Tribunal rules in favor of assessee, denies tax deduction on payments to HRD, allows additional depreciation for manufacturing.

The Tribunal upheld the CIT(A)'s decision, dismissing the Revenue's appeal. It ruled that payments to HRD were not subject to tax deduction at source as they did not constitute 'fees for technical services.' Additionally, the assessee was entitled to additional depreciation for diamond cutting and polishing activities, considered as manufacturing under Section 32(1)(iia) of the Income Tax Act.

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Issues Involved:
1. Disallowance under Section 40(a)(i) of the Income Tax Act due to non-deduction of tax at source on payment to HRD, Antwerp NV, Belgium.
2. Entitlement to additional depreciation under Section 32(1)(iia) of the Income Tax Act for cutting and polishing diamonds.

Issue 1: Disallowance under Section 40(a)(i) due to Non-Deduction of Tax at Source

The Revenue challenged the deletion of disallowance of Rs. 22,95,152/- under Section 40(a)(i) of the Income Tax Act, which was made by the Assessing Officer (AO) on the grounds that the assessee failed to deduct tax at source on payments made to HRD, Antwerp NV, Belgium. The CIT(A) set aside the disallowance, holding that Section 40(a)(i) was inapplicable as the assessee was not required to deduct tax at source on such payments.

The assessee, a partnership firm engaged in importing, cutting, polishing, and selling diamonds, paid HRD for grading and certification services conducted entirely in Belgium. The AO contended that these payments were for technical services, thus taxable in India under Section 9(1)(vii) of the Act and the India-Belgium DTAA, requiring tax deduction at source under Section 195(1). The CIT(A) disagreed, citing HRD's lack of a Permanent Establishment (PE) in India and the nature of services not constituting 'fees for technical services' as per the India-United Kingdom DTAA, which applies due to the Most Favoured Nation (MFN) clause in the India-Belgium DTAA.

The Tribunal upheld the CIT(A)'s decision, noting that the services did not involve the transfer of technical knowledge to the assessee and thus did not qualify as 'fees for technical services.' The Tribunal also supported the alternative plea that the retrospective amendment to Section 9(1)(vii) by the Finance Act, 2010, could not retroactively impose a tax deduction obligation on the assessee for payments made when no such obligation existed.

Issue 2: Entitlement to Additional Depreciation under Section 32(1)(iia)

The Revenue contested the CIT(A)'s decision allowing additional depreciation of Rs. 18,26,347/- under Section 32(1)(iia) for new plant and machinery used in cutting and polishing diamonds. The AO denied the claim, referencing the Supreme Court's decision in Gem India Manufacturing Co., which held that diamond cutting and polishing did not constitute manufacturing.

The CIT(A) allowed the additional depreciation, relying on the Tribunal's decision in Sheetal Diamonds Ltd., which considered the process of cutting and polishing as manufacturing. The Tribunal affirmed this, referencing multiple decisions that supported the view that cutting and polishing diamonds constitutes manufacturing, thus entitling the assessee to additional depreciation under Section 32(1)(iia).

Conclusion:

The Tribunal dismissed the Revenue's appeal, upholding the CIT(A)'s decisions on both issues. The payments to HRD were not subject to tax deduction at source, and the assessee was entitled to additional depreciation for its manufacturing activities involving diamond cutting and polishing.

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