9911796707
TMI Blog2017 (11) TMI 1427X X X X Extracts X X X X X X X X Extracts X X X X ..... Income Tax Act, 1961 cannot be applied in view of the provisions of the Double Tax Avoidance Agreement between the Indian and Japan and India and the US? (ii) Whether the ITAT fell in error in reversing the findings of the DRP with respect to the existence of the PEs in India?" 3. The Assessee, Mitsubishi Corporation India Private Limited (hereafter 'MI') was incorporated in India on 22nd May, 1996. It is engaged in the development of international trade and is also procuring raw materials and marketing finished products in India, through various Indian joint ventures of Mitsubishi Corporation, Japan (hereafter 'MC'). The return of income for AY 2006-07 was filed by the Assessee on 29th November, 2006 declaring a total income of Rs. 6,39,59,620/- and the same was assessed under the provisions of Section 143 (3) read with Section 144C of the Act. 4. The Assessing Officer ('AO') passed a draft assessment order under Section 144C of the Act on 31st December, 2009 and made, amongst others, an addition of Rs. 97,89,54,176/-. The Assessee filed its objections before the Dispute Resolution Panel ('DRP') on 2nd February, 2010. The DRP on 30th September, 2010 directed the AO to complete ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... d the complete structure of MC and also notes that the various groups created in India and the divisions created thereunder including the Business Initiative Group, Energy Group, Chemical and Business Group, Metal Business Group, Living Essential Business Group, Machinery Group, are shared between the LOs and MI. The AO analyzed in detail the manner in which MC conducted its activities in various countries. The AO finally relies upon the letter dated 10th March, 2006 given by MC to the department, which stated that MC admitted that it would have no objection to pay tax in India by applying the gross profit rate of 2.75% for computing the profitability in respect of the Indian transactions of MC. This letter, as per the AO, meant that MC admitted to the existence of its Permanent Establishment ('PE') in India. The AO, thus, concludes that since MC is taxable in India and this position is not contested by it, the provisions relating to TDS i.e. Section 195 of the Act, consequently, apply to MC. 9. Insofar as Metal One is concerned, the AO analyzed the management plan of Metal One as available on its website and came to the conclusion that the functioning of Metal One is identical to ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... International Taxation and the Income Tax Officer TDS-I v. Samsung Electronics Co. Ltd., India Software Operations [2010] 320 ITR 209 (Kar) (hereafter 'Samsung Electronics') to support this view. The AO then concluded as under: "4.21 In light of the unambiguous legal position as emanates from the discussion made above under the observations of Hon'ble Apex Court and Hon'ble Karnataka High Court, the assessee was clearly under obligation to comply with the provisions of Sec.195 of the I. T. Act and to deduct tax at source on the payments made to nonresidents as discussed above. As a result of this default of the assessee, the payments made to nonresidents as above, are clearly disallowable u/s 40(a)(i) of the Income Tax Act, 1961 and I hold accordingly. 4.22 To sum up the above discussion, the payments made to non-residents are disallowable on the following grounds: 1. The non-resident entities to whom payment shave been made by the assessee are chargeable to tax in India in the light of their business model and presence in India under the provisions of Income Tax Act, 1961 and well as under the provisions of relevant DTAA as they have a PEs as well as business connectio ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... law. 13. Thus, the ITAT set aside the order of the AO and deleted the additions so made by him. However, in respect of the addition made by the AO in respect of the Arm's length pricing, the ITAT remanded the matter to the AO for fresh adjudication on the issue of the determination of comparables and to conduct a fresh TP study and file additional evidences/comparables before the AO/TPO for consideration. Decision in Herbalife International India Pvt. Ltd. 14. The decision in Herbalife ITAT (supra) was appealed to this Court and in its decision dated 13th May 2016 in CIT v. Herbalife International Pvt. Ltd. [2016] 384 ITR 276 (hereafter 'Herbalife'), this Court analyzed the provisions relating to non-discrimination, namely Article 26 (3) of the DTAA between India and U.S.A. After analyzing the extant provisions of the Act as applicable, read with the provisions of the DTAA, it was held that in the AY in question i.e. 2001-02, Section 40 (a) (i) did not provide for deduction of TDS where the payment was made in India to a resident. In view thereof, this Court held that a non-resident would have to be subjected to the same conditions as a resident and held that 'the lack of parit ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... nd (ib) to Section 40 (a) of the Act. Section 195 of the Act was also amended by the Finance Act, 2012, by adding Explanation 2 w.r.e.f. 1st April, 1962. The amended provisions as applicable to the AY in issue, read as under: "Section 40 - Notwithstanding anything to the contrary in sections 30 to 38, the following amounts shall not be deducted in computing the income chargeable under the head "Profits and gains of business or profession",- (a) in the case of any assessee - (i) any interest (not being interest on a loan issued for public subscription before the 1st day of April, 1938), royalty, fees for technical services or other sum chargeable under this Act, which is payable,- (A) outside India; or (B) in India to a non-resident, not being a companyor to a foreign company, on which tax is deductible at source under Chapter XVII-B and such tax has not been deducted or, after deduction, has not been paid on or before the due date specified in sub-section (1) of section 139: Provided that where in respect of any such sum, tax has been deducted in any subsequent year, or has been deducted during the previous year but paid after the due date specified in sub-section (1) o ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... as in Explanation 2 to clause (vi) of sub-section (1) of section 9; (ib) any consideration paid or payable to a nonresident for a specified service on which equalisation levy is deductible under the provisions of Chapter VIII of the Finance Act, 2016, and such levy has not been deducted or after deduction, has not been paid on or before the due date specified in sub-section (1) of section 139 : Provided that where in respect of any such consideration, the equalisation levy has been deducted in any subsequent year or has been deducted during the previous year but paid after the due date specified in sub-section (1) of section 139, such sum shall be allowed as a deduction in computing the income of the previous year in which such levy has been paid...." 17. Section 195 (1) along with its newly added explanation as applicable to the AY in question reads as under: "Section 195(1) Any person responsible for paying to a non-resident, not being a company, or to a foreign company, any interest (not being interest referred to in section 194LB or section 194LC) or section 194LD or any other sum chargeable under the provisions of this Act (not being income chargeable under the head "Salar ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ny payer to any resident payee Any payer to a non-resident payee Payable Outside India 40(a)(i)(A) 40(a)(i)(A) Payable in India N.A. 40(a)(i)(B) Position as amended by Finance Act, 2004 (Applicable to the present case for AY 2006-07): Any payer to any resident payee Any payer to a non-resident payee Payable Outside India 40(a)(i)(A) & 40(a)(ia) 40(a)(i)(A) Payable in India 40(a)(ia) 40(a)(i)(B) 19. Mr. Singh submits that the provisions of Chapter XVII-B are also not discriminatory as residents and non-residents have been placed on the same footing insofar as compliance of the requirements under Chapter XVII-B is concerned. Mr. Singh further submits that the provisions of the DTAA relating to non-discrimination do not mandate absolute parity between residents and non-residents. In fact, the decision in Herbalife (supra) supports the position that the imposition of withholding tax on non-residents is appropriate in their case, as non-residents are beyond the jurisdiction of the taxing country. Article 24 (3) of the India-Japan DTAA requires that 'disbursements paid by a resident of a contracting state to a resident of the other contracting state shall, for th ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... here is a conflict or a case where the Assessee is claiming any provision which is beneficial to it, as compared to the DTAA. 22. Mr. Rahul Chaudhary, learned Senior Standing Counsel also supports the case of the Revenue and submitted that the determination is essentially provisional in nature. He relied upon Areva T & D SA v. Assistant Director of Income Tax [2012] 349 ITR 127 (Del) (hereafter 'Areva SA') to submit that the deduction of tax under Section 195 of the Act is not in itself final and the payee can always seek a certificate for deduction at the lower rate under Section 197 of the Act or for refund on the ground that the income is not taxable in India etc. The deduction of tax at source being a measure to safeguard the interest of the Revenue, the payee would be subjected to scrutiny when it is assessed. That scrutiny cannot be done at this stage i.e. when the tax is to be deducted by the payer. Mr. Chaudhary also relies upon CIT v. Elbee Services Private Limited [2001] 247 ITR 109 (Bom) (hereafter 'Elbee Services') to submit that the orders under Section 195(2) are not conclusive and that they do not preempt the department from passing appropriate orders of assessment ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... taxable profits of the enterprise under the same conditions as if the payment had been made to a resident of the first-mentioned Contracting State...." 23. As per the above technical explanation, it is clear that the payee can file for refund and this method of deduction of tax is recognized within the Indo US DTAA regime. According to Mr. Chaudhary, in the present case, trading receipts are liable to withholding tax since all the Associated Enterprises ('AE') are working together to generate business in like manner and the entire business is traceable to one source namely MC. He supports the submissions of Mr. Singh, that a person, who is a resident of India as in the case of MI, cannot invoke the non-discrimination clause under any DTAA. Respondent-Assessee's Submissions 24. Mr. Syali, learned Senior advocate appearing for the Respondent heavily relies upon the various DTAAs to state that the said regime was more beneficial to the Assessee and it has, therefore, opted for being governed by the same. According to Mr. Syali, the profits from the business of the payee can be taxed in India only if the payee has a PE. He specifically relies upon Article 7 of the India-Japan DTAA r ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Syali fairly submits that the amount paid by the payer to the payee constitutes income, but for the purpose of determining whether TDS is to be deducted, the chargeability of the said amount to tax has to be established. He relies upon Prithvi Information Solutions v. ACIT [2014] 34 ITR (Trib) 429 (ITAT Hyd) (hereafter 'Prithvi Information Solutions') to submit that according to the ITAT, the judgment in GE India Technology (supra) still holds good. He urges this Court to uphold the view taken by the ITAT in Prithvi Information Solutions (supra). Mr. Syali states that MC Thailand and MO Singapore have no LO in India and the AO rightly records that if there is no LO then the onus is higher on the Revenue for proving existence of a PE. He relies upon the observations of the ITAT to the effect that the transaction is at arm's length. Mr. Syali further relies upon Rajeev Sureshbhai Gajwamo v. ACIT 129 ITD 145 (Ahmd) (S.B.) (hereafter 'Rajeev Sureshbhai'). 29. Mr. Syali, thus, submits that though the wordings in the various DTAA are different, the impact of all the said DTAAs is the same. According to him, non-discrimination forms the foundation of all the DTAAs despite the clauses bei ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... (3) of the India-Japan DTAA which clearly provides that tax is deductable on the same conditions as is deductible qua residents and thus Section 40 (i) (a) applies equally both for the residents and non-residents. Analysis and Reasoning 32. Before proceeding with the facts, it is necessary to analyze the change in the statutory position post the amendments that have taken place by the Finance Act, 2004 w.e.f. 1st April, 2005 and the Finance Act, 2012 with retrospective effect w.e.f. 1st April, 1962. Scheme of the Income Tax Act, 1961, after amendments 33. The scheme of the Act has undergone a substantial change subsequent to the decision in Herbalife (supra). The change arises due to the substitution and insertion of Section 40 (a) (i), Section 40 (a) (ia) and Section 40 (a) (ib), in place of the earlier Section 40 (a) (i) as also the addition of Explanation 2 to Section 195, to the Act. These provisions read with Sections 4, 5 and 9 of the Act leave no manner of doubt that tax is deductible at source, whether payments are made to residents or non-residents if the sum is chargeable to tax under any of the provisions of the Act. In fact as per the newly added Explanation, charge ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... payable under any provision of this Act. Section 5 - (1) Subject to the provisions of this Act, the total income of any previous year of a person who is a resident includes all income from whatever source derived which- (a) is received or is deemed to be received in India in such year by or on behalf of such person ; or (b) accrues or arises or is deemed to accrue or arise to him in India during such year ; or (c) accrues or arises to him outside India during such year : Provided that, in the case of a person not ordinarily resident in India within the meaning of sub-section (6) of section 6, the income which accrues or arises to him outside India shall not be so included unless it is derived from a business controlled in or a profession set up in India. (2) Subject to the provisions of this Act, the total income of any previous year of a person who is a nonresident includes all income from whatever source derived which - (a) is received or is deemed to be received in India in such year by or on behalf of such person ; or (b) accrues or arises or is deemed to accrue or arise to him in India during such year. Explanation 1 - Income accruing or arising outside India shall not ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... profession, capital gains and income from other sources. The scheme of Tax deduction at source applies not only to the amount paid which wholly bears "income" character such as salaries, dividends, interest of securities etc., but also to gross sums, the whole of which may not be income or profits of the recipient, such as payments to contractors and sub-contractors and the payment of insurance commission. It has been contended that the sum which may be required to be paid to the nonresident may only be a trading receipt, and, may contain a fraction of sum as taxable income. It is true that in some cases, a trading receipt may contain a fraction of sum as taxable income, but in other cases such as interest, commission, transfer of rights of patents, goodwill or drawings for plant and machinery and such other transactions, it may contain large sum as taxable income under the provisions of the Act. Whatever may be the position, if the income is from profits and gains of business, it would be computed under the Act as provided at the time of regular assessment. The purpose of Sub-section (1) of Section 195 is to see that the sum which is chargeable under Section 4 of the Act for levy ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... India Technology (supra)and Vodafone (supra) it can be said that- * A sum is chargeable to tax if it can be assessed to tax under the Act and tax is leviable thereon; * The question whether the sum can be assessed to tax is to be determined under Sections 4, 5 or 9; * The heads of income are to be determined as per Section 14; * A trading receipt could be chargeable to tax either as income tax from the business or income from other sources depending on the facts; * In the case of a trading receipt even if a fraction of the sum forms part of the taxable income, it could still be included in the computation of income at the time of regular assessment; * A trading receipt cannot be said to be completely exempt from the tax * The deduction under Section 195 is a tentative deduction subject to regular assessment and payees are not affected adversely; 41. From the above it is clear that even if the payment is for purchase of goods it does not exempt the payer from making deduction of tax at source. Moreover, as per the facts of this case it is not a case of only purchase of goods or a trading receipt. A reading of the AO's order clearly gives the impression that the Assess ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... lusively decide at the time of deduction that the sum is not chargeable to tax or even bring all the facts relating to all the payee's businesses in India before the Court in its assessment proceedings. A resident company is fully bound by the provisions of the Act, and for the said purpose the existence of a PE of the payee is not essential. What is required to be seen is as to whether the sum is chargeable under the provisions of the Act and for the said purpose even a 'business connection' is sufficient as per Explanation 2 to Section 9 of the Act. The said Explanation reads - "Section 9 - ................ Explanation 2 - For the removal of doubts, it is hereby declared that "business connection" shall include any business activity carried out through a person who, acting on behalf of the non-resident,- (a) has and habitually exercises in India, an authority to conclude contracts on behalf of the non-resident, unless his activities are limited to the purchase of goods or merchandise for the non-resident; or (b) has no such authority, but habitually maintains in India a stock of goods or merchandise from which he regularly delivers goods or merchandise on behalf of the non-res ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... chnology (supra) related to an AY which is prior to the insertion of Explanation 2 to Section 195 of the Act. Addition of the said explanation, in the present case, changes the nature of the payment inasmuch as it takes away the need to establish existence of a PE or a business connection in India. Thus, the legislative scheme has undergone a change post the decision in GE India Technology (supra). Even otherwise, going by the ratio decidendi in GE India Technology (supra), that chargeability to tax has to be read in conformity with the charging provisions i.e. Sections 4, 5 and 9 of the Act, the analysis hereinafter makes it evident that all the payees in the present case either have a PE or a close business connection in India and thus, the obligation to deduct tax at source exists. Moreover, even the nature of the transaction, as recorded in the AO's order, suggests that it could be composite in nature i.e., purchase of goods as also providing of services as an intermediary. In such a case, the ratio in Transmission Corporation (supra) squarely applies. Analysis of Section 40 (a) and the provisions of DTAAs 46. The decision of this Court in Herbalife (supra) was clearly render ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... n computing the income is a question that arises at a subsequent stage. The stage of deduction of tax at source arises at the inception itself and Section 195 of the Act applies at that stage. Section 40 provides for the consequence of not deducting the tax at source. Taking Mr. Syali's arguments at its highest, it would mean that in the case of residents, it is only if the amount payable is either 'interest, commission or brokerage, rent, royalty, fees for professional services or fees for technical services payable to a resident', that the amount is not deductible while computing the income under Section 40, whereas, in the case of non-residents, if tax is not deducted at source qua 'any sum chargeable' then the deduction under Section 40 (a) (i) is not available. In fact this goes to show that the provisions are more favourable in the case of non-residents as compared to residents. Though, the obligation to deduct TDS exists qua both residents and non-residents, the deduction under Section 40 (a) (ia) is given only qua certain payments. The mention of the various amounts in Section 40 (a) (ia) does not determine that it is only qua these amounts that TDS is deductible. The oblig ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ttled that the deduction at source is not conclusive by itself. MC may well, as a part of its own assessment proceedings, be able to obtain deductions and benefits as permissible in law, however, for deduction of TDS, at the stage of inception, it cannot be categorically held that the payments are not liable to deduction. As held earlier, Section 195 and Section 40 operate in different spaces - the former at the stage of payment by the payer to the payee, and the latter at the stage of assessment of the payer. Insofar as the payer is concerned, there may be interlinking of the two however, insofar as the payee is concerned i.e. MC, Section 40 is not triggered qua it at this stage. 51. The Assessee before us being MI, it had an obligation to deduct tax under Section 195 and the non-deduction attracts the consequences as contemplated under Section 40 (a) (i) and not Section 40 (a) (ia). The payer i.e. MI cannot determine that the payment to MC is not the 'sum chargeable' under this Act. Thus, having not deducted TDS for the payments made to MC, the AO has rightly disallowed the deduction under 40 (a) (i). At this juncture, it is relevant to note that the ITAT, unfortunately, appears ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 0 (a) (ia) could still be available, since purchases are not mentioned in the provision. The logic is not hard to believe inasmuch as, if the payer does not deduct tax qua the purchase payments made to a payee who is a resident, then the collection of tax, if chargeable, can happen through the payee's assessment itself as the payee is subject to the jurisdiction of the authorities concerned. However, such a luxury does not exist qua a non-resident payee who is outside the shores and from whom the collection of tax would be difficult to say the least. Thus, purchase payments made by a resident payer to a resident payee, could still be claimed as expense even if tax is not deducted at source though the obligation to deduct does exist. In any event, w.e.f. 1st April, 2015, even qua residents the expression used in Section 40 (a) (ia) is `any sum payable' and the listing of various services has been done away with. The intention appears to be clear that on all payments to residents and non-residents, tax ought to be deductible so long as the sum is `chargeable under the provisions of this Act'. 55. The argument of non-discrimination has to be considered from the point of view of wheth ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... on or any requirement connected therewith which is other or more burdensome than the taxation and connected requirements to which nationals of that other State in the same circumstances and under the same conditions are or may be subjected." 58. A perusal of the DTAAs shows that the law of the Contracting State should govern taxation of income and the provisions for non-residents should not be more burdensome than those applicable to residents. Thus, the clauses under both these DTAAs primarily require the Assessee to show that there is either a contrary provision in the DTAA or a less burdensome provision in the DTAA. No submission has been made before this Court that there are any provisions in either of these DTAAs which contradict the Act or are more burdensome to the Assessee. Thus, the argument of discrimination does not apply in the case of the transactions of the Assessee with either MC Thailand or MO Singapore. 59. The payments being made to these companies are subject to the obligation under Section 195 which falls in Chapter XVII-B of the Act relating to collection and recovery of tax deduction at source. The deduction as per Explanation 2 to Section 195 has to be made ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... n are concerned, neither side has made any submissions qua these companies as the transactions are of low value. In any event, all these three companies are part of MC group and are governed by the Indo-US DTAA and India-Japan DTAA provisions. 62. The payments to these companies ought to have made after deduction of tax at source. The ITAT, apart from applying the wrong provision i.e. Section 40 (a) (ia), has failed to notice the various changes in the provisions of the Act as were applicable in the judgment in Herbalife (supra) and the present case. Thus, the ITAT proceeds on the basis that if these entities do not have a PE in India, they are not chargeable to tax in India, which clearly is an incorrect finding inasmuch as even the existence of business connection is sufficient for being chargeable to tax in India. None of these entities lack a business connection with India and the observations made by the DRP and the AO clearly points to an unequivocal existence of a business connection, at least while viewed from the payer's perspective. The question as to whether all these companies would have to pay tax on these transactions is a question that needs to be determined when th ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... shi Corporation, Japan ('MC') and other group companies of MC, Metal One Corporation, Japan ('Metal One Japan'), Petro Diamond Corporation, Japan ('Petro Diamond') and Miteni, Japan ('Miteni'). It also concerns payments made to certain other non-resident entities including viz., MC Metal Services Asia, Thailand ('MC Metal Thailand'), Metal One Asia Pvt. Ltd., Singapore ('Metal One Asia'), and Mc Tubular Inc. USA ('Mc Tubular'). 3. The Double Taxation Avoidance Agreements ('DTAAs') between Indiaand Japan (the Indo-Japan DTAA) and between India and the USA (the Indo-US DTAA) both contain identically worded non-discrimination clauses that would govern the payments made to non-resident entities incorporated in those respective countries. In other words, the payments made by MI to MC, Metal One Japan, Petro Diamond and Miteni are governed by the IndoJapan DTAA and the payment by MI to Mc Tubular is governed by the Indo-US DTAA. In these cases, as regards the tax treatment of these payments and claiming deductions thereof while computing its taxable income, MI has opted for the more beneficial DTAA provisions. Question (i) framed by the Court therefore pertains to the above payments. 4 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... vant. The distinction between sub-clauses (i) and (ia) of Section 40 (a) 8. The consequence for the failure to deduct TDS in terms of Sections 40 (a) (i) and 40 (a) (ia) of the Act, as they stood during the AY 2006-07, differed in a significant way. To understand this, both provisions (as they stood during AY 2006-07) require to be set out in full. They read as under: "40. Notwithstanding anything to the contrary in sections 30 to 38, the following amounts shall not be deducted in computing the income chargeable under the head "Profits and gains of business or profession" (a) in the case of any assessee (i) any interest (not being interest on a loan issued for public subscription before the 1st day of April, 1938), royalty, fees for technical services or other sum chargeable under this Act, which is payable, (A) outside India; or (B) in India to a non-resident, not being a company or to a foreign company, on which tax is deductible at source under Chapter XVII-B and such tax has not been deducted or, after deduction, has not been paid during the previous year, or in the subsequent year before the expiry of the time prescribed under sub-section (1) of Section 200....... Prov ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... r purchases would not suffer the same consequence of non-deductibility. This difference has since 1st April 2015 been done away with by further amending sub-clause (ia). However during the relevant AY 2006-07, this difference did exist. Analysis of the relevant provisions of the DTAA 10. As already noted, under Article 24 (3) of the Indo-Japan DTAA the taxtreatment given to payments made to non-residents which are entities incorporated in Japan has to be no different from that given to payments made to resident entities. This non-discrimination provision reads thus: "24 (3) Except where the provisions of article 9, paragraph 8 of article 11, or paragraph 7 of article 12 apply, interest, royalties, and other disbursements paid by an enterprise of a Contracting State to a resident of the other Contracting State shall, for the purpose of determining the taxable profits of such enterprise, be deductible under the same conditions as if they had been paid to a resident of the first mentioned Contracting State." 11. What does the above provision actually say? It says that barring certain kinds of payments covered under Articles 9, 11 (8) or 12 (7) of the IndoJapan DTAA, payment to non ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ter was remanded to the TPO by the ITAT for a fresh determination. 16. The Dispute Resolution Panel (DRP) by its order dated 30th September 2010 rejected the Assessee's objections to the AO's draft assessment order. The DRP virtually endorsed the AO's draft order. It also rejected the contention of the Assessee based on the decision of the ITAT in Herbalife International (India) P. Ltd. v. ACIT [2006] 101 ITD 450 (Delhi) ('Herbalife ITAT') by referring to another decision of the Pune Bench of the ITAT in Automated Securities Clearance Inc. 118 TTJ 619 (Pune ITAT) which had declined to follow the decision in Herbalife ITAT. It was further held: "......Therefore, genuine requirement and reasonableness of putting a system in place to examine payment to non-residents in special manner cannot be held to be a ground for nondiscrimination." In his final assessment order the AO reiterated his draft order in its entirety and also extracted portions of the DRP's order. 17.The Assessee's further appeal was allowed by the ITAT by relying on its decision in Herbalife ITAT. As regards the payments made to the entities in Japan and the USA, the ITAT held that the said decision which interprete ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the context of the payments made to the Thailand and Singapore entities, the submission of the Revenue has focussed largely on Section 195 of the Act and the insertion therein of Explanation 2 by the FA 2012 with retrospective effect from 1st April 1962. It is submitted that there is a material difference in determining the existence of a PE for levying charge of income tax on the non-resident, and in determining the existence of a PE for ascertaining the compliance by a resident payer under Section 195. A detailed enquiry must take place in the former and not in the latter. In the latter, a detailed enquiry is possible if Sections 163, 161 and 166 are attracted. The AO, it is contended, had conducted the appropriate enquiry for applying Section 195. Reliance is placed on the decision in Aggarwal Chamber of Commerce v. Ganpat Rai [1958] 33 ITR 245 (SC). 22. Secondly, it is contended by learned counsel for the Revenue that afterthe insertion of Explanation 2 to Section 195 (1), the determination of the existence of a PE is not required. It is stated that while for chargeability the business connection/PE is a sine qua non, it is not for deductibility. The focus ought to be on "sum ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... LO in India. There was therefore, no factual basis for the conclusion that payments to those entities had to be subject to deduction of TDS. 25. It is further submitted on behalf of the Assessee that Explanation 2 to Section 195 only lays down compliance on part of the 'payer'. It stipulates an obligation to deduct TDS even if the payer is a non-resident, provided the income is chargeable to tax in India. The said Explanation has nothing to do with the chargeability of the amount to tax which is a condition precedent for deducting TDS. It does not shift the onus from the Revenue of having to establish that the payee has a PE in India. With the ITAT having held that the said onus had not been discharged, there can be no consequence under Section 40 (a) (i) of the Act for failure to deduct TDS. Question (i) 26. The Court first takes up question (i) which is more or less the question that arose for determination in its decision in Herbalife HC. The Revenue contended that the AY in question in the said decision was AY 2001-02 whereas in the present case it is AY 2006-07. According to the Revenue, one important distinction is the insertion of sub-clause (ia) in Section 40 (a ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... r purchases, if it would not be denied deduction of such sum if paid by it to a resident entity for purchases. However, in terms of Section 40 (a) (i) of the Act as it stood in AY 2006-07, MI would be denied such deduction of the sum paid to the entities in Japan and USA if it did not deduct TDS. The payments made by it to resident entities during the same period for purchases would not be denied deduction even if no TDS was deducted from such payment. The decision of this Court in Herbalife 30. The above conclusions are fully supported by the decision of this Court in Herbalife HC which upheld the decision of the ITAT in Herbalife ITAT which has been followed by the ITAT in the impugned order. 31. The expression 'other disbursements' occurring in the identically worded Article 26 (3) of the Indo-US DTAA was interpreted by the Division Bench of this Court in Herbalife HC. There the sum which was not allowed by the AO to be deductible was that paid by the Indian assessee (Herbalife India -HIAI) to Herbalife USA as 'administrative fees' which the Revenue was characterizing as Fee for Technical Services (FTS). The ITAT had in Herbalife ITAT agreed with the Assessee there that the d ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... under Sections 30 to 38 of the Act in computing business income would be subject to deductibility condition in Section 40 of the Act. The payment of FTS to HIAI would be allowable in terms of Section 37 (1) of the Act but before such payment can be allowed the condition imposed in Section 40 (a) (i) of the Act regarding deduction of TDS has to be complied with. In other words if no TDS is deducted from the payment of FTS made to HIAI by the Assessee, then in terms of Section 40 (a) (i) of the Act, it will not be allowed as a deduction under Section 37 (1) of the Act for computing the Assessee's income chargeable under the head 'profits and gains of business'. 47. Article 26(3) of the DTAA calls for an enquiry into whether the above condition imposed as far as the payment made to HIAI, i.e., payment made to a non-resident, is any different as far as allowability of such payment as a deduction when it is made to a resident. 48. Section 40 (a) (i) of the Act, as it was during the AY in question i.e. 2001-02, did not provide for deduction in the TDS where the payment was made in India. The requirement of deduction of TDS on payments made in India to residents was inserte ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... untry." (emphasis supplied) 50. While the above explanation provides the rationale for insisting on deduction of TDS from payments made to non-resident, the point here is not so much about the requirement of deduction of TDS per se but the consequence of the failure to make such deduction. As far as payment to a non-resident is concerned, Section 40 (a) (i) of the Act as it stood at the relevant time mandated that if no TDS is deducted at the time of making such payment, it will not be allowed as deduction while computing the taxable profits of the payer. No such consequence was envisaged in terms of Section 40 (a) (i) of the Act as it stood as far as payment to a resident was concerned. This, therefore, attracts the non-discrimination rule under Article 26 (3) of the DTAA." 33. In Herbalife HC, this Court interpreted the expression "same conditions" occurring in Article 26 (3) of the Indo-US DTAA which incidentally is also found in Article 24(3) of the Indo-Japan DTAA. In Herbalife HC, this Court noted the submissions of the parties and gave its reasoning as under: "51. The arguments of counsel on both sides focussed on the expression 'same conditions', in Article 26(3) of the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... umber of compromises, and it may be uncertain as to whether a full and sufficient quid pro quo is obtained by both sides. The Court acknowledged that developing countries allow 'treaty shopping' to encourage capital and technology inflows which developed countries are keen to provide to them. It was further noted that the corresponding loss of tax revenues could be insignificant compared to the other non-tax benefits to the economies of developing countries which need foreign investment. The Court felt that this was a matter best left to the discretion of the executive as it is dependent upon several economic and political considerations. 55. Consequently, while deploying the 'nexus, test to examine the justification of a classification under a treaty like the DTAA, the line of enquiry cannot possibly be whether the classification has nexus to the object of the 'statute' for the purposes of Article 14 of the Constitution of India, but whether the classification brought about by Section 40 (a) (i) of the Act defeats the object of the DTAA. 56. The argument of the Revenue also overlooks the fact that the condition under which deductibility is disallowed in respect of payments t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ia) in the Act with effect from 1st April, 2005. However, even after this change, the element of discrimination continued in AY 2006-07. The distinction between sub-clauses (i) and (ia) as regards the consequence of disallowance of the sum paid to a non-resident towards purchases as a deduction on account of the failure to deduct TDS, continued. That distinction was ultimately done away with only by the amendment of sub-clause (ia) by the FA 2014 with effect from 1st April, 2015. 36. Therefore, the assertion by the Revenue in para 4 of its written submissions that "discrimination as held by CIT v. Herbal Life [2016] 384 ITR 276 (Delhi) has been done away with" is true only after 1st April, 2015 and not during the relevant AY 2006-07. The contention about the situs of payment has been raised for the first time in this Court in the written submissions. It was not the case of the Revenue earlier that the payments were made outside India and not in India. It was only argued that the discrimination pointed out in Herbalife HC no longer exists whereas, as demonstrated earlier, it did even during AY 2006-07. 37. The inevitable conclusion is, therefore, that the decision of this Court in ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... eemed to "have always applied and extends and shall be deemed to have always extended to all persons, resident or non-resident whether or not the non-resident person has (i) a residence or place of business or business connection in India or (ii) any other presence in any manner whatsoever in India. 43. There is merit in the contention of the Assessee that the above Explanation emphasises the obligation of the 'payer' whether resident or non-resident and does not obviate the pre-condition of the sum having to be chargeable to tax, which is written into sub-section (1) of Section 195 and which requirement has not undergone any change. This is also acknowledged in the Memorandum explaining the insertion of Explanation 2 by the Finance Bill, 2012 (reported in 342 ITR (St) 234 @ p.265), the relevant extract of which reads thus: "... Section 195 of the Income-tax Act requires any person to deduct tax at source before making payments to a non-resident if the income of such non-resident is chargeable to tax in India. "Person", here will take its meaning from section 2 and would include all persons, whether resident or non-resident. Therefore, a non-resident person is also required to de ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the payments to the non-resident included an element of income which was exigible to tax in India. 46.3 The contention of the Assessee in that case was that TDS was deductible only to 'pure income' payments and not to 'composite payments' which had an element of income embedded or incorporated in them. It was in that context that the Supreme Court held against the Assessee and observed that: "9. The scheme of sub-sections (1), (2) and (3) of Section 195 and Section 197 leaves no doubt that the expression 'any other sum chargeable under the provisions of this Act' would mean 'sum' on which income-tax is leviable. In other words, the said sum is chargeable to tax and could be assessed to tax under the Act. Consideration would be - whether payment of sum to nonresident is chargeable to tax under the provisions of the Act or not? That sum may be income or income hidden or otherwise embedded therein. If so, tax is required to be deducted on the said sum. What would be the income is to be computed on the basis of various provisions of the Act including provisions for computation of the business income, if the payment is a trade receipt. However, what is to be deducted i ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... nterest or any other sum to a non-resident is not liable to deduct tax if such sum is not chargeable to tax under the Income-tax Act. For instance, where there is no obligation on the part of the payer and no right to receive the sum by the recipient and that the payment does not arise out of any contract or obligation between the payer and the recipient but is made voluntarily, such payments cannot be regarded as income under the Income-tax Act. It may be noted that Section 195 contemplates not merely amounts, the whole of which are pure income payments, it also covers composite payments which has an element of income embedded or incorporated in them. Thus, where an amount is payable to a non-resident, the payer is under an obligation to deduct TAS in respect of such composite payments. The obligation to deduct TAS is, however, limited to 'the appropriate proportion of income chargeable under the Act forming part of the gross sum of money payable to the non-resident. This obligation being limited to the appropriate proportion of income flows from the words used in Section 195(1), namely, "chargeable under the provisions of the Act". It is for this reason that vide Circular No. ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... even in a case where an amount paid is not chargeable to tax in India at all. We cannot read section 195, as suggested by the Department, namely, that the moment there is remittance the obligation to deduct TAS arises. If we were to accept such a contention it would mean that on mere payment income would be said to arise or accrue in India. Therefore, as stated earlier, if, the. contention of the Department was accepted it would must obliteration of the expression "sum chargeable under the provisions of the Act" from section 195(1).....Hence, the provisions relating to TDS applies only to those sums which are chargeable to tax under the Income-tax Act. If the contention of the Department that any person making payment to a non-resident is necessarily required to deduct TAS then the consequence would be that the Department would be entitled to appropriate the moneys deposited by the payer even if the sum paid is not chargeable to tax because there is no provision in the Income- tax Act by which a payer can obtain refund. Section 237 read with section 199 implies that only the recipient of the sum, i.e., the payee could seek a refund. It must therefore follow, if the Department is ri ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... chargeable under the Income-tax Act then it would be open to the Assessing Officer to disallow such claim for deduction....." (emphasis supplied) 47.2 It is therefore plain from the decision in GE India (supra) that: (i) Under Section 195 (1) of the Act, a person paying interest or any othersum to a non-resident is not liable to deduct tax if such sum is not chargeable to tax under the Act. (ii) Circular No. 728 dated 30th October 1995 issued by the CBDT clarifies that the payer who is expected to deduct TDS can take into consideration the effect of DTAA on such payment. (iii) If the contention of the Revenue that the moment there is remittance, theobligation to deduct TDS arises is accepted, then it would result in obliterating the words "chargeable under the provisions of the Act" in Section 195 (1) of the Act. (iv) The link between Section 195 (1), which is in Chapter XVII B and Section 40 (a) (i) of the Act was acknowledged. It was noted that where the payer is an Assessee he will claim the payment made to the non-resident as a deduction. If on inquiry the AO finds that the sum paid in respect of which TDS was not deducted is one chargeable to tax under the Act, he can di ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Electronics Co. Ltd. (supra). Incidentally, it is the latter two decisions that have been heavily relied upon by the AO in the present case. 48. After the above clarification of the legal position that for deduction of TDS under Section 195 (1) of the Act from payments made by MI to the non-resident entities of Thailand and Singapore, the provisions of the DTAA have to be accounted for, it is plain that Explanation 2 to Section 195 (1) will not compel deduction of TDS where the payer is reasonably certain that the sum paid for purchases is not chargeable to tax. 49. Before concluding this discussion, a reference may be made to the decision in Aggarwal Chamber of Commerce v. Ganpat Rai (supra), relied upon by learned counsel for the Revenue. There the Supreme Court was not called upon to decide any issue in the context of a DTAA. The issue considered was whether for the purposes of deduction of TDS, determination of the world income of the payee was essential and whether the payer was required to consider the impact of losses on taxability of the sum paid and in respect of which TDS was to be deducted. Both issues were answered in the negative. In the present case, the questions a ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... d and Singapore entities) was for purchases. They were not for 'composite transactions'. In other words the payment was not for any other services rendered by such non-resident entities, as was perhaps the case in Transmission Corporation (supra). In determining whether TDS is to be deducted from such payments, the provisions of the DTAA have to be considered. I, therefore, do not subscribe to the view of my colleague as expressed in para 48 of her opinion that "the obligation under Section 195 operates and exists independently of Section 40." 53. The second major reason for the divergence of opinion stems from my conclusion that even after insertion of sub-clause (ia) in Section 40 (a) of the Act, with effect from 1st April 2005, the discrimination in the consequence for non-deduction of TDS for payments made for purchases from nonresidents and those made to residents for purchases, is apparent. In my considered view the decision of this Court in Herbalife HC also holds likewise after noticing the insertion of sub-clause (ia) in Section 40 (a) although that case pertained to AY 2001-02 whereas the present case pertains to AY 2006-07. Therefore, I conclude that Section 40 (a) (i) ..... X X X X Extracts X X X X X X X X Extracts X X X X
|
