2022 (2) TMI 1518 - AT - Income Tax

Service tax and VAT excluded from gross receipts under Sec 44BB; Article VII covers PE-connected interest, refund interest Article 11(2).

ITAT DELHI - AT held that service tax and VAT collected are not part of gross receipts under Sec 44BB, following the Delhi HC line that such amounts are ... VAT & Service Tax u/s 44BB - AO held that the receipts on account of service tax and VAT are in the nature of royalty/FTS u/s 9(1)(vi)/9(1)(vii) - HELD THAT:- We have examined the issue of inclusion of service tax and VAT with reference to the provisions of Section 44BB in the light of the judgment of Mitchell Drilling International Pvt. Ltd. [2015 (10) TMI 259 - DELHI HIGH COURT] which held as under for the purposes of computing the presumptive income of the assessee for the purposes of Section 44BB the service tax collected by the assessee on the amount paid to it for rendering services was not to be included in the gross receipts in terms of Section 44BB(2) read with Section 44BB(1). The service tax is not an amount paid or payable, or received or deemed to be received by the assessee for the services rendered by it. The assessee only collected the service tax for passing it on to the Government. Interest Income - AO taxed the interest on Income Tax Return @40% whereas the assessee pleaded that it should be taxed @10% in terms of Article 11 of Indo-Cyprus DTAA - HELD THAT:- Article VII deals with taxation of business profits and also provides for mechanism to compute the profits of the business. Paragraph no. 4 relieves the source State from the rigors of paragraphs nos. (1) and (2) in case the interest is found to be effectively connected with the PE, even if it is not in the nature of business income of the assessee but is effectively connected with the PE. If interest is the business income as a matter of fact, such income falls automatically within the ambit of Article VII without even taking recourse of paragraph no. 4. Therefore, this paragraph contemplates a different condition upon whose satisfaction interest becomes taxable under Article VII. It is an accepted canon of interpretation that no part of the statute should be rendered null and void by interpretation. Therefore, some meaning has to be placed on the contents of this paragraph. Interest income need not be necessarily business income in nature for establishing the effective connection with the PE because that would render provision contained in paragraph 4 of Article XI redundant. Thus, there may be cases where interest may be taxable under the Act under the residuary head and yet be effectively connected with the PE. The bank interest in this case is an example of effective connection between the PE and the income as the indebtedness is closely connected with the funds of the PE. Interest on income tax refund is not effectively connected with the PE either on the basis of asset-test or activity-test. Hence, it is taxable as per the provisions in the Para No. 2 of Article 11 of Indo-Cyprus DTAA. ISSUES PRESENTED AND CONSIDERED 1. Whether amounts collected as service tax and value added tax (VAT) are includible in 'gross receipts' for computation of presumptive income under Section 44BB of the Income-tax Act. 2. Whether interest received on an income-tax refund is taxable as business income attributable to a Permanent Establishment (PE) in the source State (and therefore taxable at domestic maximum marginal rate) or is eligible for taxation under the relevant DTAA interest provision (limited rate/exemption), including the application of Section 90(2) (more beneficial rule) and the concept of 'effective connection' of the debt claim with the PE (Article 11 read with Article 7/paragraph 4 and related paragraphs of the DTAA). ISSUE-WISE DETAILED ANALYSIS Issue 1 - Inclusion of Service Tax and VAT in Gross Receipts under Section 44BB Legal framework: Section 44BB prescribes a presumptive scheme for computation of profits of non-resident assessees engaged in specified activities, by applying a fixed percentage to 'gross receipts'. The question centers on whether statutory levies collected from clients (service tax and VAT) constitute receipts 'paid or payable' to the assessee for services rendered or are amounts merely collected on behalf of government and thus excluded from gross receipts. Precedent Treatment: The Tribunal relied on the decision of the Delhi High Court in the principal authority which held that service tax collected by an assessee for rendering services is not to be included in gross receipts for Section 44BB purposes because the assessee merely collects it to pass on to the government and it is not an amount paid or payable, or received or deemed to be received by the assessee for the services rendered. Interpretation and reasoning: The Court framed the issue as one of substance over form - whether the collected tax constitutes part of receipts for services or is a statutory levy held in trust for the government. Applying the established jurisprudence, it concluded that service tax (and by parity VAT) are not amounts that enrich the assessee and therefore do not form part of the gross receipts subject to presumptive taxation under Section 44BB. The Tribunal expressly treated the appellate authority's decision as based on 'established jurisprudence' and declined to interfere. Ratio vs. Obiter: Ratio - the legal conclusion that statutory indirect taxes collected and passed on to government (service tax/VAT) are not includible in gross receipts for computation under Section 44BB; Obiter - any ancillary observations about the general scope of Section 44BB beyond the specific nature of statutory levies. Conclusion: Receipts on account of service tax and VAT are excluded from gross receipts for the purpose of computing presumptive income under Section 44BB; the assessing officer's addition of such amounts to gross receipts was not sustained. Issue 2 - Taxability of Interest on Income-Tax Refund: DTAA Benefit, Section 90(2), and 'Effective Connection' with PE Legal framework: The interplay between domestic law and DTAA: Section 90(2) provides that where DTAA provisions apply, the provisions more beneficial to the assessee shall apply. The DTAA provision on interest (Article 11) permits taxation in the State of residence and limits source State taxation (e.g., 10%), but paragraph 5/4 of Article 11 and Article 7 create an exception where the beneficial owner carries on business through a PE in the source State and the debt claim is effectively connected with that PE - in which case Article 7 (business profits) applies and source State may tax. Precedent Treatment: The Tribunal considered the treaty text and domestic positions argued by parties; it did not rely on any contrary precedent but applied treaty interpretation principles and the statutory 'more beneficial' rule under Section 90(2). Interpretation and reasoning: Two analytical strands were followed. (a) Application of Section 90(2) and the 'more beneficial' test - the Tribunal articulated a practical test: compare tax payable under the DTAA with tax payable under domestic law; if DTAA results in a lower tax, the assessee is entitled to DTAA benefit automatically. Applying this, the Tribunal calculated that taxation of the interest under domestic law (as income under other sources/business at rates applicable to a foreign company) would produce tax in excess of the treaty rate; therefore Section 90(2) mandates application of the DTAA rate. (b) Effective connection test under the DTAA - the Tribunal examined whether the interest on the income-tax refund was 'effectively connected' with the PE by either the asset-test or activity-test. It reasoned that interest need not be business income to be effectively connected (to avoid rendering paragraph 4 of Article 11 redundant), but there must be a close link between the indebtedness and the PE's funds/activities. Applying the facts, the Tribunal found that the indebtedness (refund interest) was not effectively connected to the PE: the debt claim did not satisfy the asset/activity connection required by the treaty; hence paragraph 2 of Article 11 applied and source State tax was limited to the treaty percentage. Ratio vs. Obiter: Ratio - (1) where DTAA application yields lower tax than domestic law, Section 90(2) requires application of the DTAA without exercise of option; (2) interest on income-tax refund in the facts of the case was not effectively connected with the PE and therefore fell within the limited source taxation under Article 11 (paragraph 2) rather than as business profits under Article 7; (3) accordingly the source State could not tax the interest at domestic maximum marginal rate. Obiter - interpretive remarks on the non-redundancy of paragraph 4 of Article 11 and generalized tests (asset/activity) for effective connection beyond the facts. Conclusion: Interest on the income-tax refund was not effectively connected with the PE; the tax computed under the DTAA (Article 11 - limited rate) was more beneficial than domestic taxation; therefore the assessee was entitled to treaty benefits and the assessing officer's imposition of tax at the maximum marginal rate was overturned. Disposition On the issues considered the Tribunal dismissed the Revenue appeals and allowed the assessee's cross-objection: (i) statutory indirect taxes collected (service tax and VAT) are excluded from gross receipts for Section 44BB; and (ii) interest on income-tax refund is taxable under the DTAA interest article (limited source taxation) because it was not effectively connected with the PE and the DTAA was more beneficial under Section 90(2).