Arm's length transfer pricing and treaty non-discrimination barred section 40(a)(i) disallowance on non-resident payments.

Where transfer pricing analysis had already accepted the non-resident associated enterprises' transactions at arm's length, no further profit attribution could be made merely on the basis of an alleged permanent establishment or business connection. Applying that principle, and the non-discrimination clause in the Indo-Japan treaty, the Tribunal held that disallowance under section 40(a)(i) for payments to non-residents without tax withholding was not sustainable on these facts. The reassessment-related grounds were not examined on merits because the reassessment proceedings had later been quashed and the remaining grounds were not pressed. The section 40(a)(i) addition was deleted.

---

---

Issues: Whether the disallowance under section 40(a)(i) for payments made to non-resident associated enterprises without deduction of tax at source was sustainable, and whether the reassessment-related grounds survived for adjudication.

Analysis: The appeal was heard in the backdrop of a transfer pricing determination where the transactions with the non-resident associated enterprises had been accepted at arm's length. The Tribunal followed the binding precedent that once the arm's length principle is applied, no further profit attribution can be made merely on the basis of an alleged permanent establishment or business connection. It further applied the non-discrimination principle in the Indo-Japan treaty to hold that the disallowance mechanism under section 40(a)(i), when invoked against non-resident payments in the present facts, could not be sustained. The reassessment grounds were not examined on merits, having become infructuous in view of the subsequent quashing of the reassessment proceedings and other grounds being not pressed.

Conclusion: The addition made under section 40(a)(i) was deleted and the assessee succeeded on the substantive issue.

---