TMI Blog2011 (2) TMI 606X X X X Extracts X X X X X X X X Extracts X X X X ..... in Koenig who are two of its employees based in USA without deducting tax at source. In the Chartered Accountant's certificate filed with the remitter bank, it was stated that no tax is required to be deducted at source, since the remittance is consideration towards non-compete fee and the beneficiary is an employee and is covered by Article-16(1) of the DTAA between India and USA. The Assessing Officer however, felt that the assessee company (SCTL) ought to have deducted tax before remitting the amounts under consideration. He therefore, issued notices calling for information as well as asking SCTL to show cause as to why it should not be treated as an 'assessee in default' in terms of provisions of section 201(1) of the IT Act. The assessee submitted the following details; "The payees i.e Mr M.S Kumar Mr Kevin Koenig both had entered into employment with M/s Sasken Network Systems Ltd.,(SNSL) on 01-04-2004. The SNSL is fully owned subsidiary of the assessee company i.e. SCTL. Prior to joining M/s Sasken group, both the payees were working for M/s Lucent Technologies, USA and after joining M/s SNSL, they worked as Chief Operating Officer and Chief Executive Officer of M/s SNSL ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... , while he signed the agreement on 05-06-2005 which shows that the payment was made prior to entering of agreement. As regards the payment made to Mr. Kumar, he observed that Mr.Kumar signed the agreement without dating it, while he has received the payment on 31-05-2005. He also observed that the payment of non-compete fees should have been made by SCTL to its employees and not to the employees of its subsidiaries which maintains separate accounts and have different employees. He held that since no independent verification is available, M/s SCTL has only its word to prove that the agreements were signed on the days they were supposed to have been signed and not later i.e after commencement of the inquiry in this case. He also held that the terms and conditions of the non-compete agreements are covered by the NDA which in fact every employee of SCTL is expected to sign and therefore, the non-compete fees is not required to be paid to the employees. He also observed that even if the non-compete fee is payable, then the non-compete agreement (NCA in short) is to see that the employees do not join any other employer whose business is substantially similar to or competitive with the bu ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... he termination of the contract of employment with the assessee in order to insulate or protect from the adverse effects of competition. The assessee had entered into Non-compete agreement with Mr.Madan S Kumar and Mr.Kevin Koenig, as they were having wide experience in the assessee's organization having occupied key positions in the course of employment and they were instrumental in the growth of the business of the assessee. It was submitted that the assessee was keen to retain them during their transition from M/s SNSL to the rolls of assessee by recognizing their contributions and at the same time protecting its interest in the eventuality of their resigning from the job with the assessee. It was submitted that for this very reason, the Non-compete agreement was entered into and certain payments were made in pursuance of such agreements at the time of entering into the contract of employment with these employees. 4.1 As regards the AO's finding that no such agreement was entered into with any other employees and the Non-compete agreement need not be entered into with all the employees, it was submitted that the assessee would be the best person to decide whether to enter into ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... t is in its own business interests and the revenue authorities cannot decide whether the assessee should make such payments for Non-competition etc., However, without adjudicating all these issues, the CIT(A) proceeded to consider whether the income arises in India which is an essential condition for chargeability of such income in India and held that there was no infirmity in the approach of the AO who has examined the taxability of payments under the Non-compete agreement from the view point of both the Act and the DTAA. He also held that the assessee has not been able to furnish copies of the income-tax returns of these two employees filed in the USA. He rejected its claim that these payments are taxable only in USA. Therefore, he held that these payments would be covered Under Article 23(3) of DTAA and these represent income arising from India and tax ought to have been deducted at source before making the payments. He therefore, confirmed the findings of the AO that the assessee is 'the assessee in default' u/s 201(1) of the IT Act and also liable for interest u/s 201(1A) of the IT Act. 4.3 Aggrieved, the assessee is in appeal before us. The learned counsel for the assessee ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e Non-compete agreement was entered into. He also submitted that certain clauses were common between the Non-disclosure and Non-compete agreements, but there were other clauses that were unique to the Non-compete agreement, such as the condition of non-solicitation of the employees of the assessee and also the employees shall not join the employment of certain business houses. Thus, according to the learned counsel for the assessee, the Non-compete agreement was an attempt to secure and protect the business of the assessee. As a consideration for such agreement, a consideration of Rs. 2,46,53,770/-each was agreed upon and paid to the employees in USA and no tax was deducted at source as the impugned payments were not chargeable to tax in India by virtue of Article-16(1) of the Indo-US Treaty. As regards the nature of payments the learned counsel for the assessee submitted that the two persons to whom the payments were made were the employees of assessee group and therefore, the payment is said to constitute one of the following; 1. Compensation at the time of termination from the subsidiary company; 2. Inducement for joining the employment of the assessee i.e. signing or join ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... nd gains of business' or 'capital gains' and save such exceptions, the Non-compete amounts would continue to be capital in nature and not taxable. As no asset was transferred by the employees in favour of assessee for Non-compete amounts, the capital gains tax is not exigible as capital gains arise only when there is a transfer of a capital asset. As the two employees were not carrying on any business, but were in the employment of the assessee, he contended that the payments under Non-compete agreement cannot be taxed as business income u/s 28(va) of the IT Act. He submitted that under the Treaty between India and the USA, business income would be chargeable to tax only on the existence of a permanent establishment in India but as they do not have any permanent establishment in India, the payments were not taxable as business income. He submitted that as per Article-16, of Indo-US Treaty, the salaries are taxable in the countries of employees and undisputedly, the two employees are the residents of USA and therefore, the payments were not taxable in India. He also submitted that the payments fall under Article-16, and not fall under Article-23, of the Indo-US Treaty for taxation o ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ay in filing of this appeal against the order u/s 201(1) of the IT Act and taken it on to record. 5.1 The assessee has also filed a paper book containing pages 1 to 127 containing the provisions of DTAA between India and the USA with the Commentary on the OCED alongwith Artiles-15,16 23 and the Commentary Clause of Article-15 of DTAA and the extracts from the decisions of the Hon'ble Supreme Court in the case of Union of India v. Azadi Bachao Andolan [2003] 263 ITR 706/132 Taxman 373 and also extracts from the decision of the Tribunal in the case of Wipro Ltd. v. ITO [2005] 92 TTJ 796/94 ITD 9 (Bang.), Essar Oil Ltd. v. Dy. CIT [2006] 102 TTJ 614/5 SOT 669 (Mum.) and that of the Hon'ble Karnataka High Court in the case of VDO Tachometer Werke v. CIT [1979] 117 ITR 804 (Kar.). 5.2 From these documents, the learned counsel for the assessee tried to demonstrate his point that the payments made to the employees of the assessee company are not taxable under the DTAA between India and USA, which fall under the term of salary as defined under Article-16 of DTAA and the salary is taxable in the place of residence of the employees where the services are rendered. 6. On the other han ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Oord ACZ India (P) Ltd. v. Addl. CIT [2008] 14 TTJ (Delhi) 808/112 ITD 79 (Delhi), wherein the Tribunal at Delhi has ruled that the payer/assessee is duty bound to deduct tax at source for the payments made to non-residents at the appropriate rates as provided under the provisions and the payer cannot escape the liability for doing so unless a certificate from the AO is obtained for the deduction of the tax either at a rate lower than the rate as prescribed or for non-deduction of tax at source and that the duty of the payer ends here only and he is not required to examine and look into other aspects beyond this like whether the payer received the services from the non-resident to whom such payments were made or from some other person though the nonresident, whether such receipt in the hands of the recipient nonresident would be his income or part of it would be his income on which he is liable to pay tax. The payer is not expected to step into the shoes of the AO for examining whether the receipts in the hands of the recipient are income or not, whether he is liable to pay tax thereon or not. In case the assessee feels that the tax is not to be deducted at source or is required to ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... he AO u/s 195(2) of the IT Act, before remitting the payments to the employees with out deducting tax at source? 9. Whether the assessee can be deemed to be an assessee in default' u/s 201(1) of the IT Act? 10. Whether interest u/s 201(1A) of the IT Act is to be levied on the assessee? 8. Coming to the first question, we find that it is undisputed that the two employees i.e. Mr. M.S.Kumar and Mr.Kevin Koenig were in the employment of M/s SNSL with effect from 01-04-2004 as Chief Executive Officer and Chief Operating Officer of M/s SNSL respectively. On the merger of subsidiary company of the M/s SNSL with the assessee company (SCTL) on 01-04-2005, the subsidiary company i.e. M/s SNSL ceased to be in existence. Therefore, it is imperative on the part of M/s SCTL to have offered employment to these two persons on 31-03-2005 as they were in key and strategic positions of M/s SNSL. Mr. Kumar accepted the offer of employment with M/s SCTL on 31-03-2005, while Mr.Kevin Koenig accepted the offer on 23-05-2005, but he joined the organization on 01-07-2005. The Non-compete agreements were allegedly entered into on 02-05-3005 and the payments were made on 31-05-2005. Thus, it can be ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... no other employee had been paid such huge amount as Non-compete fees, the assessee was under no obligation to make such payments. We find that there are three contracts entered into by the assessee company with these two employees; 1. Employment agreement 2. Non-disclosure agreement 3. Employee Non-compete agreement The assessee has filed before us a paper book containing the copies of the employment contracts between M/s SCTL and Mr.Madan S Kumar and Mr.Kevin Koenig and also Non-disclosure agreement between them and the Non-compete agreements. On comparison of these three agreements, we find that the employment contract between M/s SCTL and its employees contains the clauses relating to emoluments and perquisites and the relocation expenses, leave and medical insurance and also a clause that the employees are expected to execute employee agreement, covering among other things Non-disclosure confidential information. It also contains that the employee is 'at will' employee and can be terminated at any time, which means that if the company wants to terminate the services with cause no notice is required and without cause one month notice is given. It also provides that t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e ( not withstanding the cause or reason for termination) The said clause also defines the personnel or customer who cannot be solicited to include such 'personnel', 'customers' that were associated with M/s SCTL group for a period of one year prior to the termination of the employee's services from M/s SNSL or M/s SCTL which ever is later in time 5. Consideration: Consideration for agreeing to the Non-compete agreement also clarifies that all tax arising from the consideration will be to the employees account. It also mentions that the payment of consideration will be made to each employee with in a period of 45 days from the entering into of this agreement. 6. Miscellaneous; This clause contains the remedy for breach of the agreement constituting that M/s SNSL or M/s SCTL shall be entitled to injunctive relief or a decree for specific performance and such other relief as may be appropriate. It also safeguards M/s SNSL M/s SCTL from any liability to employee or any third party for any direct or special, consequential special or speculative damages including without limitation damages caused due to loss of profit arising from this agreement. Annex-I contains the list of ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e agreements are after thought, in order to evade taxation and therefore, they are sham transactions. The learned counsel for the assessee has argued before us that if these are considered as sham transactions, they are null and void and no tax was deductible at all. Consequently, the payments shall not be taxed in the hands of the assessee, as 'the assessee in default' for non-deduction of tax at source. We find that the Non-compete agreement had been entered into on 02-05-2005 and the payments have been made on 31-05-2005. We have already held that the terms and conditions of the Non-disclosure agreement are not exactly the same as the Non-compete agreement, as the two employees have been with the group company considerably for a long period and have also attained considerable knowledge about the assessee's group. It was necessary on the part of the assessee to enter into Non-compete agreement with these two employees to safeguard its interests. In view of the same, according to us, it cannot be held to be sham transactions. As rightly submitted by the learned counsel for the assessee that if these transactions are to be considered as sham transactions, then the necessary consequ ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... o placed reliance upon the commentary of Article-15 OECD Convention concerning taxation of income from employment, wherein it is mentioned that the employment is exercised in the place where the employee is physically present, when performing activities for the employment income is paid. He also made a reference to the commentary by a renowned economist and an expert on international taxation Mr.Klaus Vogel on Double Taxation convention, wherein it was mentioned that according to its wording 'Article-15' is not restricted to 'remuneration' derived in respect of personal services from sources in a contracting state. It differs from the other distributive rules in that, it therefore, applies to remuneration received from sources in third states as well. As a result, Article-21 is not applicable to income from dependent personal services. While referring to the explanatory notes on the Model Conventions of OECD and particularly to Article-15 of the said convention, he drew our attention to the meaning of 'Dependent Personal Services' According to the said notes, when a person perform a dependent service, all consideration received is income from such service under Article-15 and a bro ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... income at source before making the payments and not as to whether the recipients have paid their taxes in USA. 9. As regards the finding of the AO that this amount is taxable as business income, the learned counsel for the assessee submitted that for invoking provisions of section 28 of IT Act a nexus with a business is a pre-requisite and he submitted that the said two employees were not carrying on business, but they were in employment with the assessee and thus, the payments made under Non-compete agreement cannot be taxed u/s 28(va) of the IT Act. He submitted that even if it is treated as business income, the business income would be charged to taxed only on the existence of a permanent establishment i.e. permanent establishment in India, but as the two employees did not have a permanent establishment in India, the same is not taxable as business income. 9.1 As regards the findings of the CIT(A) that this amount is taxable under the head ' Other income' under Article-23 of DTAA, the learned counsel for the assessee submitted that the Article-23 is residuary provision, which means that if the income does not fall under any other heads, only then can it be considered as inco ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... or accrued to the recipients in USA as provided under Article-16 of the DTAA between India and USA because, the recipients are residents of USA and are also rendering services in USA. 9.5 As regards question No.8, learned DR had relied upon the order of the CIT(A) and had submitted that the assessee should have approached the appropriate authority for issuance of certificate under sub-section-2 of section 195, if it was the opinion that the whole of the amounts payable would not be the income chargeable to tax in the hands of the recipients, which the assessee has failed to do. Thus, according to learned DR, the amount was tax deductible at source and in the absence of the same the assessee should be treated as the 'assessee in default'. 10. The learned counsel for the assessee on the other hand submitted that these amounts paid to the employees were in the nature of salary which was not taxable in India, in view of the Article-16 of DTAA and therefore, it was not necessary on its part to approach the appropriate authority under sub-section-2 of section 195 of IT Act. 10.1 Having heard both the parties and having gone through the relevant provisions, we find that it is provid ..... X X X X Extracts X X X X X X X X Extracts X X X X
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