Treaty protocol limits fee for technical services, so overseas fabric testing payment escapes withholding tax.

Testing charges paid to a Spanish non-resident for services performed outside India were not fee for technical services under the India-Spain DTAA because the protocol imported the more restrictive India-UK treaty definition. As the Spanish recipient had no permanent establishment in India, the Tribunal held that the payment fell outside the scope of fee for technical services and section 195 withholding was not triggered. Consequentially, the disallowance under section 40(a)(ia) could not be sustained.

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Issues: Whether the payment made to the Spanish non-resident for fabric testing constituted fee for technical services under the India-Spain DTAA so as to attract tax deduction at source under section 195 and disallowance under section 40(a)(ia) of the Income-tax Act, 1961.

Analysis: The payment was made for testing services rendered by the Spanish entity outside India and the entity had no permanent establishment in India. Paragraph 7 of the Protocol to the India-Spain DTAA required the more restricted scope of fee for technical services appearing in the India-UK DTAA to be read into the India-Spain DTAA, because the India-UK treaty entered into force after 1 January 1990. On that basis, the expression fee for technical services was not to be given a wider meaning so as to cover the present testing charges. The Tribunal followed the Delhi High Court view that the protocol mechanism imports the more beneficial and restrictive treaty definition.

Conclusion: The payment did not constitute fee for technical services and section 195 had no application; the disallowance under section 40(a)(ia) could not be sustained.

Ratio Decidendi: Where a protocol to a DTAA incorporates a more restrictive treaty definition from another treaty with a third OECD State, that restrictive definition applies and a payment falling outside it is not subject to withholding tax under section 195.

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