TMI Blog2014 (10) TMI 702X X X X Extracts X X X X X X X X Extracts X X X X ..... ded does not have much of an impact on its analysis of FAR - The cost of goods sold would be relevant if and only if the assessee would have assumed any significant risks associated with such goods sold and when monetary impact of such risks is not reflected in operating expenses of the assessee - GAP International Sourcing India Pvt Ltd Vs ACIT [2012 (9) TMI 766 - ITAT DELHI] - a business entity does not assume any significant inventory risk or perform any functions on the goods traded or add any value to the same, by use of unique intangibles or otherwise, the right profit level indicator should be operating profit to operating expenses i.e. berry ratio. There is neither anything inappropriate in the use as such of berry ratio per se, nor there are any real issues with respect to accounting policies of the assessee vis-à-vis accounting policies of the comparables finally selected – there is nothing wrong in principle in use of berry ratio in the case of an assessee, though, in the absence of any specific comparables before us, it is not possible to visualize and deal with the difficulties with regard to variations in, and impact of, accounting policies in such cases - the use ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ndation of disallowances ceases to hold good in law - The disallowances of payments to MC Metal Services Asia (Thailand), Metal One Corporation (Japan) and to Metal One (Asia) Pte Ltd Singapore is to be deleted. Payment made to foreign entities – TDS not deducted – Held that:- There is no failure on the part of the assessee in deducting tax at source u/s 195 and there is no cause of action for disallowance u/s 40(a)(ia) - the AO is directed to delete the disallowance u/s 40(a)(ia) in respect of payment to Mitsubishi Corporation Singapore, MC Tubular Inc USA, Thai MC Co Ltd, Thailand, and Peto Diamond Corporation, Japan. Payment made without deducting TDS – PE in India – Held that:- As decided in Daimlerchrysler India (P) Limited. Versus Deputy Commissioner Of Income-Tax [2009 (1) TMI 339 - ITAT PUNE-B] – so far as payments made to Japanese non-residents is concerned, there cannot be any discrimination so far as deductibility of the payments in the hands of the person making the payment is concerned - If appropriate tax withholding by the person making the payment is a sine qua non for business deduction so far as payments to non-residents are concerned, unless there is a simi ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... rected against the order dated 14th October 2011 passed by the Deputy Commissioner of Income Tax, Circle 6(1), New Delhi ( hereinafter referred to as 'the Assessing Officer') under section 143 (3), read with section 144(C), of the Income Tax Act, 1961 (hereinafter referred to as 'the Act'), for the assessment year 2007-08. Core issues in this appeal which require our adjudication 2. Although the assessee has raised as many as fourteen grounds of appeal, there are only two issues which really require to be adjudicated upon by us, i.e.,: (a) whether or not the arm's length price adjustment of ₹ 68,15,17,853 under section 92C, is justified on the facts and in the circumstances of the case - referred to in grounds of appeal nos. 1 to 4, and subsidiary grounds of appeal set out in these main grounds of appeal; and (b) whether or not the disallowance of ₹ 102,17,16,483 under section 40(a)(i) is justified on the facts and in the circumstances of the case referred to in grounds of appeal nos. 5 to 11, and subsidiary grounds of appeal set out in these main grounds of appeal. We will take up these issues in the same sequence. Issue 1: Correctness of ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 3 5. Business Promotion 1,14,750 6. Communication Expenses 1,00,17,241 7. Membership and subscription 6,99,453 8. Reimbursement of expenses 2,67,78,928 The proceedings at the assessment stage: 4. The Transfer Pricing Officer further noted that the assessee has used TNMM (Transactional Net Margin Method) as the most appropriate method, and that the PLI (profit level indicator) selected is 'Berry Ratio' which, as stated in the transfer pricing study, benchmarks gross profit and/or net revenues (after subtraction of any potential cost of sales) against operating expenses. The assessee's claim was that since MCI's three year's average berry ratio is 1.19, whereas in the case of 22 comparables set out in the report, using three year data, the average berry ratio is 1.14 and adjusted average berry ratio is 1.13, the international transactions entered into by the assessee are at arm's length price. 5. The approach so adopted by t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ination activities in relation to the international transactions and that if FAR (functions, assets and risks) analysis of the assessee was to be analyzed , it will be akin to that of a service provider rather than that of a trader, did not find favour with the TPO. 7. As the Transfer Pricing Officer rightly noted, the main issue in this case is adjudication on the question whether (the assessee).. is being adequately compensated for the functions performed by the assessee. The TPO then proceeded to analyze functions of the assets, risks assumed by the assessee and assets employed by the assessee. He noted that, as set out in paragraph 3.4 of the transfer pricing study, the assessee has provided the services for (a) facilitating communication between buyer and seller; (b) arranging freight, insurance and custom clearance through third parties; (c) collecting market information; (d) identifying potential customers (in import transactions only) or suppliers (in export transactions only); and (e) advising an associated enterprise or third party in regulatory or financial matters. It was also noted that, as stated in the transfer pricing study, the presence of assessee in India ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... developed several unique intangibles which have given advantage to the AE in form of lower cost of the product, quality of the product and enhanced profitability of the AE but adequate compensation for these unique intangibles is not reflected in the compensation to the assessee. In other words, according to the TPO, these intangibles have increased profit potential of the AEs and the same should be reflected in increased margins to the assessee. These unique intangibles were stated to be (a) supply chain intangibles, and (b) human assets intangibles. As for the supply chain intangibles, it was noted that the MCJ is one of Japan's leading sogo shoshas or general trading companies which deals in products ranging from bulk commodities such as grain and oil, to specialized equipment. It was noted that functions of the assessee included, apparently in the case of sourcing the goods, (1) identification of contacted manufacturer, (2) qualifying the contract manufacturer, (3) identifying appropriate source of goods, (4) warehousing the goods, (5) control over contracted manufacturer and quality control over manufacturing process, (6) scheduling of the product and order tracing, ( ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... s follows: 5.3 I have carefully examined the compensation model in this case, and have noted that the assessee was allowed a very nominal markup (which does not include cost of development and use of intangibles) without allocating any profit component for development and use of unique intangibles by the assessee which has resulted in huge commercial and strategic advantage to the AE in the form of low cost of goods, high profit margin and assured timely supply of quality goods i.e. these intangibles have enhanced the profit potential of the AE, without any corresponding markup to the assessee. In the light of these facts, I am of view that cost plus model used by the AE is not the most appropriate method because it does not capture the compensation for the development and use of intangibles by the assessee. These facts lead to the irresistible conclusion that the remuneration model used in this case does not provide compensation to the assessee at the arm's length price as the model does not include compensation form development and use of intangibles. 10. It was also noted that as a result of transfer of manufacturing and procurement activities from high cost economies ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... be adjusted to the value of international transitions for the FY 2006-07. The assessing officer shall enhance the income of the assessee by ₹ 68,15,17,853. The Assessing Officer may examine issue of initiation of penalty u/s 271(1)(c) of the Act in accordance with Explanation 7 of the same. No adverse inference is drawn in respect of other transactions undertaken by the assessee during FY 2006-07. The assessee was given adequate opportunity including oral hearing as per details at Col.7 at Page 1 of this order 12. Aggrieved with the ALP adjustment of ₹ 68,15,17,853 consequently proposed by the Assessing Officer, on the basis of the TPO's order, assessee carried the grievance before the Dispute Resolution Panel but without any success. Accordingly, the Assessing Officer framed the assessment by making addition in respect of, inter alia, this ALP adjustment. The assessee is not satisfied and is in appeal before us. 13. We have heard the rival contentions on this transfer pricing dispute, perused the material on record in respect of the same and duly considered factual matrix of the case as also the applicable legal position. Shri M. S. Syali, Senior Advocate, ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... th these observations this ground is allowed for statistical purposes. The position in the immediately preceding assessment year- esteemed views of Hon'ble High Court: 5. The views so expressed by the coordinate bench were challenged by the assessee before Hon'ble Delhi High Court, and upholding the stand so taken by the coordinate bench- though with a clarification, Hon'ble Delhi High Court, vide judgment dated 4th July 2014 [now reported as 48 taxmann.com 45 (Del)], has observed as follows: 7. The international transactions reported by the appellant are of four kinds; services, commission, cost to cost reimbursement as well as from sale of products imported from the Associated Enterprise. While, there is no dispute as to the international transactions resulting in receipts as commission and cost to cost reimbursement for rendering service, the assessee seriously contests the addition made on account of transactions of sale and purchase of goods. The assessee is aggrieved by the margin of 19.6% being applied with respect to transactions of sale and purchase. 8. It was submitted by the learned counsel that its functional profile was not that of a trader but ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... o principal basis. We find no infirmity with the reasoning of the ITAT that such transactions are akin to trading and cannot be considered activities of a commission agent or a broker. However, the learned counsel for the assessee has expressed his apprehension that in view of the findings of the ITAT, the assessee is likely to be treated as an ordinary trader and compared with other traders who may not be similarly situated. We do not find any ground for such apprehension as the ITAT has made it clear that appropriate comparables would have to be considered for determination of the ALP. This would obviously mean that entities which are similarly placed as the assessee including in respect of their functional and risk profile as well as working capital exposure would be chosen as comparables. 12. We accordingly find no reason to interfere with the order of the Tribunal. The appeal is accordingly dismissed with the above clarification. (Emphasis by underlining supplied by us) Rival contentions: 16. Learned counsel points out that so far as assessment year 2006-07, in respect of which the above decisions were rendered, the dispute was confined to the trading transactions. ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... invited to the fact that the authorities below have duly accepted the uniqueness of business model of the assessee group and made elaborate observations to the effect that it is a low risk and high volume business model. When this is the admitted position, and it is also not in dispute that it is a case of back to back trading with no inventory risks involved, according to the learned counsel, there cannot be any justification for including the cost of inventories in PLI computation. It is submitted that the PLI adopted by the assessee, i.e. berry ratio, takes care of this critical aspect. It is pointed out that, for all these reasons, berry ratio is the most appropriate PLI in the present case particularly as, beyond any doubt or controversy, assessee does not carry any inventory risk and its actual financial risk is confined to the operating costs minus inventory costs, i.e. operating expenses. Learned counsel relies upon the literature filed by the assessee, in support of the relevance and utility of berry ratio on the facts of this case, and contends that its usage is most appropriate to the facts and circumstances of this case. In the kind of peculiar activity that the assesse ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... that the costs borne by the AEs with respect to the sales are to be excluded from the cost base of the assessee. It is the submitted that the TPO has made some factually inaccurate comments, based on pure surmises and conjectures, with respect to alleged ownership of supply chain management intangibles and human assets intangibles. It is submitted that these intangibles are figments of his imagination of the TPO and the onus is on the revenue authorities to show, based on material on record, that these intangibles exist. It is submitted that the assessee was not even put to notice, in the proceedings before the TPO, in respect of these inferences. It is further submitted that there is no basis for TPO's coming to the conclusion that profit on account of location savings ought to have been taxed in India and that the compensation model of the appellant did not include profit attributable to the assessee due to locational savings. It is further contended that despite the assessee having raised grievances against these findings before the Dispute Redressal Panel, the DRP has not at all adjudicated on these grievances. This issue is also now, according to the learned counsel, cover ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the nature of business activity remains the same. As regards the use of intangibles, learned Departmental Representative relied upon the observations made by the TPO and justified the same. It was thus submitted that delivery supply chain management and human assets are important intangibles and the assessee's compensation model, which clearly does not take account adequate compensation for developing these intangibles, cannot be accepted as an arm's length price for the services rendered by the assessee. Learned Departmental Representative contends that all these issues, as being raised by the assessee now, are indeed open issues which can be agitated before the TPO and that there is no need for any further directions beyond the directions given by the coordinate bench in the immediately preceding assessment year. We are thus urged to follow the orders of the coordinate bench, in letter and in spirit, and to remit the matter to the file of the TPO for adjudication de novo in the light of the observations made in the said order. 19. Learned counsel for the assessee, in his rejoinder, submitted that the subject matter of adjudication before us travels much beyond what was ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ittle different vis- -vis the facts of the immediately preceding assessment year which were before the coordinate bench. The nature of assessee's trading activity: 21. We have also noticed that even with respect to the trading transactions, which were claimed by the assessee to be in the nature of a service rather than a trading activity, Hon'ble Court has taken note of assessee's apprehension that the assessee may be treated as an ordinary trader and compared with other traders who may not be similarly situated and clarified that the assessee will only be compared with such entities which are similarly placed as the assessee including in respect of their functional and risk profile as well as working capital exposure would be chosen as comparables . 22. The Transfer Pricing Officer himself has, at page 2 of the order, set out the profile of the MCJ, the holding company, and MCI, the assessee before us, as follows: 2.2 Profile of the Group Mitsubishi Corporation ( MC ) is one of the Japan's leading sogo shoshas or general trading companies. These companies are unique in the world of commerce and play an important role in linking buyers and sellers ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ghtly noted, sogo shosha is a unique business model in the world of commerce. As a corollary to this observation, it is an admitted position that a sogo shosha cannot be equated with a general trading company in all material respects. Sogo shosha has been described as follows at www.referenceforbusiness.com : A sogo shosha is a form of industrial organization and a kind of vertically integrated trading company that originated in Japan and for the most part has remained unique to Japan. At the center of these organizations is a trading company that arranges financing, coordinates activities, and handles marketing functions for the companies in its group of companies. These subordinate companies may be considered operating companies, because they specialize in certain types of business. Since World War II, Japan has emerged as one of the dominant world traders in part because of the sogo shosha. While the term sogo shosha is Japanese for general trading company, the term generally refers to the entire group of operating companies that comprise the conglomerate or sogo shosha. Unlike typical Western trading companies and Japan's some 9,000 other trading companies, the sogo ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... where have become convinced that there should be. ** ** ** These huge Japanese companies (names are set out, including that of the assessee's parent company) ..share pattern of business strategy, operations and organization that are very different from those of other types of business firms. Defining their business is an elusive goal, for their activities donot fit into any of the conventional categories. They could be called commodity traders, wholesalers, bankers and manufacturers, miners, venture capitalists and many other labels but none of these conveys a true picture of the substance of their activities. 26. There could indeed be somewhat varying perceptions on the precise connotations of 'sogo sosha' as a business model, and, as Prof Yoshino, in his above mentioned book, states at page 3, Even in Japan, the sogo shosha is indeed regarded as a mysterious entity, difficult to know about or understand but universally acknowledged as a powerful force in the economy , but one common thread in all descriptions of 'sogo shosha', whatever be the source, is sheer complexity of its business model, range of its activities and int ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... a lower tolerance range at one third the level of normal tolerance range. Of course, this notification is in the context of tolerance range, prescribing lesser tolerance range for the whole traders implying that the margin of profits for wholesalers must move in a lower range which can only happen when margins are also lower vis- -vis margins in wholesale trading, but this also indicates that lower inventory levels lead to lower inventory risks and generally resultant lower profit levels also. There is thus a direct relationship between the normal inventory levels and the normal profitability. 29. It is beyond dispute and controversy that the comparables carrying on the trading activity similar to assessee group's trading activity are difficult to find. Here is a case in which true comparables are difficult, or almost impossible, to find and, therefore, a way is to be found to find such comparison meaningful by adopting a profit level indicator which ignores the impact of vital dissimilarities in inventory levels between the assessee and the comparables. We will deal with this aspect of the matter a little later. Impact of Hon'ble High Court's directions on compar ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... in the nature of trading or in the nature of commission agent. If trading activity and commission agent activity are two ends of a broad spectrum of activities dealing in goods and commodities, and these ends are plotted by mark X and mark Y, sogo shosha activity, is somewhere between these two extremes and between the point X and point Y. The location of this point, as implicit in coordinate's bench observation that sogo shosha is akin to trading and it cannot be bracketed with commission agent or broker, is closer to point X. There can be no dispute with this proposition at this stage; that is an uncontroverted finding of fact. This can be shown in the following way: Mid point Between X and Y X | Y (If X is trading and Y is commission agency, as held by the Tribunal in immediately preceding assessment year, Sogo shosha is in the shaded area above- somewhere between X and Y but before the midpoint, i.e. closer to X rather than with Y) 33. Yet, clearly, there is still a difference between normal trading and sogo shosha trading, and one vital aspect of this difference is that in the present sogo shosha trading there are no inventories at all. Any comparison exerc ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ing principles primarily contribute the financial information inputs and mechanism for financial analysis, economic principles lay down the foundational principles on the basis of which such inputs and mechanism are to be used in transfer pricing analysis. The very fundamental economic concept, which is foundation for the arm's length price determination, is that all business entities, irrespective of their inter se relationship, should make profit from a transaction and such a profit should be commensurate with functions performed, risks assumed and assets utilized . This exercise, by definition, cannot exalt the accounting entries to a status that these accounting entries, dehors the FAR analysis, determine the arm's length price. Whatever be the call of accounting and legal principles, once we come to the conclusion that cost of inventories is not a material factor so far as FAR analysis is concerned, it is wholly justified to exclude the cost of inventories in formulae adopted for the ALP determination. 39. That exclusion, however, proceeds on the assumption that there is a vital nexus between inventory levels and profitability. Economic nexus between inventory l ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... appropriate, the method employed in determining ALP has to be used with certain modification which take it within definition of Transaction Net Margin Method but has berry ratio as the PLI. In plain words, thus, the mechanism suggested to eliminate the impact of uniqueness of assessee's business model is use of berry ratio as a PLI in TNMM analysis. Berry ratio: connotations and its background 44. Simply put, berry ratio is ratio of gross profit to the operating expenses. 45. Unlike in Indian TP regulation, wherein no specific ratios are prescribed, US Regulation 482-5(b)(ii)(4)(B) accepts this PLI as one of the financial ratios that may be appropriate to measure the arm's length price, even though it puts a rider that, reliability under this profit level indicator also depends on the extent to which the composition of tested party's operating expenses is similar to that of the uncontrolled comparables . So far as Indian TP provisions are concerned, the PLIs set out in rule 10B(1)(e)(i) are only illustrative inasmuch as it ends with the expression or having regard to any other relevant base but there is no prohibition as such on the use of this ratio. How ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ities where a taxpayer purchases goods from an associated enterprise and on-sells them to other associated enterprises. In such cases, the resale price method may not be applicable given the absence of uncontrolled sales, and a cost plus method that would provide for a mark-up on the cost of goods sold might not be applicable either where the cost of goods sold consists in controlled purchases. By contrast, operating expenses in the case of an intermediary may be reasonably independent from transfer pricing formulation, unless they are materially affected by controlled transaction costs such as head office charges, rental fees or royalties paid to an associated enterprise, so that, depending on the facts and circumstances of the case, a Berry ratio may be an appropriate indicator, subject to the comments above. (Emphasis by underlining supplied by us) 47. As evident from the underlined portion of the OECD approach, highlighted above, berry ratio can be particularly useful in the situations in which the entity is engaged in the business as a trade intermediary, the value of services performed by the entity is adequately reflected by operating expenses, the value of functions p ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ts incurred on rendering this service rather than in the value of goods traded. That was a case in which the assessee was simply involved in distributorship function without much risks, though certainly much more risks than in a back to back trading, associated with inventories or with uncertainties of normal trading. The key contribution to the economic activity was recognized as performing the distributorship function rather than the value of goods sold. Accordingly, distributors must achieve a particular gross profit in order to compensate them for their services, the costs of which are accounted for, almost entirely, in their operating expenses. To reflect the reality of distributors' economic significance and to provide an arm's length return to DuPont's Swiss subsidiary, Berry utilized a ratio that has since been named in his honor and is computed as gross profit to operating expenses. There are some variants to this ration but that aspect of the matter is not really relevant for the present purposes. 51. The underlying assumption for applicability of berry ratio is that the return to the tested party should be commensurate with his operating expenses and the v ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... eturn commensurate to the distribution services performed, measured as a percentage of the value-adding (operating) expenses incurred by them. The value of the products being distributed, in other words, is irrelevant. Distributors must achieve a particular gross profit in order to compensate them for their value-adding services, the costs of which are accounted for in their value-adding (operating) expenses. An excerpt from the article by Dr. Berry on this aspect reads as under:- Similarly, the cost of goods sold is excluded from the cost base because the measure indicates the value of the merchandise distributed, not the service rendered by the firm that distributes the merchandise. It was for exactly the same reason that I excluded in the case of advertising agencies, the cost of advertisement placement. The placement cost is a measure of the activities of the media carrying the advertising agency in planning and designing that advertising. If we use a cost plus method, and the Berry ratio is a cost plus method, we want a measure of the costs of the firm involved, i.e. the distributor or advertising agency in these examples, not something that measures only the value of the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... , this relationship could be as follows: 57. In our considered view, to sum up, in a situation in which a business entity does not assume any significant inventory risk or perform any functions on the goods traded or add any value to the same, by use of unique intangibles or otherwise, the right profit level indicator should be operating profit to operating expenses i.e. berry ratio. In such a situation, no other costs are relevant since (a) the cost of goods sold, in effect, is loses its practical significance, (ii) there is no value addition, and, accordingly, there are processing costs involved, and (iii) there is no unique intangible for which the business entity is to be compensated. 58. In typical cases of pure international trading, there is neither any processing of goods involved nor is there use of any significant trade or marketing intangibles. The inventory levels are also extremely low, at least with respect to the goods traded, since the nature of activity does not require maintenance of inventories and there is sufficient lead time between order being received and the actual procurement activity. There are no other factors, in addition to the operating cos ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... in such a situation, computation of return on the value of goods will not lead to an exorbitant return on the operating expenses or value added expenses which is all that the assessee has de facto borne. Use of berry ratio when assessee is following TNMM 62. One of the reasons of the TPO's rejection of the berry ratio is that the berry ratio is de facto cost plus method and that the assessee cannot resort to the use of this ratio when the assessee has consciously chosen the TNMM as most appropriate method. While on this objection, it is interesting to take note of the fact that in the transfer pricing study itself it has been noted that even though principles of the CPM may be appropriate, it cannot be used in this analysis for the reasons stated herein and has to be used with modification thus falling within definition of Transaction Net Margin Method (at internal page 30; paper-book page 242) and thus presence of some traits of CPM, by itself, does not render this ratio inapplicable as long as it fits with the scheme of rule 10B(1)(e), which, as we will see now, it does fit in. The Assessing Officer's observations about assessee's conscious choice of TNMM, and ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... above, no resources are used in the inventories. Use of berry ratio when tested party has high level of current assets 66. As for the objection regarding use of this ratio only in the situations in which current assets are not significant, there cannot indeed be much dispute with this proposition on principle but there is nothing on the record to evidence that there are high current assets in the present case either. Such vague generalities, as resorted to the TPO, cannot be sustained in law. There is no mention about any specific element of assets which can be related to high current assets. The TPO has mentioned about use of intangibles but on the question of intangibles as well, for the reasons we will set out in a short while, the stand of the TPO was devoid of any legally sustainable foundation. It is not the case of the TPO that the assessee owns any significant unique intangibles, which are acquired by the assessee at a specific cost, which have significant replacement cost or which are developed otherwise than as a bye product of carrying out routine business activities of the assessee. As we have noted elsewhere in this order, not only that there should be intangibl ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... with trading activities of the tested party and the comparables, without any processing or other costs, the occasion for any impact of significant variations in the accounting policies does not arise. There can be little scope of differences in approach so far as trading costs are involved, TPO's stand on locational savings not being accounted for 70. We have also noted that the TPO has also taken up a point regarding locational savings which, according to him, have accrued to the AEs but the compensation model, which provides for a mark up on costs, does not take into account the benefits from the locational savings. It is elementary that locational savings can only relate to net savings in costs that may be derived by an MNE group that relocates some of its activities to a place where labour or real estate expenditures, to cite only a couple of examples, are lower than in the location where the activities were initially performed. It follows that the savings have to be with respect to the activities and operations performed, which MNE was earlier performing at another location, and not with respect to the costs of purchases. Therefore, if an assessee is able to buy a pr ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... case, nor is there any concrete finding even about something as fundamental as existence of locational savings. The TPO has raised some murmurs of locational savings being present in this case but such vague generalities are devoid of legally sustainable foundation. The allocation of location savings comes into play only when these savings are not directly passed on to the independent customers and thus add to the profits of the group as a whole. However, in a situation in which the group is only a facilitator, as sogo shosha business model apparently envisages, there may not be any locational savings to the group. These locational savings may at best be derived by the independent customer. The question of allocating the locational savings between the AEs would have arisen only when there were any such locational savings but given the facts of the present case that aspect of the matter is wholly academic in effect. Human asset intangibles and supply chain intangibles correctness of TPO's stand 71. Coming to TPO's observations that the compensation model adopted in this case does not provide for meeting the costs of developing supply chain intangibles and human asset ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ee is a result of group synergy and intangibles as a result of such group synergy cannot, therefore, be assigned to the assessee alone. In any event, when the impact of group synergy is taken into account, it is only when it consists of deliberate concerted action benefits, and not when it merely consists of the passive association benefits. There is no such suggestion of deliberate concerted action benefits in the present case. 73. In any event, as observed by Hon'ble Delhi High Court, in Li Fung's case (supra), the assesse may have developed experience and expertise which the Tribunal has held to be human capital and supply chain intangibles but such description does not in any way reveal how the appellant bears any risk - either enterprise or economic . Summing up the decision, Their Lordships have further observed that, Tax authorities should base their conclusions on specific facts, and not on vague generalities, such as significant risk , functional risk , enterprise risk etc. without any material on record to establish such findings. If such findings are warranted, they should be supported by demonstrable reason, based on objective facts and the relative e ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... icant costs for developing the workforce which is not factored in the arm's length price. All that the assessee has incurred as costs are the routine staff costs and all such costs are already factored in the arm's length price. No matter which PLI is adopted, these operating costs will anyway be taken into account. The question of its being a unique intangible, justifying a separate specific adjustment in the ALP, arises only when it is acquired or developed at a cost which find no mention in the TP analysis. A trained workforce is an intangible asset and it is on the basis of this asset that the assessee carries out his business activity but that intangible is common to all business entities inasmuch as anyone pursuing a business activity, as it goes along, develops a workforce trained in that activity. In order to have its impact on determination of the ALP, as we have noted earlier as well, not only an intangible should exist but it should also be a unique intangible giving an edge to the business in which such an intangible is used. 77. A trained workforce, in the absence of any specific and significant features attached to it, significant training or development co ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... re-characterized the same as trading activities as he was of the view that the right course of action will be to treat the same as equivalent to trading segment, because what the assessee has disclosed as service/commission income is infact trading income. Accordingly, the cost of goods sold by the AEs, which was ₹ 2927,92,05,406, was also to be included in cost base of the service/commission segment and then ALP was recomputed. So far as this aspect of the matter is concerned, the issue is now covered in favour of the assessee by Hon'ble jurisdictional High Court's decision in the case of Li Fung wherein Their Lordships have, inter alia, observed as follows: ..This Court is of opinion that to apply the TNMM, the assessee's net profit margin realized from international transactions had to be calculated only with reference to cost incurred by it, and not by any other entity, either third party vendors or the AE. Textually, and within the bounds of the text must the AO/TPO operate, Rule 10B(1)(e) does not enable consideration or imputation of cost incurred by third parties or unrelated enterprises to compute the assessee's net profit margin for applicat ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... nal adjustments made by the TPO are deleted, no ALP adjustment will be warranted. However, we are not inclined to go into verifications which must take place at the assessment stage. Conclusion on commission /service fees segment of assessee's activities 82. Accordingly, we deem it appropriate to uphold the grievances of the assessee in principle, as the terms above, delete the notional adjustments by TPO's adopting cost base of the AEs in assessee's ALP determination, and remit the matter to the file of the TPO for the necessary factual verifications on impact of this corrections. Accordingly, the matter stands restored to the file of the TPO in this respect also. Conclusions with respect to correctness of ALP determination 83. In the result, so far as grievances against ALP adjustment of ₹ 68,15,17,853 are concerned, the matter stands restored to the file of the TPO but in the terms indicated above. Correctness of disallowance, under section 40(a)(i), of ₹ 102,17,16,483 84. So far as this issue is concerned, the relevant material facts are like as follows. During the relevant previous year, the assessee made payments to following associat ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... levant to us only from the point view of revenue's contention that the payments made to the MCJ and its affiliates were taxable in India, were discussed in detail in the assessment order. A reference was then made to Metal One Corporation and its affiliates and it was noted that this group was following the same business model, that, though it was a separate entity, it was assigned to deal with metal business earlier being carried on by metal division of MCJ and that the Metal One Corporation must also, therefore, be held to have a PE, and consequent tax liability, in India. The Assessing Officer noted that these entities, even though non-resident, are taxable in India in the light of their business model and their presence in India under the provisions of the Income Tax Act, 1961, as also under the provisions of relevant DTAA as these entities have a permanent establishment in India. The purchases in the instant case are not purchases simplictor as the non-resident entities are trading houses whose work is liaison with the seller and purchaser and to make that deal happen . It was also observed that the assessee is not an end user of the product but a mediator between sell ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... bligations, these payments cannot be allowed as a deduction in computation of business income. The assessee did raise a grievance before the DRP but without any success. The AO thus proceeded to make the impugned disallowance of ₹ 102,17,16,483. The assessee is aggrieved and is in appeal before us. 86. We have heard the rival contentions, perused the material on record and duly considered facts of the case in the light of the applicable legal position. Shri M. S. Syali, Senior Advocate, alongwith Shri Tarandeep Singh, argued for the assessee on these issues as well while, so far as these aspects in the present appeals are concerned, now Shri Sanjeev Sharma, Commissioner - Departmental Representatives (International Taxation), made his submissions for the revenue. 87. We find that there are three broad categories of non-resident entities to which payments for purchases have been made without deducting tax at source, namely - (a) foreign entities which did not have any permanent establishment in India and there is material on record to show that revenue's claim of their having PE in India is negated by the judicial authorities; -(b) foreign entities which may not have ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e business model discussed above, it is apparent that it does not make any difference if the trading is down through the business model discussed above, it is apparent that it does not make any difference if the trading is down through/with an entity based in Singapore or Thailand. The said offices also function in similar manner in respect of entire group of locating and negotiating with potential buyer and seller in metal market. The tax residency certificate etc. are of no consequence in such a business model. 9.6 The Delhi E Bench of the Tribunal in the case of Metal One Corpn. (supra) for the Assessment Year 2008-09 considered the issue whether the assessee M/s Metal One Corporation has a P.E. in India. At para 6.6 to 6.8 it was held as follows : 6.6. We may now consider the decision in the case of Sofema SA. The finding of the Tribunal is that in absence of any evidence on record with regard to commercial activity having been done by the assessee in India, the LO cannot be considered to be a PE. The Hon'ble High Court of Delhi dismissed the appeal of the Revenue by mentioning that no substantial question of law arises. However, the Hon'ble Supreme Court dea ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... r against the assessee. Therefore, we are of the view that the India office does not constitute PE of the assessee in India. The result is that the assessee succeeds on ground No.1. 9.7 In the above decision the Tribunal has concluded that Metal One Corporation does not have a P.E. in India. The Assessing Officer on the analogy that the functions of Metal One Asia Pte.Ltd. Thailand are similar to that of Metal One Corporation, drew an inference that Metal One Asia Pte. Ltd. have a P.E. in India. Similar inference has been drawn in the case of MC. Tubular Inc. USA, Petro Diamond Corp. Japan and Miteni Japan. As the ITAT had, in the case of Metal One Corpn. (supra) held that the entity does not have a P.E. in India, on the facts and circumstances of the case, the ratio applies to all other entities other than Mitsubishi Corporation, Japan. We are informed that, for none of the entities, other than Metal One Corporation, Japan the Revenue authorities have passed any order holding that those entities have a P.E. in India. We find that the A.O. drew an inference that these entities have a P.E. in India while examining the provisions of S.195 and S.40(a)(ia) in the case of the assess ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... orporation (Japan) and of ₹ 1,74,72,633 to Metal One (Asia) Pte Ltd Singapore, accordingly stand deleted. Disallowance of payments under section 40(a)(i) made to the foreign entities, without deduction of tax at source, which may not have any permanent establishment in India but there is no material to establish that fact and there is also no material on record to show that revenue's claim of their having PE in India is negated by the judicial authorities. 91. In the second segment, we take up disallowance of payments made to the foreign entities which may not have any permanent establishment in India but there is no material to establish that fact and there is also no material on record to show that revenue's claim of their having PE in India is negated by the judicial authorities. So far as this segment is concerned, the related payments are (i) payment of ₹ 93,345 to Mitsubishi Corporation Singapore, (ii) payment of ₹ 33,76,808 to MC Tubular Inc USA, (iii) payment of 23,73,391 to Thai MC Co Ltd, Thailand, and (iv) payment of ₹ 22,95,618 to Peto Diamond Corporation, Japan. 92. Coming to the taxability of these payments in the hands of the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... that such a non-existent PE must also be dealing in the same or similar products as sold by that vendor. Such a fertile imagination may indeed help as inputs for investigation but it does no good to assessment of income which must be based on cogent material on record. We are unable to see any legally sustainable merits in this approach. On the basis of these assumptions, as made by the Assessing Officer and which we find to be unsustainable in law and on facts, tax liability of recipients cannot be inferred. In any event, normal purchases from non-resident companies based in Thailand, Singapore and USA, as these vendors are, cannot give rise to taxability of income from such purchases, in the hands of the non-resident vendor, unless such nonresident companies have a permanent establishment in India. The onus to show that a foreign company has a PE in India is on the revenue and when that onus is not discharged, there cannot be any occasion to hold taxability of business profits of those entities in India. It is also well settled legal position that when the income embedded in the payments in question is not held to be taxable in India, there is no requirement to deduct tax at sou ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... fe International (P.) Ltd. (supra), held as follows: 22. Article 26 of India-US DTAA deals with 'non-discrimination'. Article 26(1) says that nationals of one contracting State shall not be subjected in the other contracting State to any taxation or any requirement connected therewith which is much more onerous, than it is on the nationals of that other contracting State. Article 26(2) provides against discrimination in the context of a permanent establishment in the other contracting State. Article 26(3) is a general clause providing for indirect discrimination against a non-resident. The provisions of section 40(a)(i), as it stood prior to it's amendment by the Finance Act, 2003 with effect from 1.4.2004, applied to payments by an assessee outside India to a nonresident only. After 1-4-2004, the provisions apply equally to both resident and non resident. In the instant appeal, the provisions of section 40(a)(i) as it existed prior to 1-4-2004 alone were applicable. Admittedly in the instant case, the exceptions set out in article 26(3) were not attracted. Therefore, the payment made by the assessee to 'H' was of the nature contemplated by article 26(3). ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... o invoke the provisions of section 40(a)(i) to disallow the claim of the assessee for deduction even on the assumption that the sum in question was chargeable to tax in India. [Para 26] 9.2 The propositions laid down in this decision are squarely applicable to the transactions with MC. Tubular Inc. USA, as this is covered by the Indo-US DTAA. 9.3 The Non Discrimination Clause under Indo-Japan DTAA reads as follows: Except where the provisions of paragraph 1 of article 9 (Associated Enterprises), paragraph 7 of article 11 (interest) and paragraph 8 of article 12 (Royalties and Fees for Included Services) apply, interest, royalties and other disbursements paid by a resident of a contracting state to a resident of the other contracting state shall, for the purposes of determining the taxable profits of the first mentioned resident, be deductible under the same conditions as if they had been paid to a resident of the first mentioned contracting state . As the wording of this Clause is pari materia with the wording used in the Non Discrimination Clause in the Indo-US DTAA. This is not disputed by the Revenue. Hence, we hold that the propositions laid down in the case of He ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... not material insofar the facts of the instant case were concerned because there was no dispute about the computation of income which included deduction of expenses from the income earned by the PE. Therefore, it was necessary to examine and interpret the intent and purpose of the paragraph (2) of article 26. In simple language and taking into account the facts of case, the language employed in the provisions means that taxation of a PE of the USA shall not be less favourable than the taxation of a resident enterprise carrying on the same activities. [Para 8.1]. Insofar as the status of commentary on the OECD Model Convention is concerned, for interpretation of the DTAA, it is clear that the commentary does not lay down any binding precedent. The commentary contains the views of the author about the Model Convention. This view can be taken as an argument by the assessee but finally, it will be for the Courts or the quasi-judicial authorities in India to decide as to whether the views expressed by the author are in conformity with the intent and purpose of the DTAA or not. [Para 8.3] The revenue referred to the Board Circular No. 621, dated 19-12-1991, issued after introductio ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ing assessment year. Learned counsel also takes us through a coordinate bench's decision in the case of DaimlerChrysler India Pvt Ltd v. DCIT (29 SOT 202) in support of the proposition that it is not a condition precedent for the assessee to be a resident of the treaty partner country in order to seek treaty protection. It is submitted that discrimination is against the entities which are tax residents of treaty partner jurisdictions inasmuch as the payments made to these entities is discriminated vis- -vis payments made to similarly situated domestic business entities. It is this discrimination against the tax residents of treaty partner jurisdictions that is being sought to be nullified. He also takes us through some observations made by Prof Klaus Vogel in his oft quoted book 'Klaus Vogel on Double Taxation Conventions' in support of the contention that this type of a discrimination with regard to the deductibility of payments made to resident taxpayers and non-resident taxpayers is impermissible. When it is put to him that with the insertion of Section 40(a)(ia) in the Income Tax Act with effect from 1st April 2005, there does not seem to be any discrimination under ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... thholding requirements, the fate is the same i.e. both the categories of payments are disallowed in computation of business income of the person making such payments. As for learned counsel's point that there is no tax deduction at source requirements from payments made to Indian residents on account of purchases, and that any such requirement in the case of non-residents will thus be discriminatory, there is no discussion whatsoever on this aspect of the matter in the order under reference nor has it been even specifically taken up by the assessee before the authorities below. The coordinate bench was simply swayed by the Herbalife decision, and there is not even a whisper of a discussion on this aspect of the matter. Learned Departmental Representative submits that that the decision of the Tribunal in the case of Automated Securities Clearance Inc v. ITO (118 TTJ 619) is indeed irrelevant in the present context but the reliance of the assessee on Suresh Rajeevbhai Gajnani's case (supra) is also equally irrelevant as both this decisions deals with PE tax neutrality, which is a distinct and separate clause in India Japan tax treaty i.e. Article 24(2), whereas deduction neut ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... instant appeal, the provisions of section 40a (i) as it existed prior to 1-4-2004 alone were applicable . The decision in case of Herbalife clearly stated that after 1.4.2004, the provisions apply equally to both resident and nonresident. Therefore, as the year under appeal is AY 2007-08, the Revenue relies on the decision of Herbalife to contend that the ratio is in favour of the Revenue for AY 2007-08 and there is no discrimination. 6. It is humbly submitted that the Hon'ble ITAT for AY 2006-07 fell in error and committed an error in applying the decision in case of Herbalife wrongly and in fact the decision was in favour of the Revenue. It is humbly submitted that such a decision which was wrongly arrived at need not be followed. The Revenue places reliance on the judgment of the Hon'ble Supreme Court in the case of Distributor (Baroda) Pvt. Ltd v. UOI 155 ITR 120 to submit that paragraph 2 of the judgment reads as: To perpetuate an error is no heroism. To rectify it is the compulsion of judicial conscience. A judge ought to be wise enough to know that he is fallible and therefore ever ready to learn: great and honest enough to discard all mere pride of opinion and ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... low the decision of the coordinate bench in the immediately preceding assessment year, Hon'ble Courts above may have the benefit of examining revenue's perspectives on this aspect of the matter. However, for the reasons we will set out in a short while, it not necessary to go into all these fine points, so strenuously argued by the learned Departmental Representative, though we must reproduce extracts, from the written submission filed by the learned Departmental Representative, as follows: Paragraph 1 of non-discrimination Article does not apply 11. This paragraph applies to situations when the Nationals of a Contracting State are subjected in the other Contracting State to any taxation and any requirement connected therewith. It is not the case of the assessee that non-resident (foreign company) is being subjected to any discrimination. Therefore, this paragraph is not applicable. Paragraph 3 does not apply to deductions on account for purchases 12. The provisions apply to interest, royalties and other disbursements. The payments were made for purchases and not are of the nature of interest, royalties and other disbursements. 13. Copy of Article 24 of the U ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... subjected to tax in the country of recipient. US Treasury Department Technical Explanation of the Convention and Protocol between the USA and the Republic of India for the avoidance of Double Taxation and Prevention of Fiscal Evasion. 18. This explanation pertaining to Article 26 is attached (pages 109 to 113 of the Revenue's PB). 19. It is submitted that the DTAA is an international agreement. The interpretation adopted by the USA also equally applies in India as the obligations and its effect is reciprocal. If the USA interprets some portion of its law and Regulations (which do not have corresponding provisions in Indian law) are not affected or not covered in the scope of non-discrimination provisions then on reciprocal basis some provisions of domestic law of India, which has a genuine and legal requirements, would also not be covered in the scope. 20. Explanation says that the requirement to withhold tax on distributions to Indian partner and not to US partner's share is not discriminatory taxation, but, like other withholding tax on non-resident aliens, is merely a reasonable method for the collection of tax from persons who are not continually present in ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... le under various sections of Chapter XVII-B of the Act out of various payments to residents. The deduction for these payments is not allowed under section 40a (ia) of the Act if the tax is either not deducted or after deduction the same is not paid to the government account. 24. These provisions are compliance provisions only as the payer is under obligation to deduct tax and authorised to do so far and on behalf of the Government. It is a great obligation and such deductors act as an arm of the government. A great responsibility is cast on them to deduct the tax and not to use the same for their business use but to pay to the government. This provision is similar to section 43B of the Act and if this provision is not in Statute then the deductors will not deposit the tax deducted until detected by the Government. 25. The contention that there is no disallowance in cases of payments to residents if tax is not deducted out of payments for purchases. It is submitted that there is no deduction of tax out of payments on account of purchases made therefore no question arises for disallowances. Further, if the purchases are a part of contract then the provisions of section 194C app ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ss tax is deducted. 31. In case of residents the AO can take actions under section 131, 132, 133A and 133(6) of the Act. Such an actions are not possible in case of non-residents. In some cases (Section 115), the non-residents are not requiring to file tax returns. Residents and non-residents are not under the same conditions. 32. The non-discrimination clause is not intended to offer the protection to resident or non-resident so as to encourage them to disobey the law of the land or reward them for non-compliance of law. The purpose of non-discrimination clause is to protect from discrimination but not to enable them to disobey the law of the land or allow them to unnecessary enrich themselves. For example, if the contention of the Ld Sr. Counsel is accepted then in that case, the resident can deduct the tax and it need not pay the money and use the government money for its business and get enriched at the cost of the government and at the same time non-discrimination clause will protect it. Such type of unintended interpretation will lead to disastrous consequences which are not thought of at present. 33. Further, the residents are subjected to full tax liability (taxati ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... is, what seems to us to be, a somewhat discriminatory practice. Learned Departmental Representative was also asked to take into account, in his submissions, two decisions of the Tribunal - one, in the case of Rajeev Kumar Agarwal v. ACIT (149 ITD 363), wherein it is held that insertion of second proviso to Section 40(a)(ia) is to be treated as effective from 1st April 2005; and - second, in the case of DCIT v. Gupta Overseas [30 ITR (Trib) 738], wherein, following special bench decision in the case of Rajeev Sureshbhai Gajwani v. ACIT [8 ITR (Trib) 616)] it was held that even a differentiation simplictor for treatment in deductibility of payments made to residents vis- -vis nonresidents will amount to impermissible non-discrimination. 103. Learned Departmental Representative submitted his argument is primarily on principle and to highlight the correct legal position because whatever is held by the Tribunal in one case essentially becomes a precedent for other similarly placed cases as well. It was submitted that his basic contention is that Herbalife is no longer good law, and, as evident from the unambiguous caveat put in by the bench to the effect that in this appeal we are c ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... use the decision relied upon by the Assessing Officer was disapproved in this case. If nothing turns on this case, the Assessing Officer had no reasons to reject the treaty protection demanded by the assessee because the only defence available to the Assessing Officer was this decision of the Tribunal. Learned counsel further submitted that whether or not treaty protection is available in respect of the deduction neutrality, this issue is no longer res integra, inasmuch as Herbalife decision (supra) lays down that principle and a large number of decisions of the coordinate benches, including in the case of Gupta Overseas (supra) have consistently followed that path. Learned counsel submits that when the claim for deduction neutrality for payments made to Japanese tax residents was put, the Assessing Officer had only two objections- first, that the assessee, being a tax resident of India, was not eligible for treaty protection; and, second - that Herbalife decision is not good law in view of certain observations made in a later decision of the Tribunal in the case of Automated Securities Clearance. Both of these objections are devoid of any legally sustainable foundation. As for the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ct of income so computed, no disallowance under section 40(a)(ia) can be made. However, in corresponding provision for payments made to non-resident assessees, i.e. under section 40(a)(i), when an assessee makes payments to non-resident assessees without deducting tax at source and even if the recipient takes into account such receipts in his computation of business income and files income tax under section 139(1) in respect of the same, the disallowance will be made nevertheless. Learned counsel submits that since the provision of section 40(a)(ia) is held to be retrospective with effect from 1st April 2005 by a coordinate bench's decision in the case of Rajeev Kumar Agarwal (supra), there is a clear discrimination so far as deductibility of the related amounts paid to a MCJ, a Japanese tax resident, is concerned. In this view of the matter, according to the learned counsel, even the question of disallowance under section 40(a)(i) being discriminatory in the light of Herbalife decision is now purely academic. Learned counsel further submits that it is an undisputed position, as evident from the material on record, that the recipient has duly taken into account the impugned rec ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ts that now that taxability of income embedded in a payment in India is beyond doubt or controversy, and there is no dispute that the assessee has not deducted tax at source from the said payment, there is no escape from the conclusion that the assessee ought to have deducted tax at source from such a payment and that the assessee's failure to do so has to be necessarily visited with disallowance under section 40(a)(i). We are thus once again urged to confirm the action of the Assessing Officer on this point and decline to interfere in the matter. Is deduction parity to Japanese non residents covered by non discrimination clause of Indo Japan DTAA even in the assessments of Indian tax residents? 104. A preliminary objection which has been very strongly taken up by the AO, duly approved by the DRP, is that the assessee being a resident taxpayer is not at all entitled to the protection of India Japan DTAA. On this issue, the DRP has inter alia observed as follows: .the argument of the applicant quoting non-discrimination clause is entirely misplaced and out of context inasmuch as a resident applicant cannot take recourse to non-discrimination clause contained in the t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... gainst the PEs of the other Contracting States. That of course implies that an enterprise of a Contracting State has a PE in the other Contracting State, which, in turn, requires that in order to claim non-discrimination in the host State, the PE must belong to an enterprise of the other Contracting State. In the third category of non-discrimination provisions, payments made to the residents of the other Contracting State vis-a-vis payments made to the residents of the host State so far as deductibility in computation of business profits is concerned, must be dealt at par. Therefore, it is not necessary that the assessee must belong to the other Contracting State; just a payment to the resident of the other Contracting State would suffice to claim the treaty protection under this clause. Finally, and that is the situation that we are dealing with, non-discrimination provisions can be invoked when enterprises of the host State in which capital is, partly or fully directly or indirectly, held by one or more residents of the other Contracting State, is discriminated against visa-vis other similar enterprises of the host State. This analysis shows that barring the case of invoking PE n ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... vassed by the assessee. We may also add that there is a series of decisions on this issue, starting with path-breaking decision in the case of Herbalife (supra) and including other oft quoted decisions in the cases of Asianet Communications Ltd v. DCIT (38 SOT 158), B4U International Holdings Limited v. DCIT (52 SOT 545), Central Bank of India v. DCIT (42 SOT 450), DCIT v Lazard India Ltd (41 SOT 72), DCIT v. Incent Tours Pvt Ltd (53 SOT 308), Millennium Infocom Technologies v. ACIT (21 SOT 152) , and Sandoz Pvt Ltd. v. ACIT (149 ITD 507), holding, by implication, that the treaty protection against non-discrimination, to ensure deduction parity, can be extended in the assessments of the domestic enterprise claiming the deduction. We are in respectful agreement with the stand so taken by the coordinate benches on this aspect of the matter. In view of these discussions, in our considered view, the preliminary objection raised by the authorities below was ill conceived, and we reject the same. Our analysis of non discrimination clause in India Japan DTAA 108. We consider it appropriate to reproduce Article 24 of India Japan Double Taxation Avoidance Agreement, for ready referenc ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... cope of this provision, the OECD Model Convention Commentary, which is reproduced with approval and concurrence in the UN Model Convention Commentary as well, observes as follows: 73. This paragraph is designed to end a particular form of dis- crimination resulting from the fact that in certain countries the deduction of interest, royalties and other disbursements allowed without restriction when the recipient is resident, is restricted or even prohibited when he is a nonresident. The same situation may also be found in the sphere of capital taxation, as regards debts contracted to a non-resident. It is however open to Contracting States to modify this provision in bilateral conventions to avoid its use for tax avoidance purposes. 74. Paragraph 4 does not prohibit the country of the borrower from applying its domestic rules on thin capitalisation insofar as these are compatible with paragraph 1 of Article 9 or paragraph 6 of Article 11. However, if such treatment results from rules which are not compatible with the said Articles and which only apply to non- resident creditors (to the exclusion of resident creditors), then such treatment is prohibited by paragraph 4. 75. Al ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ated legislative provision, because of the treaty provisions, and where a legal provision, such as section 80HHE, has been held to be applicable even when the assessee was, on a simple reading of the legislative provision, was not eligible for the same. We are unable to uphold this plea of the learned Departmental Representative. Differentiation Vs discrimination legal position 112. In all fairness to the learned Departmental Representative, there indeed was a school of thought that mere differentiation in treatment cannot be treated as discrimination in effect, unless differentiation is discriminatory in character, but than this school of thought, which was articulated in the case of Automated Securities Clearance Inc (supra), is in particular respect of the Indo US tax treaty. This school of thought proceeded mainly on the basis of equality in treatment in treaty partner jurisdiction, even though it has been specifically clarified in the case of DaimlerChrysler India Pvt Ltd (supra), by the same bench consisting of the same coram that the decision in the case of Automated Securities Clearance Inc. (supra) was given in the context of Indo-USA Tax Treaty in which different ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... US, to art. 26(2) its Model Convention which, barring the opening words except where the provisions of para 3 of art. 7 (business profits) apply is exactly the same as art. 26(2) of Indo-US tax treaty. This Explanation, inter alia, observes as follows: .There are cases, however, where the two enterprises would not be similarly situated and differences in treatment may be warranted. For instance, it would not be a violation of the non-discrimination protection of para 2 to require the foreign enterprise to provide information in a reasonable manner that may be different from the information requirements imposed on a resident enterprise, because information may not be as readily available to the Internal Revenue Service from a foreign as from a domestic enterprise. Similarly, it would not be a violation of para 2 to impose penalties on persons who fail to comply with such a requirement [see, e.g., ss. 874(a) and 882(c)(2)]. . . Sec. 1446 of the Code imposes on any partnership with income that is effectively connected with a US trade or business the obligation to withhold tax on amounts allocable to a foreign partner. In the context of the Model Convention, this obligatio ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... on the US Model Convention having recognized that there are cases, however, where the two enterprises would not be similarly situated and differences in treatment may be warranted , what becomes very important and crucial is to take note of the dissimilarities in the position of a PE of the US company vis-a-vis an Indian enterprise, and to test reasonableness on the limitations on incentive deduction under s. 80HHE in the light of these dissimilarities. 40. This approach is quite in harmony with the concept of non-discrimination well founded in the Indian legal system. Guarantee against non-discrimination is one of the fundamental rights granted by the Constitution of India. There are certain non-discrimination articles, e.g., Arts. 15 and 16, which are exclusively for the citizens, but Art. 14 of the Constitution of India specifically prohibits discrimination against any person, whether citizen or not, by guaranteeing that the State shall not deny to any person equality before the law or the equal protection of the laws within the territory of India . While construing the scope of this right to equality, Hon'ble Supreme Court of India has time and again held that notwiths ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... of the considered view that a differential treatment to the PE of the US tax resident, by itself, cannot be treated as covered by the scope of rule prohibiting non-discrimination. The true test for deciding whether or not there is a non-discrimination is whether or not the resident enterprise and the PE of the other Contracting State, who are similarly situated, get the same tax treatment or not. There could indeed be different tax treatments to the PE of the other Contracting State and the enterprise of the source State, but, as long as such tax differentiation could be justified on the grounds of dissimilarities in their situation, the prohibition against discrimination cannot be invoked. 113. Not only that the above decision was treaty specific in the context of Indo US tax treaty and did not automatically to the other tax treaties entered into by India, a special bench of this Tribunal, in the case of Rajeev Sureshbhai Gajwani (supra) ruled that differentiation simplicitor is enough to invoke the non-discrimination clause even in Indo US tax treaty by observing as follows: 8.3 Having considered the rival submissions, we may now deal with them. In so far as the status of ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... commentary or the technical explanation for coming to a conclusion in the matter. 8.4 The learned Departmental Representative referred to the Board Circular No. 621, dt. 19th Dec., 1991, issued after introduction of s. 80HHE in the IT Act. Reference is made to para No. 34 of the circular which states that with a view to provide fiscal incentives for export of computer software, a new s. 80HHE has been inserted in the Act for providing tax concession similar to the earlier s. 80HHC of the IT Act. We do not find anything in the circular which could be of aid in interpreting art. 26(2). Further, reference has been made to Circular No. 333, dt. 2nd April, 1982, issued in respect of treaty override . The heading of the circular is specific provision made in DTAA whether it would prevail over general provisions contained in the IT Act . In para 3, it is mentioned that where DTAA provides for a particular mode of computation of income, the same should be followed irrespective of the provisions in the IT Act, which is the basic law, i.e., the IT Act will govern taxation of income. The case of the learned Departmental Representative on the basis of this circular is that since there is ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ame activities used in art. 26. The case of the learned counsel is that the assessee is engaged in the business of export of software in the same manner in which a number of Indian enterprises are exporting software. The fact that the assessee has been allowed to export software shows that the business does not fall in the prohibited category. Accordingly, the assessee's case has to be compared with the case of an Indian enterprise engaged in the business of exporting software. If that is done, the assessee would be entitled to deduction under s. 80HHE on the same footing and in the same manner as the deduction is admissible to a resident assessee. On the other hand, the case of the learned Departmental Representative is that various deductions under ss. 80HHE, 10A or 10B are area specific or industry specific. However, he was not able to carry this argument any further. The case of the learned counsel is that the provision contained in s. 80HHE is industry specific and the assessee is not precluded in any manner from conducting this business in India. We agree with this view as no debate seems to be feasible in this regard. Therefore, we are of the view that the assessee is c ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ng with a situation in which payment has been made to a non-resident taxpayer but the said non-resident taxpayer has taken into account the receipts in question in his business income and has already filed his income tax return under section 139(1), a copy of which is also produced by the learned Departmental Representative in support of his contention that the recipient non-resident indeed had a tax liability in respect of these amounts. As to what would have been the status of deductibility of such payments, if the recipient was a resident and all other facts were materially similar, we find guidance from decision of a coordinate bench in the case of Rajeev Kumar Agarwal (supra), wherein a coordinate bench of this Tribunal, while dealing with provision regarding disallowance of payments made to a resident assessee without deduction of tax at source, has, inter alia, observed as follows: 4. Let us first take a look at the legislative amendment of section 40(a)(ia), vide Finance Act 2012, and try to appreciate the scheme of things as evident in the amended section. Second proviso to Section 40(a)(ia), introduced with effect from 1st April 2013, provides, that where an assessee ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... atter. The legislative amendment so brought about by the Finance Act, 2012, so far as the scheme of disallowance under section 40(a)(ia) is concerned, substantially mitigates the rigour of, what otherwise seemed to be, a rather harsh disallowance provision. 5. As for the question as to whether this amendment can be treated as retrospective in nature, even in the case of Bharti Shipyard (supra)- a special bench decision vehemently relied upon in support of revenue's case, the special bench, on principles, summed up the settled legal position to the effect that any amendment of the substantive provision which is aimed at .(inter alia)removing unintended consequences to make the provisions workable has to be treated as retrospective notwithstanding the fact that the amendment has been given effect prospectively . It was held that if the consequences sought to be remedied by the subsequent amendments were to be treated as intended consequences , the amendment could not be treated as retrospective in effect. The special bench then proceeded to draw a line of demarcation between intended consequences and unintended consequences, and finally the retrospectivity of first pro ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ra), what we have to really examine is whether 2012 amendment, inserting second proviso to Section 40(a)(ia), deals with an intended consequence or with an unintended consequence .7. When we look at the overall scheme of the section as it exists now and the bigger picture as it emerges after insertion of second proviso to section 40(a)(ia), it is beyond doubt that the underlying objective of section 40(a)(ia) was to disallow deduction in respect of expenditure in a situation in which the income embedded in related payments remains untaxed due to non-deduction of tax at source by the assessee. In other words, deductibility of expenditure is made contingent upon the income, if any, embedded in such expenditure being brought to tax, if applicable. In effect, thus, a deduction for expenditure is not allowed to the assessees, in cases where assessees had tax withholding obligations from the related payments, without corresponding income inclusion by the recipient. That is the clearly discernible bigger picture, and, unmistakably, a very pragmatic and fair policy approach to the issue - howsoever belated the realization of unintended and undue hardships to the taxpayers may have been. ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... but, so far as the legal framework is concerned, this provision is not for the purpose of penalizing for the tax deduction at source lapses. There are separate penal provisions to that effect. Deincentivizing a lapse and punishing a lapse are two different things and have distinctly different, and sometimes mutually exclusive, connotations. When we appreciate the object of scheme of section 40(a)(ia), as on the statute, and to examine whether or not, on a fair, just and equitable interpretation of law- as is the guidance from Hon'ble Delhi High Court on interpretation of this legal provision, in our humble understanding, it could not be an intended consequence to disallow the expenditure, due to non-deduction of tax at source, even in a situation in which corresponding income is brought to tax in the hands of the recipient. The scheme of Section 40(a)(ia), as we see it, is aimed at ensuring that an expenditure should not be allowed as deduction in the hands of an assessee in a situation in which income embedded in such expenditure has remained untaxed due to tax withholding lapses by the assessee. It is not, in our considered view, a penalty for tax withholding lapse but i ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ken into account by the recipients in computation of their income, and taxes in respect of such income are duly paid and related income tax returns are duly filed by the resident recipients under section 139(1). However, as section 40(a)(i) does not have an exclusion clause similar to second proviso to Section 40(a)(ia), so far as payments made to nonresidents, without deduction of applicable tax deduction at source, are concerned, such payments will be disallowable even in a situation, as is the admitted factual position in this case, even when the non-resident recipient has taken into account such payments in computation of his income, has paid taxes on the same and duly filed, under section 139(1), related income tax return. It is also elementary that so far examining discrimination to the non resident Japanese taxpayers is concerned, the right comparator will be a resident Indian taxpayer. As we are examining the issue of deduction parity, we have to examine the position of deductibility in respect of a similar payment, i.e. without deduction of tax at source, made to a resident Indian taxpayer. To this extent, in the light of the legal position prevailing as on now and as ther ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... on principle are to be read down in view of clear mandate of section 90(2). 117. In view of the above discussions, in our considered view, second proviso to Section 40(a)(ia) is also required to be read into Section 40(a)(i), in the cases where related payments are made to the tax residents of Japan, inasmuch as long as the Japanese tax residents have taken into account the payments made to them by Indian residents, without deduction of tax at source, in their computation of income, paid interest thereon and have filed the related income tax returns, under section 139(1), in India, the payments so made by the Indian enterprise cannot be disallowed in their hands. As this proviso in held to retrospective in effect, i.e. with effect from 1st April 2005, in the case of Rajeev Kumar Agarwal (supra) and as no contrary decision has been brought to our notice, this provision will be equally applicable in the assessment year before us as well. What holds good for section 40(a)(ia) on a conceptual note, so far as deincentivizing non deduction of tax at source is concerned, must hold equally good for section 40(a)(i) as well. As was noted by a coordinate bench in the case of Rajeev Kumar ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... lso deleted. 118. As we have deleted this disallowance under section 40(a)(ia) on the short ground that the MCJ, the recipient, has taken into account the related payments in computing its business income in India, paid taxes on the same and duly filed, under section 139(1), its income tax return in India, we see no need to deal with the issue whether Section 40(a)(i) itself will not apply to the facts of this case in view of Article 24(3) of India Japan DTAA- as was held in the immediately preceding assessment year and which has been so vehemently challenged by the learned Departmental Representative. That aspect of the matter is, in the present situation, wholly academic in this assessment year. Whether Herbalife decision, for the assessment years in which section 40(a)(ia) is on the statute, is good in law or not is wholly irrelevant because, for the detailed reasons set out above, even when section 40(a)(i) is applicable, the disallowance under section 40(a)(i) can be invoked on the peculiar facts of this case. It would not be appropriate for us to get into this issue which has been, given our findings above, rendered academic. Our conclusion on disallowance under section ..... X X X X Extracts X X X X X X X X Extracts X X X X
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