Treaty-protected reimbursement and no repeated disallowance under section 40(a)(i) for prior-year expenditure.

Lease line charges reimbursed on a cost-to-cost basis, with no income element, were treated as treaty-protected payments and not as royalty or fees for technical services. The domestic amendment to the definition of royalty in section 9(1)(vi) could not override the unamended India-USA treaty, so section 195 withholding was not attracted and the consequential disallowance under section 40(a)(i) failed. Amounts pertaining to an earlier year, already booked and allowed then, could not be disallowed again in the year of payment under section 40(a)(i), which applies only at accrual or payment, whichever is earlier.

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Issues: (i) whether lease line charges reimbursed to the associated enterprise were chargeable as royalty or fees for technical services so as to attract deduction of tax at source and disallowance under section 40(a)(i); (ii) whether the amount relating to the earlier year but paid during the year under appeal could again be disallowed under section 40(a)(i).

Issue (i): whether lease line charges reimbursed to the associated enterprise were chargeable as royalty or fees for technical services so as to attract deduction of tax at source and disallowance under section 40(a)(i).

Analysis: The payments were found to be on a cost-to-cost reimbursement basis with no income element. The underlying bandwidth arrangement was between the foreign service provider and the overseas group company, and the treaty definition of royalty was not amended. The domestic amendment to section 9(1)(vi) could not be read into the India-USA treaty. Since the amount was not taxable in the hands of the recipient under the treaty, section 195 was not attracted and the consequential disallowance could not stand. The acceptance of the international transaction by the TPO as reimbursement at arm's length also supported this conclusion.

Conclusion: The issue was decided in favour of the assessee; no tax was required to be withheld on the lease line reimbursements and section 40(a)(i) disallowance was unsustainable.

Issue (ii): whether the amount relating to the earlier year but paid during the year under appeal could again be disallowed under section 40(a)(i).

Analysis: The amount had already been booked and allowed in the preceding year. Section 40(a)(i) operates at the stage of accrual or payment, whichever is earlier, and therefore could not be invoked again in the year under appeal for the same expenditure.

Conclusion: The issue was decided in favour of the assessee; the second disallowance was deleted.

Final Conclusion: The additions made for non-deduction of tax on lease line charges were deleted in full, and the assessee's appeal succeeded.

Ratio Decidendi: A payment that is merely a treaty-protected reimbursement with no income element does not attract withholding tax, and a unilateral domestic amendment to the definition of royalty cannot enlarge liability under an unamended DTAA.

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