2025 (5) TMI 274 - AT - Income Tax

TDS u/s 195 - payment made to non-resident entity - Whether payments made by the assessee to its USA-based subsidiary for technical services attract taxation under Article 12(4)(b) of the India-USA DTAA particularly whether such services constitute making available technical knowledge or designs thereby mandating tax deduction at source? HELD THAT - As this Tribunal in M/S IRUNWAY INDIA PRIVATE LIMITED 2022 (5) TMI 670 - ITAT BANGALORE in respect of regular Income tax assessment proceedings held that the disallowance made u/s 40(a)(ia) of the Act in respect of the above cannot be sustained and is directed to be deleted and therefore we are of the opinion that assessee company cannot be treated as assessee in default and therefore we direct to delete total demand as raised by the AO u/s 201(1) 201(1A) of the Act r.w.s. 206AA of the Act and accordingly we dismiss the appeal of the revenue.

Summary

The core legal questions considered in this appeal revolve around the taxability and withholding tax obligations concerning payments made by the assessee to non-resident entities and individuals, specifically:

1. Whether payments made by the assessee to its USA-based subsidiary for technical services attract taxation under Article 12(4)(b) of the India-USA Double Taxation Avoidance Agreement (DTAA), particularly whether such services constitute "making available" technical knowledge or designs, thereby mandating tax deduction at source under the Income Tax Act, 1961 ("the Act").

2. Whether the source of income in respect of payments to the USA subsidiary and non-resident individuals is correctly identified as India or USA, particularly in light of section 9(1)(vii)(b) of the Act, and whether reliance on precedents such as the Delhi High Court decision in DTT vs. Lufthansa Cargo India Ltd. was appropriate.

3. Whether payments characterized as sales commissions to a non-resident individual, Mr. Neeraj Gupta, fall within the ambit of Fees for Technical Services (FTS) or professional services under the Indo-US Treaty, and whether tax deduction at source was warranted.

4. Whether the disallowance of provisions recorded for professional charges without tax deduction at source was justified under section 40(a)(ia) of the Act.

Issue 1: Taxability of Payments to USA Subsidiary under Article 12(4)(b) of the Indo-US DTAA and Section 195 of the Act

The legal framework includes Article 12 of the Indo-US DTAA, which governs royalties and fees for included services, and section 195 of the Act, which mandates tax deduction at source on payments to non-residents chargeable to tax in India. Article 12(4)(b) specifies that fees for technical services are taxable in India only if the services "make available" technical knowledge, experience, skill, know-how, or processes, or consist of development and transfer of a technical plan or design.

Precedents such as Raymond Ltd. vs. DCIT and CESC Ltd. vs. DCIT were relied upon to interpret the phrase "make available." The Tribunal emphasized that mere rendering of technical services does not equate to making available technical knowledge; the recipient must be enabled to independently utilize the knowledge or skill permanently after the service ends. The services rendered by the USA subsidiary were primarily litigation support, patent portfolio analysis, and technology research, which did not confer any transferable technical knowledge or skill to the assessee.

The AO's interpretation that the subsidiary "made available" technical knowledge was found to be flawed, particularly as the subsidiary's employees were bound by a US court's Protective order restricting disclosure, and the assessee's employees did not have access to confidential technical information. Thus, the payments did not attract tax in India under Article 12(4)(b), and accordingly, the assessee was not obligated to deduct tax at source under section 195.

Issue 2: Source of Income and Applicability of Section 9(1)(vii)(b) of the Act

Section 9(1)(vii)(b) excludes income from any source outside India from being deemed to accrue or arise in India. The revenue argued that since the assessee's clients were in the USA but the business was carried on in India, the source of income was India, mandating tax deduction. The Tribunal, however, upheld the view that the income source was outside India, given the nature of services and location of clients, consistent with the earlier ITAT ruling and the Delhi High Court decision in Lufthansa Cargo India Ltd.

The Tribunal rejected the revenue's contention that the location of clients alone determines source of income, reaffirming that the situs of the income must be assessed in light of the nature of services and place of rendering. This interpretation aligns with the treaty and domestic law principles, thereby negating the revenue's claim.

Issue 3: Taxability of Sales Commission Paid to Non-Resident Individual

The assessee paid sales commission to Mr. Neeraj Gupta, a USA tax resident, under a Sales Contractors Agreement. The revenue contended that the commission was in the nature of FTS, taxable in India, and that the assessee was liable to deduct tax at source. The assessee argued that the payments were for sales consulting, not technical or managerial services, and thus not taxable in India.

Article 15 of the Indo-US Treaty was pivotal here, which taxes income from professional services in the country of residence unless the professional has a fixed base in India or stays in India for 90 days or more. Mr. Gupta neither had a fixed base nor visited India during the relevant period. The Tribunal held that the payments were for professional services and not taxable in India under Article 15. Furthermore, the "make available" clause of Article 12(4)(b) was inapplicable as the services did not confer technical knowledge or skill to the assessee. The clause in the agreement asserting ownership of intellectual property rights was insufficient to transform the nature of the payments into FTS.

Issue 4: Disallowance of Provision for Professional Charges under Section 40(a)(ia)

The assessee had recorded a provision for professional charges on an accrual basis without actual invoices being received by the end of the financial year. The AO disallowed the provision under section 40(a)(ia) for non-deduction of tax at source, relying on the principle that tax deduction is required at the time of crediting income to the payee.

The assessee contended that under the mercantile system, the provision was an estimate and not a liability, and tax deduction was not warranted until actual invoices were received and amounts credited. The Tribunal referred to judicial precedents, including the Karnataka High Court and ITAT Bangalore decisions, which held that tax deduction obligation arises only when income is credited or paid, not merely on provisions.

The CIT(A) upheld the AO's order relying on an ITAT decision in IBM India Pvt. Ltd., but the Tribunal distinguished the facts and accepted the assessee's submissions. It held that while tax deduction is mandatory on credited income, mere provisions without credit to the payee's account do not trigger TDS obligations. However, the Tribunal accepted the revenue's right to disallow if tax is not deducted on credited income subsequently but directed that double disallowance should be avoided when provisions are reversed in the next year.

Conclusions and Treatment of Competing Arguments

The Tribunal extensively analyzed the nature of services, the meaning of "make available" under the treaty, and the interplay between domestic law and treaty provisions. It rejected the revenue's broad interpretation equating any technical service with making available technical knowledge. The Tribunal also clarified that source of income must be determined based on the place of rendering and utilization of services, not merely on the location of clients.

Regarding the sales commission, the Tribunal distinguished between sales consulting and technical services and applied Article 15 of the treaty to exclude such income from Indian taxation in the absence of a fixed base or presence in India.

On provisions for professional charges, the Tribunal balanced the requirements of the Act and accounting principles, emphasizing that TDS obligations arise on actual credit or payment, not on mere provisions.

Significant Holdings

"The words 'making available' in Article 13.4 refers to the stage subsequent to the 'making use of' stage... The technical knowledge, experience, skill etc. must remain with the person utilizing the services even after the rendering of the services has come to an end... A transmission of the technical knowledge, experience, skill, etc. from the person rendering services to the person utilizing the same is contemplated by the article."

"The services so provided were... in the nature of services in connection with patent registration, patent litigation and procuring evidence for patent litigation and similar services... These services by no stretch of imagination can be considered as making available any technical knowledge to the assessee."

"Merely because he was technically qualified, sales commission paid for enabling sale cannot become payment for rendering technical services."

"Income derived by a person from the performance of professional services shall be taxed in the country of which he is resident except where the professional has a fixed base regularly available to him in India or has stayed in India for a period or periods amounting to or exceeding in the aggregate 90 days in the relevant taxable year."

"It is only, thereafter, at the time of credit of any income to the account of the payee or at the time of payment thereof that the liability to deduct income-tax at source would arise on the part of the assessee."

The Tribunal ultimately concluded that the payments made to the USA subsidiary and to Mr. Neeraj Gupta did not attract tax deduction at source under section 195 of the Act, and the disallowances under section 40(a)(ia) were unsustainable. The assessee could not be treated as an "assessee in default" under sections 201(1) and 201(1A). The appeal filed by the revenue was accordingly dismissed, and the total demand of Rs. 2,75,48,190/- raised by the AO was deleted.