Treaty cap on royalty tax and excluded service tax deductions: ITAT rules domestic surcharge and cess cannot exceed the DTAA rate.
ITAT Mumbai held that service tax deducted by customers under reverse charge did not constitute income of the assessee because it was neither received nor accrued, and the assessee had no enforceable right to recover it; the addition was deleted subject to factual verification. It further held that surcharge, education cess and secondary and higher education cess could not be levied over and above the 10% treaty rate on royalty under the India-France DTAA, because the treaty cap governed the tax liability and domestic levies could not exceed it. The assessment was to be recomputed accordingly.
Issues: (i) Whether the amount deducted by customers towards service tax under the reverse charge mechanism could be treated as income of the assessee. (ii) Whether surcharge, education cess and secondary and higher education cess could be levied over and above the 10% rate prescribed under the India-France DTAA for royalty income.
Issue (i): Whether the amount deducted by customers towards service tax under the reverse charge mechanism could be treated as income of the assessee.
Analysis: The amount was not received by the assessee and did not accrue to it. The customers deducted the service tax component from the royalty payable, discharged that liability with the revenue, and the assessee had accepted the reduced remittance without retaining any enforceable right to recover the deducted amount. On these facts, the amount retained the character of tax liability adjustment and not of income in the hands of the assessee.
Conclusion: The addition made on account of service tax deduction was not sustainable and was deleted subject to verification of the factual claim by the Assessing Officer. The issue was decided in favour of the assessee.
Issue (ii): Whether surcharge, education cess and secondary and higher education cess could be levied over and above the 10% rate prescribed under the India-France DTAA for royalty income.
Analysis: The treaty rate under Article 13, read with Article 2 of the India-France DTAA, governed the tax on royalty income. Since the treaty framework included surcharge within the tax description and education cess was treated as akin to an additional surcharge, the domestic levy could not expand the treaty capped rate. The tax liability on royalty income therefore had to remain confined to 10% under the treaty.
Conclusion: The surcharge and cess could not be levied over and above the treaty rate, and the tax had to be recomputed accordingly. The issue was decided in favour of the assessee.
Final Conclusion: The appeals succeeded on the substantive issues, and the assessment was required to be modified in line with the treaty cap and the exclusion of the service tax component from income.
Ratio Decidendi: Amounts not received and not accrued cannot be taxed as income, and where a tax treaty prescribes a capped rate, domestic surcharge and cess cannot be added to exceed that cap if the treaty language governs the tax liability.