2010 (10) TMI 852 - HC - Income Tax

Disallowance under section 40(a)(iii) - non eduction of tds - amount of salaries paid in foreign currency to the employees - Indian and Netherlands DTAA - Held that - The salary payment can be said to be earned in India only if the corresponding services are rendered in India. In other words if the services are rendered outside India for which salary has been paid then the income cannot be said to accrue or arise in India. Further since in the instant case services are rendered outside India in respect of which the employees received salary outside India it cannot be said that the same accrue or arise in India - See CIT v. Avtar Singh Wadhawan 2000 (11) TMI 116 - BOMBAY High Court wherein the assessee had worked outside the India he received salary outside India from an Indian employer namely Shipping Corporation of India & the Bombay High Court on these facts held that since the place where the services are rendered is relevant for determining chargeability of the tax no tax would be payable on the salary received on the services rendered outside India. In favour of assessee.

Summary

Issues Involved:
1. Justification of the Income Tax Appellate Tribunal in reversing the order of the Commissioner of Income Tax (Appeals) and upholding the disallowance of Rs.1,929,632 under section 40(a)(iii) of the Income Tax Act, 1961.
2. Applicability of the Double Taxation Avoidance Agreement (DTAA) between India and Netherlands.

Detailed Analysis:

1. Justification of the Income Tax Appellate Tribunal in Reversing the Order of the Commissioner of Income Tax (Appeals):

The primary issue revolves around whether the Income Tax Appellate Tribunal (ITAT) was justified in reversing the CIT(A)'s order, which deleted the disallowance of Rs.1,929,632 made by the Assessing Officer (AO) under section 40(a)(iii) of the Income Tax Act. The AO had disallowed this amount, representing salaries paid in foreign currency to non-resident employees in the Netherlands, on the grounds that no tax was withheld on these payments.

The CIT(A) had earlier deleted this disallowance, arguing that the provisions of TDS would not be applicable when the sum paid is not chargeable to tax in India, in accordance with section 40(a)(iii) read with sections 5(2) and 9(1)(iii). The CIT(A) relied on explanation 1 to section 5(2), which clarifies that income accruing or arising outside India is not deemed to be received in India merely because it is accounted for in a balance sheet prepared in India.

The ITAT, however, reversed this decision, holding that the provisions of section 40(a)(i) and 40(a)(iii) are analogous and that the salary payments made outside India were still liable to taxation, thus requiring the assessee to deduct tax at source. The ITAT cited the case of Van Oord ACZ India (P.) Ltd. and Vijay Ship Broking Corporation to support its decision.

2. Applicability of the Double Taxation Avoidance Agreement (DTAA) between India and Netherlands:

The High Court examined whether the salaries paid to non-resident employees in the Netherlands were taxable in India in light of the DTAA between India and the Netherlands. Article 15 of the DTAA stipulates that salaries, wages, and other similar remuneration derived by a resident of one State in respect of an employment shall be taxable only in that State unless the employment is exercised in the other State.

The High Court noted that the employees were non-residents, the salaries were paid in foreign currency, and the tax was paid in the Netherlands as per their tax laws. The court emphasized that the salary paid to these employees would not be chargeable to tax in India if the conditions mentioned in Article 15(2) of the DTAA are fulfilled:
- The recipient is present in the other State for a period not exceeding 183 days in the fiscal year.
- The remuneration is paid by an employer who is not a resident of the other State.
- The remuneration is not borne by a permanent establishment or a fixed base which the employer has in the other State.

The High Court concluded that all these conditions were met in the present case. The employees were non-residents, the remuneration was paid by an Indian company (not a resident of the Netherlands), and there was no permanent establishment in the Netherlands that bore the remuneration.

Conclusion:

The High Court held that the provisions of section 40(a)(iii) of the Income Tax Act were not applicable in this case because the salary payments were not chargeable to tax in India under the DTAA. The court emphasized that the salary payments can only be taxed in India if the corresponding services are rendered in India, which was not the case here. The High Court also referred to the judgment of the Bombay High Court in CIT v. Avtar Singh Wadhawan, which supported the view that no tax would be payable on salary received for services rendered outside India.

Thus, the High Court answered the question of law in favor of the assessee and against the Revenue, setting aside the order of the ITAT and restoring the order of the CIT(A).