2006 (6) TMI 423 - AT - Income Tax

Tax Deduction at Source Exemption for Foreign Technical Services Upheld by ITAT Bangalore.

The ITAT Bangalore ruled in favor of the assessee, concluding that the payment made to M/s. Chang Leung Hvi and LI CPA Ltd. Hongkong was exempt from tax ... Deduction of tax at source - only grievance of the assessee is that the learned Commissioner of Income-tax (Appeals) has erred in holding that tax was required to be deducted at source in respect of payment made to M/s. Chang Leung Hvi and LI CPA Ltd. Hongkong in spite of the fact that such payment is covered under exception clause of 9(1)(vii)( b) - HELD THAT:- Source of income is not a legal concept but it must mean something which a practical man regard as a real source of income. When the customer of company i.e. associate company is located outside India than it cannot be said that source of income is not outside India. It is not the case of the revenue that associate company was importing the goods but is mentioned that assessee-company was making exports. Fees paid for getting the patent registered in Hongkong is for making or earning income from a source outside India. The Legislature has used the word making or earning income. The income of the assessee-company is profit from sale to associate company and such sale is a part of marking of income. Making an assessment has been held to cover the whole period during which assessment is made. Keeping in view the fact that patent was registered outside country for making an income from a source outside the country. The amounts paid are covered in exception provided in section 9(1)(vii)( b). Hence, the assessee was not required to deduct tax at source - Moreover, it is not the case of revenue that professional fees paid to M/s. Chang Leung Hvi and Li C PA Ltd., Hongkong are taxable in India and steps have been taken to tax the same. If the receipts are not taxable in the hands of recipient then payee is not required to deduct tax at source as per provisions of section 195 of the Income-tax Act. The appeal is allowed. ISSUES PRESENTED AND CONSIDERED 1. Whether tax is required to be deducted at source under section 195 read with the charging provision where payments are made by a resident as 'fees for technical services' falling within section 9(1)(vii)(b). 2. Whether the exception in section 9(1)(vii)(b) - payments in respect of services 'utilized in a business or profession carried on by such person outside India' or 'for the purposes of making or earning any income from any source outside India' - applies to fees paid for registration of a patent/name in a foreign jurisdiction. 3. Whether the payer can be regarded as 'carrying on a business' outside India for the purpose of the exception in section 9(1)(vii)(b), and how 'source' of income is to be ascertained in this context. ISSUE-WISE DETAILED ANALYSIS Issue 1: Requirement to deduct tax at source where payment constitutes fees for technical services Legal framework: Section 9(1)(vii)(b) (substantive charging provision) identifies income by way of fees for technical services payable by a resident as taxable unless covered by the specified exception; section 195 imposes obligation on payer to deduct tax at source where payments to non-residents are chargeable to tax in India. Precedent treatment: The Tribunal considered prior determinations that distinguish payments covered by the exclusionary clause of section 9(1)(vii)(b) as not chargeable to tax in India and hence not attracting TDS obligations under section 195. Interpretation and reasoning: The Tribunal accepted that the remitted amount was in nature of fees for technical services but emphasized that the statutory exemption in 9(1)(vii)(b) operates to exclude such fees from Indian taxation if the services are utilized in a business carried on outside India or for making/earning income from a source outside India. Where the exception applies, the underlying receipts are not chargeable to tax in India and therefore no TDS obligation arises under section 195. Ratio vs. Obiter: Ratio - where fees for technical services fall squarely within the exception of section 9(1)(vii)(b), the payer is not required to deduct tax under section 195. Conclusions: The Court concluded that a finding that the exception applies removes the chargeability in India and the obligation to deduct tax at source. Issue 2: Applicability of the exception in section 9(1)(vii)(b) to services rendered abroad for registration of patent/name - 'utilized in a business carried on by such person outside India' and 'for making or earning income from any source outside India' Legal framework: The exception requires (a) that the services be utilized in a business or profession carried on by the payer outside India, or (b) that the services be for the purpose of making or earning income from any source outside India. The Legislature's use of 'making or earning' indicates a purposive connection between the services and the generation of income outside India. Precedent treatment: The Tribunal relied on an earlier ITAT decision holding that payments for services utilized to earn income outside India fall within the exclusionary clause and are not chargeable to tax in India. Interpretation and reasoning: The Tribunal examined the factual matrix: (i) professional services were rendered entirely outside India (in Hong Kong); (ii) the services (registration of the company's name/patent in Hong Kong) were intended to enable and facilitate sales/marketing in the Asia Pacific region by an overseas associate; and (iii) the payments were thus made for the purpose of making or earning income from a source outside India. The Tribunal rejected a narrow construction that would confine 'carrying on business' only to presence of a permanent establishment or direct control at the foreign place; instead it focused on the practical connection between the services and the overseas economic activity (marketing/sales) that was the source or means of earning income outside India. The Tribunal considered 'source' as a practical commercial concept - what a practical man would regard as the real source of income - and held that where customers and sales are located abroad the source can be outside India even if certain business activities (manufacture/export) occur in India. Ratio vs. Obiter: Ratio - services rendered abroad for registration of intellectual property used to facilitate sales abroad and to make/earn income from sources outside India fall within the exception of section 9(1)(vii)(b), precluding chargeability and the consequent TDS obligation. Obiter - observations on the breadth of 'carrying on business' as a 'bundle of activities' including marketing, and the discussion on what constitutes 'source' as a practical concept (useful to reasoning but ancillary to the decision). Conclusions: The Tribunal held that the fees paid for patent/name registration in Hong Kong were utilized for making/earning income from a source outside India and therefore fell within the exception in section 9(1)(vii)(b); accordingly the payments were not taxable in India and no tax was required to be deducted at source. Issue 3: Whether the payer must itself 'carry on a business' outside India (presence/Permanent Establishment) for the exception to apply; and the treatment of 'source' of income Legal framework: The exception language refers to services 'utilized in a business or profession carried on by such person outside India' - prima facie necessitating an inquiry into whether the payer itself carries on the relevant business abroad. The statutory concept of 'source' is not defined and is informed by commercial realities. Precedent treatment: The Tribunal considered earlier authority and administrative pronouncements drawing a distinction between legal concepts like permanent establishment and the practical connections constituting business activity abroad; it also cited a prior AAR observation on the expression 'making' used by the Legislature. Interpretation and reasoning: The Tribunal acknowledged that 'carrying on business' conventionally implies some interest, control or share in gain/loss at the foreign place, but read the statutory exception in context: the critical inquiry is whether services are utilized in relation to earning income from abroad. The Tribunal found it unnecessary to construe the payer as having a formal permanent establishment abroad where the commercial arrangements (use of an overseas associate to market under the payer's brand) and the decision to register intellectual property abroad demonstrate a practical orientation to earning income outside India. On 'source,' the Tribunal adopted a pragmatic test: when customers and sales are located abroad, the source of the relevant income may be outside India notwithstanding production or some activities in India. Ratio vs. Obiter: Ratio - formal existence of a permanent establishment or complete business presence abroad is not an absolute prerequisite where, on facts, services are demonstrably utilized for earning income from a source outside India. Obiter - elaboration on the constituent elements of 'carrying on business' as a bundle of activities including marketing. Conclusions: The Tribunal concluded that the payer did not need to show a traditional permanent establishment abroad where the services were demonstrably utilized to earn income from foreign sources; consequently, the exception clause applied and negated the chargeability and TDS liability. Cross-references and Final Determination Cross-reference: Issue 2 and Issue 3 are interlinked - the determination that services were for making/earning income from sources outside India (Issue 2) obviated the need to find a conventional business presence abroad (Issue 3) to attract the exception. Final determination: The Tribunal allowed the appeal, holding that the payments for registration of the name/patent in the foreign jurisdiction fell within the exception in section 9(1)(vii)(b), were not chargeable to tax in India, and therefore no tax was required to be deducted at source under section 195.