2025 (5) TMI 1386 - AT - Income Tax

TDS u/s 195 - Disallowance u/s. 40(a)(i) - assessee was found to have paid commission to foreign agents as sales commission and also by way of purchases commission - HELD THAT - In a case of payment of commission provisions of section 40(a)(i) of the Act would come into application only where such sum is chargeable to tax under the Act. In view of provisions of section 5(2) of the Act amount of commission paid to a non resident outside India for the services rendered outside India will not fall in the category of income and as such would not be chargeable to tax. So the assessee was not liable to deduct TDS on the commission. Consequently provisions of section 40(a)(i) of the Act were not attracted for the purposes of disallowance of said amount. Thus addition made by the AO and upheld by Ld. CIT (A) deserves to be deleted. It is ordered accordingly. Addition u/s 14A - appellant submitted that said addition due to disallowance is not inconsonance with settled law as provisions of section 14A of the Act apply to earnings of actual exempt income and not to notional income - HELD THAT - As per section 14A of the Act for the purposes of computing total income no deduction is allowable in respect of expenditure said to have been incurred by the assessee in relation to income which does not form part of the total income under the Act. In PCIT v. GVK Project and Technical Services Ltd. 2019 (5) TMI 725 - SUPREME COURT Therein reference was made to decision in Cheminvest Limited 2015 (9) TMI 238 - DELHI HIGH COURT which was to the effect that section 14A would not apply where no exempt income is received or receivable during the relevant previous year. Where there is no exempt income earned by an assessee in the previous year no question of disallowance of expenditure incurred to earn exempt income would arise. Herein it is not case of the department that the appellant earned any exempt income due to investments in equities. Rather as rightly submitted on behalf of the appellant the Assessing Officer observed in the assessment order that the investments made by the appellant in equities would not generate exempt income. In the given facts and circumstances no such disallowance attracting provisions of section 14A read with Rule 8D was permissible. As a result addition made in this regard deserves to be set aside. It is ordered accordingly. Allowability of business expenses as Corporate Social Responsibility (CSR) expenses - HELD THAT - While referring to provisions of section 37(1) of the Act the Assessing Officer observed that the assessee was asked to justify expenditure incurred for the purposes of business and their relation to the business expenses for being allowed under said provision of law but the assessee did not furnish any reply and as such he presumed that the assessee had no objection towards disallowance of said amount debited in Profit Loss Account. AO also observed that Corporate Social Responsibility expenses are not in the nature of expenses incurred wholly and exclusively for the purposes of business -only contention raised by AR for the appellant is that such expenditure is allowable to be deducted u/s 80G - At no point of time the assessee claimed said deduction under section 80G of the Act. As regards section 37(1) of the Act onus to prove that said expenses were incurred exclusively for the purposes of business and that same were not of the form of personal expenses or capital expenses was on the assessee. Since the assessee did not produce any material in this regard before the authorities below and even before us nothing of the sort has been produced so as to attract provisions of section 37(1) of the Act. Therefore we see no merit in this ground raised by the appellant or to delete said addition. As a result the disallowance relating to Corporate Social Responsibility expenses is upheld.

Summary

The core legal questions considered in this appeal involve the validity of three disallowances made by the Assessing Officer under the Income Tax Act, 1961: (i) disallowance under section 40(a)(i) for non-deduction of tax at source (TDS) on commission payments to non-resident agents, (ii) disallowance under section 14A relating to expenses claimed against exempt income, and (iii) disallowance under section 37(1) concerning Corporate Social Responsibility (CSR) expenses claimed as business expenditure.

The first issue pertains to whether the assessee was obligated to deduct TDS under section 195(1) on commission payments made to foreign agents and whether the consequent disallowance under section 40(a)(i) was justified. The second issue questions the applicability of section 14A disallowance on expenses incurred in relation to investments that did not generate exempt income. The third issue examines the allowability of CSR expenses under section 37(1) as business expenses.

Regarding the first issue, the legal framework centers on sections 40(a)(i) and 195(1) of the Income Tax Act. Section 195(1) mandates deduction of tax at source on payments to non-residents chargeable to tax in India. Section 40(a)(i) disallows expenses where such TDS is not deducted or paid. The Explanation II to section 195(1) clarifies the scope, including payments of interest, royalty, fees for technical services (FTS), or other sums chargeable under the Act.

The Court examined precedents including a coordinate bench decision involving the same assessee for Assessment Year 2015-16, which relied on Satyam Polyplast v. DCIT. In that case, the payment was held to be commission and not FTS or royalty, and thus the disallowance under section 40(a)(i) was not warranted if the sum was not chargeable to tax in India. The Court emphasized that for section 40(a)(i) to apply, the payment must be chargeable to tax under the Act.

The Court analyzed the nature of the commission payments, noting that the Assessing Officer had not established that the payments constituted FTS or royalty, and that the CIT(A) had accepted the payments as commission. The Court further considered the provisions of section 5(2), which define the scope of total income for non-residents, including income received or deemed to be received in India or accruing or arising therein.

Applying this framework, the Court found that commission paid to non-resident agents for services rendered outside India, and paid outside India, does not accrue or arise in India and is not received or deemed to be received in India. Consequently, such income is not chargeable to tax in India. Additionally, the Court noted that under the Double Taxation Avoidance Agreement (DTAA), in the absence of a permanent establishment (PE) in India, such business income is not taxable in India.

Therefore, since the commission payments were not chargeable to tax in India, the assessee was not required to deduct TDS under section 195(1), and the disallowance under section 40(a)(i) was not justified. The Court accordingly deleted the disallowance.

The second issue involved the applicability of section 14A, which disallows expenditure incurred in relation to income exempt from tax. The Assessing Officer disallowed a portion of interest expenses, contending that expenses should be allowed only to the extent relatable to taxable income, and that the assessee had not bifurcated expenses relating to exempt income from those relating to taxable income.

The appellant relied on the Supreme Court decision in PCIT v. GVK Projects and Technical Services Ltd., which clarified that section 14A applies only when exempt income is actually earned or receivable during the relevant year. The Court also referred to the Delhi High Court ruling in Cheminvest Limited v. CIT, which held that no disallowance under section 14A arises if no exempt income is earned.

In the present case, the Assessing Officer himself observed that the investments did not generate exempt income. Consequently, section 14A disallowance was not applicable. The Court held that without exempt income, no disallowance under section 14A can be made, and set aside the addition.

The third issue concerned the disallowance of Rs. 75,000 under section 37(1) relating to CSR expenses. The Assessing Officer required the assessee to justify the business purpose of the expenditure, but the assessee failed to respond to notices and did not produce any evidence to substantiate the claim. The Assessing Officer also noted that CSR expenses are not incurred wholly and exclusively for business purposes.

The appellant contended that such expenses are deductible under section 80G, but did not claim such deduction at any point. The Court observed that the onus to prove that expenses are incurred exclusively for business purposes lies on the assessee. Given the absence of any evidence or explanation, the Court found no merit in the claim and upheld the disallowance under section 37(1).

In conclusion, the Court held that the disallowance under section 40(a)(i) for non-deduction of TDS on commission payments to non-residents was not sustainable as the payments were not chargeable to tax in India, and accordingly deleted the addition. The disallowance under section 14A was also deleted as no exempt income was earned by the assessee. However, the disallowance under section 37(1) relating to CSR expenses was upheld due to the assessee's failure to substantiate the business purpose of the expenditure.

Significant holdings include the Court's detailed reasoning on the first issue, which clarified that:

"Once the payment in question is commission then the provisions of Section 40(a)(i) of the Act are applicable only if such sum is chargeable to tax under this Act."

Further, the Court emphasized the import of section 5(2) in determining the chargeability of income of non-residents, stating:

"Commission paid to non-resident outside India for the services rendered outside India will not fall in the category of the income received for deemed or received in India as well as accrues or arises or is deemed to accrue or arise in India. Thus, the said amount paid to non-resident does not fall in the scope of total income of non-resident and consequently it is not chargeable to tax in India under the provisions of the Act."

On the second issue, the Court reiterated the principle from authoritative precedents that section 14A disallowance is contingent on the presence of exempt income, and in its absence, no disallowance can be made.

On the third issue, the Court upheld the principle that the burden to prove the business nexus and exclusive business purpose of expenses claimed under section 37(1) lies with the assessee, and non-compliance or failure to produce evidence warrants disallowance.

Thus, the final determinations were: deletion of disallowances under sections 40(a)(i) and 14A, and upholding the disallowance under section 37(1) relating to CSR expenses.