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Issues: (i) Whether payments made by the assessee to its holding company under the memorandum of understanding were covered by section 194C of the Income-tax Act, 1961 and liable to disallowance under section 40(a)(ia) for failure to deduct tax at source. (ii) Whether section 40(a)(ia) applies only to amounts outstanding as payable at the end of the year or also to amounts paid during the year.
Issue (i): Whether payments made by the assessee to its holding company under the memorandum of understanding were covered by section 194C of the Income-tax Act, 1961 and liable to disallowance under section 40(a)(ia) for failure to deduct tax at source.
Analysis: The memorandum of understanding was read as a composite arrangement for support services, deputation of personnel, infrastructure and allied facilities. The definitions of facilities and support services were wide, and the agreement provided for agreed service charges rather than a pure reimbursement of actual third-party cost. The arrangement was therefore treated as a contract for work and services within the ambit of section 194C. The alternative plea that the payments were mere reimbursement without profit element was rejected.
Conclusion: The payments were held to fall within section 194C, and the disallowance under section 40(a)(ia) was sustained on this issue.
Issue (ii): Whether section 40(a)(ia) applies only to amounts outstanding as payable at the end of the year or also to amounts paid during the year.
Analysis: The view that disallowance under section 40(a)(ia) is confined to year-end payables was not accepted. The decision preferred the reasoning of the Calcutta High Court and the Gujarat High Court, which held that the provision covers amounts payable at any time during the previous year, not merely sums remaining outstanding on the balance-sheet date. The contrary Special Bench view was treated as not good law, and the Allahabad High Court order was distinguished as not deciding the legal issue on merits.
Conclusion: Section 40(a)(ia) was held applicable to amounts payable during the year as well, not only to year-end outstanding liabilities.
Final Conclusion: The assessee obtained only limited relief in respect of verification of tax deduction and deposit on specific service-fee payments, while the substantive objections to the disallowance were rejected.
Ratio Decidendi: A composite service arrangement with agreed consideration for deputed staff, infrastructure and support services can attract section 194C, and section 40(a)(ia) applies to deductible payments made during the previous year as well as those remaining payable at year end.
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