Treaty classification of deputed personnel fees, gross taxation, and ad hoc transfer pricing mark-up disallowed

Remuneration for deputed managerial and technical personnel was treated differently depending on the service character and treaty classification: the Vice President (Manufacturing) services were regarded as technical in nature and the related receipts were characterised as fees for included services under the India-US DTAA. For the same income stream, the Tribunal held that treaty-based deductions were constrained by domestic law, so netting of expenses was not available and the receipts were taxable on a gross basis. It also deleted an ad hoc 10% transfer pricing mark-up because no prescribed benchmarking method had been applied, and held that interest for shortfall in advance tax was not leviable where tax was to be deducted at source.

---

---

Issues: (i) Whether the remuneration for deputed managerial and technical personnel was taxable as fees for included services under the India-US DTAA or as business profits; (ii) whether the receipts could be taxed on gross basis or had to be computed on net basis; (iii) whether a 10% mark-up could be added under transfer pricing provisions; and (iv) whether interest under section 234B of the Income-tax Act, 1961 was leviable.

Issue (i): Whether the remuneration for deputed managerial and technical personnel was taxable as fees for included services under the India-US DTAA or as business profits.

Analysis: The dispute turned on the nature of services rendered by the deputed personnel and the effect of the advance ruling. The Tribunal held that the ruling of the Authority for Advance Ruling was not an absolute and unqualified determination on the Vice President (Manufacturing) issue, because it expressly left the factual position open for examination in appropriate proceedings. On the facts available, and in the absence of the service agreement or other evidence showing the actual nature of the services, the Tribunal agreed that the services of the Vice President (Manufacturing) were technical in character and that the technology and expertise were effectively made available to the Indian entity. It further held that the managerial services limb of Article 12 did not apply in the same way to the President and Managing Director, but the appeal before it concerned the adverse finding on the Vice President (Manufacturing).

Conclusion: The receipts attributable to the Vice President (Manufacturing) were held taxable as fees for included services and not as merely non-taxable reimbursement or purely managerial services.

Issue (ii): Whether the receipts could be taxed on gross basis or had to be computed on net basis.

Analysis: The Tribunal read Article 7(3) of the DTAA with section 44D of the Income-tax Act, 1961 and held that the treaty itself subjects deductions in computing permanent establishment profits to the limitations of domestic law. Since section 44D prohibits deduction of expenditure in computing income by way of fees for technical services in the relevant period, the Tribunal held that the assessee was not entitled to netting of expenses for this component of income. The reliance placed on earlier coordinate bench decisions was distinguished on the ground that the interaction between the treaty and section 44D had not been brought to the notice of the earlier bench in the same manner.

Conclusion: The receipts were held taxable on gross basis and not on net profit basis.

Issue (iii): Whether a 10% mark-up could be added under transfer pricing provisions.

Analysis: The Tribunal held that the lower authorities had not benchmarked the transactions by any prescribed method under the transfer pricing rules and had merely adopted a 10% mark-up without proper basis. It accepted the assessee's contention that, on the material available and in light of the subsequent transfer pricing determination, no mark-up was warranted on the reimbursement of costs for the deputed personnel.

Conclusion: The 10% mark-up addition was deleted.

Issue (iv): Whether interest under section 234B of the Income-tax Act, 1961 was leviable.

Analysis: Following binding jurisdictional precedent, the Tribunal held that where the payer was required to deduct tax at source on income of a non-resident, interest under section 234B could not be levied on the non-resident assessee for shortfall in advance tax. The issue was treated as covered by earlier High Court rulings.

Conclusion: Interest under section 234B was not leviable.

Final Conclusion: The appeals succeeded only in part, with relief granted on the transfer pricing adjustment and section 234B interest, while the challenge to taxation of the deputation income on gross basis failed.

Ratio Decidendi: For computing profits attributable to a permanent establishment or income characterised as fees for included services, the treaty allowance for deductions operates subject to the domestic law restrictions applicable to that income, and where no prescribed benchmarking method is applied the Revenue cannot sustain an ad hoc transfer pricing mark-up.

---