2021 (3) TMI 1476 - HC - Income Tax

HC allows appeal on TDS disallowance under Section 40(a)(i) for crude oil payments to HEPI

M/s. Chennai Petroleum Corporation Limited Versus The Joint Commissioner of Income-tax, Chennai

The Madras HC allowed the appeal regarding TDS disallowance under Section 40(a)(i) for payments made to HEPI for crude oil purchase. The court held that ... TDS u/s 195 - disallowance u/s 40(a)(i) - payment made to HEPI for purchase of crude oil - HELD THAT:- As pointed out by the observations of the Hon'ble Supreme Court in G.E.Technology Centre P Ltd. [2010 (9) TMI 7 - SUPREME COURT] that the words “such sum” clearly indicate that the observation refers to case of composite payment where the payer has a doubt regarding the inclusion of an amount in such payment, which is exigible to tax in India. Therefore, the AO fell in error in not addressing the question as to when an application under Section 195(2) of the Act is required to be made by the assessee. CIT(A) proceeded on a tangent probably due to the contentions, which were advanced by the assessee when the case was heard by the first appellate authority. We say so because in the grounds, which were raised before the CIT(A), this issue was not one of the grounds, which was highlighted. The core issue that should have been decided is whether Section 195 requires that tax is to be deducted at source for the payment made to HEPI, as the assessee contended that such deduction would be required only if the amount is chargeable to tax. The effect of both the circulars were once again reiterated by circular dated 26.10.2016. Though the circulars will not bind the Court, yet the circulars would be binding upon the Revenue, as it would serve as a guidance to the AO to take a decision in the matter. Therefore, we are of the view that the assessment requires to be redone. Firstly, to examine the facts and take a decision qua, the claim made by the assessee that when there is no income chargeable to tax in India, then there is no requirement for deducting tax at source under the provisions of the Act. Therefore, this core issue needs to be decided by the AO for which a thorough factual examination has to be done and it is only thereafter the law on the subject should be applied to the facts and not vice versa. This appeal is allowed, the impugned orders are set aside, insofar as it relates to the issue regarding the disallowance u/s 40(a)(i) of the Act and the matter is remanded to the AO for a fresh decision on merits and in accordance with law. The core legal questions considered by the Court in this appeal under Section 260A of the Income Tax Act, 1961, pertain to the applicability and interpretation of provisions relating to tax deduction at source (TDS) under Section 195, disallowance under Section 40(a)(i), and the interplay of these provisions with the Double Taxation Avoidance Agreement (DTAA) between India and the USA. The issues can be enumerated as follows:(i) Whether the Tribunal was correct in upholding the disallowance under Section 40(a)(i) of the Act for non-deduction of tax under Section 195(1) on the total gross payments made for purchase of crude oil from the Indian Permanent Establishment (PE) of the non-resident entity, rather than on the profit chargeable to tax.(ii) Whether the Tribunal erred by not considering Article 7 of the India-USA DTAA, the Supreme Court's ratio in G.E. Technology Centre Pvt Ltd vs. CIT, and CBDT clarifications, in failing to direct the Assessing Officer (AO) to first determine the income chargeable to tax under the Act before computing any disallowance under Section 40(a)(i), especially when the assessee had not applied under Section 195(2).(iii) Whether the Tribunal erred in not holding that further disallowance in the hands of the payer, when the recipient had already paid the requisite tax, would amount to double taxation.(iv) Whether the Tribunal erred in not holding that under Section 191, once the payee has paid the tax, TDS cannot be recovered from the payer and thus no disallowance under Section 40(a)(i) can be made.(v) Whether the Tribunal erred in not applying the Non-Discrimination provision under Article 26(3) of the DTAA, which requires that payments to a non-resident of the USA be treated on the same footing as payments to an Indian resident, thus precluding disallowance for non-deduction of tax on payments for purchase of crude oil.(vi) Whether the Tribunal erred in not applying Article 26(3) of the DTAA and the provisos to Sections 40(a)(ia) and 201(1), in light of the Delhi High Court decision in CIT vs. Ansal Land Mark Township Pvt Ltd, to hold that no disallowance can be made once the recipient has paid the tax.(vii) Whether the Tribunal erred in not restricting the disallowance under Section 40(a)(i) to the amount of income actually chargeable to tax in the hands of the recipient.Each of these issues revolves around the central question of whether tax deduction under Section 195 is required on the gross payments made for purchase of crude oil from a non-resident, or only on the income element chargeable to tax, and the consequent validity of disallowance under Section 40(a)(i) for non-deduction.Regarding the first issue, the Court examined the relevant statutory provisions-Section 195(1) mandates deduction of tax at source on sums chargeable to tax under the Act when paid to non-residents. Section 40(a)(i) disallows expenses where tax deduction is statutorily required but not made. The Tribunal upheld disallowance on the gross payment amount, treating the entire purchase price as liable for TDS without segregating the income element.The Court noted that the Assessing Officer and subsequent authorities failed to address whether the payments for purchase of crude oil constituted sums 'chargeable to tax' under the Act. The assessee argued that the payments were for purchase consideration, not income, and thus not liable for TDS under Section 195. The Court relied heavily on the Supreme Court's decision in G.E. Technology Centre Pvt Ltd vs. CIT, which clarified that Section 195 applies only to sums chargeable to tax. The Court quoted paragraph 10 of that judgment extensively, emphasizing that tax deduction is required only if the payment includes an amount chargeable to tax in India. If the payment is a composite one with an embedded income element, the payer may apply under Section 195(2) to determine the appropriate amount for deduction. However, if the amount is not chargeable to tax, no deduction is required.The Court found that the AO and the Tribunal erred by not applying this principle, and by mechanically applying disallowance on the gross payment without determining the taxable income component. The Court observed that the assessee did not apply under Section 195(2), but that failure did not automatically justify disallowance on the entire payment amount.On the second and related issues concerning the DTAA and non-discrimination provisions, the Court noted that the Tribunal did not consider Article 7 (Business Profits) and Article 26(3) (Non-Discrimination) of the India-USA DTAA. Article 7 restricts taxation to profits attributable to a Permanent Establishment, and Article 26(3) mandates that residents of one contracting state should not be subjected to more burdensome taxation than residents of the other state in similar circumstances. The Court held that these provisions require that payments to a non-resident USA entity should be treated as if made to a resident, particularly since payments for purchase of crude oil from an Indian PE of the non-resident do not attract tax deduction if no income is chargeable.The Court also referred to the provisos to Sections 40(a)(ia) and 201(1) and the Delhi High Court decision in CIT vs. Ansal Land Mark Township Pvt Ltd, which held that no disallowance or recovery of TDS can be made from the payer once the recipient has paid the tax. This principle was not considered by the Tribunal.On the issue of double taxation, the Court agreed with the assessee's contention that disallowing the expense in the hands of the payer when the recipient has already paid tax would amount to double taxation, which is contrary to the principles underlying the Income Tax Act and the DTAA.Regarding the procedural aspect, the Court noted that the assessee had raised these grounds before the CIT(A), but the CIT(A) and the Tribunal proceeded on different lines, failing to decide the core issue of whether the payments were chargeable to tax and whether TDS was required. The Court observed that the assessee's inconsistent presentation of the case contributed to the confusion and misdirection in the orders below.The Court also considered the CBDT circulars issued in 2014, 2015, and 2016, which clarified the approach to deduction of tax under Section 195 where no application under Section 195(2) is filed. These circulars direct the Assessing Officer to determine the appropriate proportion of the sum chargeable to tax for computing tax liability and deem the deductor as an assessee in default accordingly. Although these circulars postdated the assessment and CIT(A) orders, they were relevant to the Tribunal's order and could have been placed on record. The Court held that these circulars, while not binding on the Court, are binding on the Revenue and serve as valuable guidance.Applying the law to the facts, the Court found that the impugned orders failed to undertake a factual examination to ascertain whether any part of the payment to HEPI was chargeable to tax in India. The Court held that the assessment requires to be reopened and redone with a proper factual inquiry, followed by correct application of the law as clarified by the Supreme Court and CBDT instructions.The Court rejected the disallowance under Section 40(a)(i) made on the gross payment amount without determining the taxable income component. It remanded the matter to the Assessing Officer for a fresh decision on merits and in accordance with law, allowing the assessee to place additional material and relevant decisions.In conclusion, the Court set aside the impugned orders insofar as they related to the disallowance under Section 40(a)(i) and remanded the matter for fresh adjudication. The substantial questions of law were left open for determination on fresh facts.Significant holdings include the following verbatim excerpt from the Supreme Court decision in G.E. Technology Centre Pvt Ltd (quoted with emphasis):'If one reads the observation of the Supreme Court, the words 'such sum' clearly indicate that the observation refers to a case of composite payment where the payer has a doubt regarding the inclusion of an amount in such payment which is exigible to tax in India. In our view, the above observations of this Court in Transmission Corporation case which is put in italics has been completely, with respect, misunderstood by the Karnataka High Court to mean that it is not open for the payer to contend that if the amount paid by him to the non-resident is not at all 'chargeable to tax in India', then no TDS is required to be deducted from such payment. This interpretation of the High Court completely loses sight of the plain words of Section 195(1) which in clear terms lays down that tax at source is deductible only from 'sums chargeable' under the provisions of the I.T. Act...'Core principles established are:Tax deduction under Section 195 is required only on sums that are chargeable to tax in India, not on gross payments devoid of taxable income.Where a payment is composite, and the payer is uncertain about the taxable portion, an application under Section 195(2) must be made to determine the amount on which TDS is deductible.Disallowance under Section 40(a)(i) cannot be mechanically applied on gross payments without first ascertaining the taxable income component.Once the recipient has paid the tax, further disallowance or recovery of TDS from the payer is impermissible under Section 191 and the provisos to Sections 40(a)(ia) and 201(1).Non-Discrimination provisions of the DTAA require that payments to non-residents be treated on the same basis as payments to residents, preventing discriminatory disallowance for non-deduction of tax.CBDT circulars provide administrative guidance that the AO must determine the proportion of the sum chargeable to tax when no application under Section 195(2) is filed.Final determinations on the issues are that the disallowance under Section 40(a)(i) on the gross payments made to the non-resident for purchase of crude oil was not sustainable. The matter is remanded for fresh examination of facts and correct application of law, including consideration of DTAA provisions and CBDT circulars, to determine whether any part of the payment is chargeable to tax and whether TDS was required to be deducted.