar activities under the same or similar conditions as the non-resident person. Thirdly, and most crucially, it must be regarded as "dealing wholly independently" with the non-resident person of which it is a permanent establishment. The second element does not require any further consideration. Applied to the present case, the first and the third elements can be restated as follows. The Pakistan Branch must be regarded as a distinct and separate person (the first element), and even when dealing with any other part of the Bank, i.e., the Other Branches, must be regarded as doing so "wholly independently" (the third element). As is obvious, one consequence is that the doctrine of mutuality does not, and cannot, apply to a situation to which section 105(1)(a) is attracted. The reason is simple. It is of the essence of the doctrine and this was indeed a point stressed by learned counsel for the applicant that it applies (insofar as is presently relevant) when one legal entity is "dealing" with itself. This is what is precisely dealt with and negated by clause (a). It is to be noted that the said clause does not merely rest with declaring the permanent establishment to be a 'distinct and separate person. It goes further and expressly spells out the crucial legal consequence that flows from such declaration: even the dealings of the permanent establishment with the non-resident person itself must be regarded as "wholly independent".

10. Clauses (c) and (d) of subsection (1) are also of direct relevance to the present case. Each of these clauses is concerned with certain dealings between the Pakistani permanent establishment and the head office and other permanent establishments of the non-resident person, and clarifies what is not to be taken into account when computing the income of the Pakistani permanent establishment. In other words, each of these clauses excludes certain types of dealings between the Pakistani permanent establishment on the one hand and the head office and other permanent establishments of the non-resident person on the other. Both of the clauses are concerned with the same types of dealings. Clause (c) deals with amounts paid or payable by the Pakistani permanent establishment in respect of such dealings, and clause (d) deals with amounts received or receivable by the Pakistani permanent establishment. The two clauses are thus mirror images, one dealing with outflows from the Pakistani permanent establishment (clause (c)), while the other deals with inflows (clause (d)).

11. One type of dealing which, as a general rule, is excluded by both clauses (c) and (d) is profit on debt. Clause (c) excludes (in its sub-clause (iii)) profit on debt on moneys lent to the Pakistani permanent establishment by the head office or other permanent establishments of the non-resident person, while clause (d) excludes (in its sub-clause (iii)) profit on debt on moneys lent by the Pakistani permanent establishment. Each of these sub-clauses however, expressly contains an exception: "except in connection with a banking business". In other words, if moneys are lent by or to the Pakistani permanent establishment in connection with a banking business the profit on debt on such transactions or dealings does not come within the scope of either clause (c) or clause (d), i.e., such profit on debt is not to be excluded. The dealings, and the profit on debt thereby payable or receivable (as the case may be), fall within the scope of the general rule laid down in clause (a) and must be dealt with in terms thereof, i.e., on the basis of the Pakistani permanent establishment being a "distinct and separate person" which is dealing "wholly independently" with the head office and other permanent establishments of the non-resident person.

12. In our view, the legal position that emerges is clear. If the Pakistani permanent establishment is engaged in banking business (which the Pakistan Branch most certainly is) then in relation to profit on debt on moneys lent by it to, or to it by, the head office or other permanent establishments' (i.e., the Other Branches) it must be regarded as dealing with the latter on the same basis and under the same conditions as it would with any other bank or financial institution (i.e., as a distinct and separate person acting wholly independently). Obviously, any profit on debt earned by the Pakistan Branch on moneys lent by it to other banks or financial institutions would be its income, and any profit on debt paid by it on moneys borrowed by it would be a deductible expense. Section 105(1) mandates that the profit on debt on moneys lent by the Pakistan Branch to the other Branches, or borrowed by it from them, is to be dealt with in precisely the same manner. It follows that in respect of the Tax Year 2003, the sum of Rs. 80,594,504 paid to the Pakistan Branch by the Other Branches was income in the hands of the Pakistan Branch and taxable as such.

13. The other provisions of the 2001 Ordinance referred to by learned counsel for the applicant do not detract from the foregoing analysis and conclusion. Section 11(6) provides as follows: "The income of a non-resident person under a head of income shall be computed by taking into account only amounts that are Pakistan- source income". This merely lays down a general rule, but does not (e.g.) specify or limit what Pakistan-source income means. Section 2(40) defines "Pakistan-source income" as having the meaning ascribed to it by section 101. Subsection (3) of the latter section provides in material part as follows:

"Business income of a non-resident person shall be Pakistan-source income to the extent to which it is directly or indirectly attributable to---

(a) a permanent establishment of the non-resident person in Pakistan; .... "

It is to be noted that the foregoing provision lays down a general principle: if any business income of a non-resident person is attributable, directly or indirectly, to the permanent establishment, it will be Pakistan-source income. Section 105 and section 101(3) obviously have to be read together and consistently. Section 101(3) specifies what is to be Pakistan-source business income of a permanent establishment of a non-resident person. Section 105 specifies how that income is to be determined. As explained above, in the case of a banking business, profit on debt paid to or payable by (as the case may be) a permanent establishment in respect of its dealings with the head office or other permanent establishment of the non-resident person is to be regarded as its income or expense respectively in light of the general rule laid down in clause (a) of section 105(1). It is difficult to see how section 101(3) can or should be read as excluding such amounts, especially when they are expressly dealt with, and provided for, in clauses (c) and (d) of section 105(1). Section 101(7), to which reference was also made, is equally inapplicable. That subsection merely specifies when profit on debt shall be Pakistan-source income, and provides (in clause (b)), that when such profit is "borne" by a permanent establishment of a non-resident person, it shall be Pakistan-source income. But obviously, it would be the Pakistan- source income of the recipient of the profit on debt, whoever that may be resident or non-resident, and not the income of the permanent establishment. This does not have any bearing on the question of when and how any profit on debt paid/payable to a permanent establishment in Pakistan of a nonresident person is to be regarded as income of the said establishment. That is a distinct and separate question, which in the present case is answered by section 105 as explained above.

14. The matter in issue can also be looked at from another angle. As noted above, the applicant was, at the relevant time, a Dutch based bank. Now Pakistan and the Netherlands entered into a double taxation treaty on or about 4-10-1982, which was duly notified on or about 12-12-1982 ("the Treaty"). This was supplemented some years later by a protocol, which was duly notified on or about 29-5-1996 ("the Protocol"). (The Treaty is reproduced at (1983) 47 Tax 67(sic), while the Protocol can be found at (1996) 74 Tax 239(sic); PTCL 1996 St 1045.) An examination of the relevant provisions of Article 7 of the Treaty (which deals with business profits) and Article II of the Protocol (which applies to Article 7 of the Treaty) is instructive. For convenience, we reproduce below the foregoing provisions in tabular form along with the relevant provisions of section 105(1):

15. The similarity between in the Treaty/Protocol and section 105 is obvious and striking. There is, our view, a specific reason for this. Both share the same textual background, which now needs to be briefly explained. The Organization for Economic Cooperation and Development (OECD) has, since 1963, developed a model double taxation treaty or convention ("the OECD Convention"), which has been regularly updated and suitably redrafted since its first publication. Along with the OECD Convention, the OECD also publishes (and regularly updates) a commentary ("the OECD Commentary") which is regarded as an authoritative guide to the former. Since 1980, the United Nations has also published a model double taxation treaty ("the UN Convention"), which is designed specifically with developing countries in mind. The UN Convention is based largely on the OECD Convention. Article 7 of each model treaty deals with business profits. When these Articles (and especially- that of the UN Convention) are examined, it at once becomes clear that the Treaty/Protocol and section 105 are based on the same. In both model treaties, permanent establishments, and interest (i.e., profit on debt) on moneys lent by a permanent establishment to its head office or other permanent establishments is dealt with in substantially the same manner as in the Treaty/Protocol and section 105, namely that in the case of a banking business, the interest, if paid to the permanent establishment may be treated as its income, and if payable by the permanent establishment, may be its deductible expense. Now the United Nations has also published a commentary on the UN Convention, which relies heavily on the OECD Commentary (the UN commentary is available at: http://unpan 1.un.org/intradoc/groups/public/documents/un/unapan002084.pdf). At page 119 of the UN commentary, the relevant portion from the OECD Commentary is reproduced, which explains why interest payable by or to the permanent establishment of a banking company is to be treated in this manner:

"It is, however, recognized that special considerations apply to payments of interest. made by different parts of a financial enterprise (e.g., a bank) to each other on advances etc. (as distinct from capital allotted to them), in view of the fact that making and receiving advances is closely related to the ordinary business of such enterprises..." (emphasis supplied\

This then, is the internationally recognized rationale behind the provisions of subsection (1) of section 105 (we say nothing regarding the qualification with respect to allocation of capital, since that issue does not arise in the present case). The same rationale is also the basis of the double taxation treaty entered into by Pakistan in the present case, i.e., the Treaty read with the Protocol.

16. Also instructive and relevant in the present context is a recent decision of the US Court of Appeals for the Federal Circuit, reported as National Westminster Bank, PLC v. United States (2008) 512 F. 3d 1347. This was an appeal by the United States against a decision of the US Court of Federal Claims, reported as National Westminster Bank PLC v. United States (1999) 44 Fed. Cl. 120 (Actually three orders were under appeal, but we are concerned with only the first decision.) The decision is available at the official website of the Court of Federal Claims: http://www.uscfc. uscourts.gov/sites/default/files/NationalWestmi.pd. The decision of the Court of Appeals is also available at the official website of that Court: http://www.uscfc.uscourts.gov/imageslstories/opinions-orders/07-5028.pdf. In issue was the proper interpretation and application of the US-UK double taxation treaty of 1975 ("the US-UK Treaty"). This was based and modeled on the OECD Convention. Article 7 of this treaty provided in its second paragraph as under:

"Subject to the provisions of paragraph (3), where an enterprise carries on business in the other Contracting State through a permanent establishment situated therein, there shall in each Contracting State be attributed to that permanent establishment the profits which it might be expected to make if it were a distinct and separate enterprise engaged in the same or similar activities under the same or similar conditions and dealing wholly independently with the enterprise of which it is a permanent establishment."

As is clear, paragraph (2) of Article 7 was in pari materia section 105(1)(a) and Article 7 of the (Pakistan-Netherlands) Treaty. This is of course, not surprising at all, for reasons already explained. The material facts of the case were stated as follows by the Court of Appeals (internal citations and references omitted; the bank is referred to as "NatWest"):

"NatWest is a United Kingdom corporation engaged in international banking activities. For the tax years 1981-1987, NatWest conducted wholesale banking operations in the United States through six permanently established branch locations (collectively "the U.S. Branch"). On its United States federal income tax returns for the years at issue, NatWest claimed deductions for accrued interest expenses as recorded on the books of the U.S. Branch. On audit, the Internal Revenue Service ("IRS") recomputed the interest expense deduction according to the formula set forth in Treasury Regulation 1.882-5. The formula excludes consideration of inter-branch transactions for the determination of assets, liabilities, and interest expenses.... The formula also imputes or estimates the amount of capital held by the U.S. Branch based on either a fixed ratio or the ratio of NatWest's average total worldwide liabilities to average total worldwide assets.... Pursuant to the IRS's recalculation of the interest expense deduction, NatWest's taxable income was increased by approximately $155 million for the years at issue."

Thus two points were in issue. One issue related to capital requirements, and is not presently relevant. The other is directly relevant, and the factual situation there was the converse of the one raised in these proceedings. Like the Bank in Pakistan, the National Westminster Bank, a British banking company, operated in the United States through directly owned branches (the US Branch). The latter held funds from the head office, on which it paid interest to the latter. The US Branch claimed the interest paid as an expense, but this was disallowed by the IRS on the basis of the relevant regulation. That regulation allowed interest payments in respect of inter-branch transactions to be claimed as an expense, but only in a limited manner and not in full. National Westminster Bank paid the additional tax demanded from it under protest, and then sued for its recovery in the Court of Federal Claims. It relied on Article 7 of the US-UK Treaty and contended that under US law, the treaty prevailed over the conflicting provisions of the IRS regulation. On this basis, it claimed that it was entitled to expense the entire amount of the interest paid to the head office and other branches.

17. The Court of Federal Claims examined Article 7 of the US-UK Treaty in detail, and came to the following conclusion:

"The face of Article 7, then, would appear to provide in the context of this case that, to determine taxable income of the U.S. Branch, the U.S. Branch is to be regarded as an independent, separate entity dealing at arm's length with other units of NatWest as if they were wholly unrelated, except that the U.S. Branch may deduct, in addition to its "own" expenses, a reasonable allocation of home office expense. Words such as "distinct" and "separate" and the phrase "dealing wholly independently" would appear to permit no other interpretation." (emphasis on "wholly" in original; rest of emphasis supplied)

The court also referred to the OECD Convention, and expressly noted that the US-UK Treaty was based on the former. The court also recognized the importance of the OECD Commentary, and after quoting at length from the latter, and referring to other relevant material, observed as follows:

"The foregoing examination of Article 7 of the Treaty, preratification reports of the Treasury Department and the Senate, and Commentaries intended to assist in interpretation leads to the conclusion that the Treaty contemplates that a foreign banking corporation in the position of plaintiff will be subjected to U.S. taxation only on the profits of its U.S. branch and that such profits should be based on the books of account of such branch maintained as if the branch were a distinct and separate enterprise dealing wholly independently with the remainder of the foreign corporation, provided that the financial records of the branch, especially those reflecting intra-corporate lending transactions, are subject to adjustment as may be necessary for imputation of adequate capital to the branch and to insure use of market rates in computing interest expense. In addition to normal deductible expenses reflected on the books of the branch, as adjusted there shall be allowed in the determination of the profits of the U.S. Branch a, reasonable allocation of general and administrative expenses incurred for the purposes of the foreign enterprise as a whole."

Finally, the court considered the IRS regulation in issue, and concluded as follows:--

"We find that rather than treating the U.S. branch of foreign enterprises as separate entities, the regulation plainly treats each U.S. branch as a unit of a worldwide enterprise and, thus, is inconsistent with the "separate entity" provision of Article 7(2) of the Treaty....

... Article 7, paragraphs 2 and 3, especially when interpreted in light of the Commentary pertaining thereto, clearly contemplate that interest expense with respect to the permanent establishment of a bank shall be allocated as any other significant deductible expense, particularly for a bank whose very business is the borrowing and lending of money. We believe it is clear that this allocation should be as shown on the books of account of the permanent establishment, with necessary adjustments, as if the permanent establishment were "a distinct and separate enterprise...dealing wholly independently with" the foreign enterprise."

18. As noted above, the United States appealed to the Court of Appeals against this decision. The appeal failed on all points. The Court of Appeals observed:

"We agree with the trial court's analysis of the plain language of the 1975 Treaty. On a fundamental level, we do not read the separate enterprise language of Article 7 para.2-requiring that the U.S. Branch's business profits be determined as "if it were a distinct and separate enterprise engaged in the same or similar activities under the same or similar conditions and dealing wholly independently with the enterprise of which it is a permanent establishment"-as permitting transactions between the permanent establishment and the enterprise to be disregarded....

In sum, we find that the plain language of the 1975 Treaty-the separate enterprise principle-mandates that expenses incurred for the benefit of the U.S. Branch be deductible, including interest expenses paid to foreign branches of NatWest." (emphasis supplied)

19. It will be seen that the observations and findings of both the Court of Federal Claims and the Court of Appeals accord fully with our analysis of section 105 and the Treaty/Protocol. As noted above, this is not surprising given that the antecedents of section 105, and the double taxation treaties between Pakistan and the Netherlands on the one hand, and the United States and the United Kingdom on the other, are essentially the same. The reasoning and analysis of the US Courts thus provide additional material that supports the view that in the present case, the interest/profit on debt paid/payable to the Pakistan Branch by the Other Branches was rightly brought to tax by the Department. Accordingly, we answer the second question in the affirmative, against the Applicant and in favour of the Department.

20. We turn now to the first question. This can be disposed of swiftly. We note that learned counsel for the applicant (quite correctly in our view) did not strongly press this question, but instead focused his attention on the second question. In our view, even if it would have been more proper for the Bench dealing with the appeal to have asked that a larger Bench be constituted, the failure to do so in the present case did not amount to any substantial failure of justice. As noted by learned counsel for the Department, although it may be that the view taken by the Tribunal in its earlier decisions was somewhat different, those decisions relate to different banking companies over different years. It is not at all clear whether the same provisions or facts were involved in those appeals, and in any case, it seems that some of those matters have also been referred to the High Court. In any case, the present matter has to be decided under the 2001 Ordinance, which has established a new and different statutory regime. Properly speaking, there was therefore no conflict of the nature claimed by learned counsel for the applicant. Furthermore, both learned counsel agreed that there was no authoritative pronouncement of a High Court or the Supreme Court in respect of substantive matter in issue (i.e., the second question) and for that reason alone, it was necessary for the present application to be considered and decided on its merits. We are of the view that no occasion arises in the facts and circumstances of the present case to answer the first question, which is essentially of an academic nature, and we therefore refuse to do so.

21. Accordingly, in light of the foregoing, we do not answer the first question, and answer the second question in the affirmative, in favour of the Department and against the applicant. This reference application stands disposed off in the above terms. A copy of this decision may be sent under the seal of this Court and the signature of the Registrar to the Tribunal, as required by section 133(5) of the 2001 Ordinance.

S.A.K./A-130/KOrder accordingly.