Withholding tax on composite equipment supply and installation payments rejected where linked services were ancillary to the sale.

Payments made under a composite equipment supply and installation arrangement were held not to attract withholding tax where site acceptance testing, installation and training were ancillary and inextricably linked to the sale; under the India-USA DTAA they were not treated as fees for included services or royalty, so section 195 did not apply. The Swiss payment issue was not pressed, while the South African payment issue was remanded only to verify whether tax had in fact been deducted and deposited. Prior period expenses were also allowed because they had crystallised in the relevant year and were considered alongside corresponding prior period income, so the disallowance was deleted.

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Issues: (i) Whether tax was deductible under section 195 on payments made to foreign entities for equipment supply, site acceptance testing, installation and training, and whether the disallowance for non-deduction of tax was sustainable; (ii) Whether the disallowance of prior period expenses was justified.

Issue (i): Whether tax was deductible under section 195 on payments made to foreign entities for equipment supply, site acceptance testing, installation and training, and whether the disallowance for non-deduction of tax was sustainable.

Analysis: The payment to the USA supplier arose from a composite arrangement for supply and installation of equipment, with testing and training forming ancillary and subsidiary services intrinsically linked to the sale. Under Article 12 of the India-USA DTAA, fees for included services do not cover amounts paid for services that are ancillary and subsidiary and inextricably and essentially linked to the sale of property. Such receipts were therefore not treated as fees for included services or royalty, and in the absence of a taxable income position under the treaty, the obligation to deduct tax at source did not arise. The payment to the Swiss entity was not pressed, while the remand relating to the South African entity was confined to verification of whether tax had in fact been deducted and deposited.

Conclusion: The disallowance relating to the USA payment was deleted, the Swiss payment issue remained against the assessee as not pressed, and the South African payment issue was remanded for verification.

Issue (ii): Whether the disallowance of prior period expenses was justified.

Analysis: The assessee had reflected both prior period expenses and prior period income during the year, and the expenditure was treated as having crystallized in the relevant year. On that basis, the prior period items were required to be considered in computing the income, and the disallowance was not sustained.

Conclusion: The disallowance of prior period expenses was set aside and the claim was allowed.

Final Conclusion: The appeal succeeded only in part, with relief granted on the main tax deduction controversy for one payment stream and on prior period expenses, while one foreign payment issue was remanded and another was left undisturbed.

Ratio Decidendi: Services that are ancillary and subsidiary to, and inextricably linked with, the sale of equipment under a composite contract do not constitute fees for included services under the treaty and do not attract withholding tax where the payment is not otherwise chargeable in India; prior period expenses are allowable where they crystallize in the relevant year and are considered along with corresponding prior period income.

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