2008 (12) TMI 235 - AT - Income Tax

Tribunal rules on income assessment, expenses disallowance, and interest charges under IT Act

The Tribunal upheld the assessment of income at 20% without allowing deductions for expenses incurred by the PE in India, as per sections 44D and 115A of ... Application of Article 7(3) of DTAA - deductibility of expenses for a permanent establishment in accordance with domestic law - non obstante effect of section 44D - prospective operation of section 44DA - non-application of Article 12(2) cap where Article 12(5) applies - limited operation of Article 24(2) non-discrimination by Article 7(3) - interest under sections 234B and 234C where tax is deductible under section 195Application of Article 7(3) of DTAA - deductibility of expenses for a permanent establishment in accordance with domestic law - non obstante effect of section 44D - Whether expenses incurred by a non-resident through its permanent establishment in India are deductible while computing income by way of royalties or fees for technical services under Article 7(3) of the IndoGerman DTAA. - HELD THAT: - Article 7(3) allows deductions for expenses of a PE but qualifies that such deductions are to be in accordance with the domestic law of the Contracting State. Section 44D of the Incometax Act is a non obstante provision that specifically overrides ss. 28 to 44C and prohibits allowance of deductions in computing income by way of royalties or fees for technical services for agreements within its temporal scope. Reading Article 7(3) with domestic law therefore requires applying the limitations in s. 44D; if domestic law forbids the deduction, Article 7(3) does not independently grant it. The Tribunal, after surveying coordinate decisions of the AAR and other Benches, adopts this combined reading and rejects the assessee's contention that Article 7(3) mandates allowance of expenses irrespective of s. 44D. [Paras 21, 22, 23, 24, 25]Deductions for PE expenses are allowable only in accordance with domestic law; s. 44D's prohibition precludes allowing such deductions for the royalties/fees for technical services in the present cases.Prospective operation of section 44DA - non obstante effect of section 44D - Whether section 44DA (introduced by Finance Act, 2003) operates retrospectively so as to permit deduction of PE expenses for agreements made before 1 April 2003. - HELD THAT: - Section 44DA was inserted with an express effective date and the Finance Act, 2003 amendments separately preserve s. 44D for agreements made before 1 April 2003 and make s. 44DA applicable to agreements made after 31 March 2003. The legislative scheme shows prospective application of s. 44DA; there is no basis to construe it as clarificatory and retrospective. The Tribunal follows coordinate authority holding the amendment substantive and prospective and rejects the assessee's reliance on cases permitting retrospective application of clarificatory provisions where the text and legislative intent differ. [Paras 14, 16, 18]Section 44DA is prospective and cannot be given retrospective effect; s. 44D governs agreements made before 1 April 2003.Non-application of Article 12(2) cap where Article 12(5) applies - application of domestic rate of tax under Article 7 - Whether the 10% cap in Article 12(2) of the DTAA applies to fees for technical services that are taxable as business profits under Article 12(5)/Article 7. - HELD THAT: - Article 12(5) excludes paras 1 and 2 of Article 12 when the beneficial owner performs services through a PE; in that event Article 7 applies and governs computation. Article 7 does not itself fix a rate of tax; taxation of the income computed under Article 7 is to be effected according to domestic law. Consequently, the 10% cap in Article 12(2) is inapplicable once Article 12(5) brings the income within Article 7, and domestic provisions (such as s. 115A where applicable) determine the rate. [Paras 32]Where Article 12(5) applies and income is computed under Article 7, the Article 12(2) cap of 10% does not apply; applicable domestic tax rates govern.Limited operation of Article 24(2) non-discrimination by Article 7(3) - Whether Article 24(2) non-discrimination requires taxing the PE's profits on a net basis notwithstanding Article 7(3) and domestic prohibitions on deductions. - HELD THAT: - Article 24(2) provides that taxation of a PE shall not be less favourably levied than that of domestic enterprises but contains an express proviso that it shall not be construed as preventing a Contracting State from charging the profits of a PE at a rate higher than that imposed on similar domestic companies nor as being in conflict with para 3 of Article 7. Given this express qualification, the nondiscrimination clause does not override Article 7(3) or the domestic law limitations incorporated thereby; therefore Article 24(2) cannot be invoked to negate the effect of s. 44D when Article 7(3) applies. [Paras 30, 31]Article 24(2) does not compel allowance of deductions or a netbasis computation where Article 7(3) and applicable domestic law (including s. 44D) determine computation.Interest under sections 234B and 234C where tax is deductible under section 195 - Whether interest under ss. 234B and 234C is leviable where tax on the relevant income is deductible at source under section 195. - HELD THAT: - Following the Special Bench decision in Motorola Inc. and related authority, where the tax is deductible at source under s. 195 the nonresident payee/assessee is not obliged to pay advance tax and consequently cannot be charged interest under ss. 234B and 234C for failure to pay advance tax. The assessee's income was chargeable to tax and subject to deduction at source under s. 195; accordingly, interest under ss. 234B and 234C cannot be imposed. [Paras 13, 33]No interest under ss. 234B and 234C is leviable where tax is deductible at source under s. 195; the CIT(A)'s deletion of such interest is upheld.Final Conclusion: The Tribunal upheld the CIT(A)'s orders: (1) deductions for PE expenses are governed by domestic law and s. 44D precludes such deductions for the relevant agreements; (2) s. 44DA is prospective and does not apply to agreements before 1 April 2003; (3) the 10% cap in Article 12(2) does not apply where Article 12(5) brings the income under Article 7; (4) Article 24(2) does not override Article 7(3) or domestic limitations; and (5) interest under ss. 234B/234C is not leviable where tax is deductible under s. 195. Consequently the Revenue's appeals and the assessee's crossobjections are dismissed. Issues Involved:1. Assessment of income under DTAA between India and Germany.2. Allowance of expenses incurred by the PE in India.3. Levy of interest under sections 234B and 234C of the IT Act.4. Applicability of section 44DA retrospectively.5. Non-discrimination clause under Article 24(2) of the DTAA.6. Rate of tax applicable to fees for technical services.Detailed Analysis:1. Assessment of Income under DTAA between India and Germany:The assessee, a non-resident company and tax resident of Germany, argued that its income should be assessed at 10% under Article 12(2) of the DTAA between India and Germany. However, the AO assessed the income at 20% as per sections 44D and 115A of the IT Act, without allowing deductions for expenses incurred by the PE in India. The CIT(A) confirmed this view, stating that income should be computed on gross fees received, applying the provisions of section 115A, and the rate of tax should be 20%.2. Allowance of Expenses Incurred by the PE in India:The assessee contended that under Article 7(3) of the DTAA, all expenses incurred for the purpose of the business of the PE, including executive and general administrative expenses, should be allowed. However, the AO and CIT(A) held that the expenses are subject to domestic law, specifically section 44D, which prohibits any deduction against income by way of royalty or fees for technical services. The Tribunal upheld this view, stating that the provisions of section 44D are non obstante and override sections 28 to 44C, thereby disallowing any deductions.3. Levy of Interest under Sections 234B and 234C of the IT Act:The Revenue challenged the CIT(A)'s decision to delete the interest levied under sections 234B and 234C. The Tribunal, following the Special Bench decision in Motorola Inc. and the Uttaranchal High Court decision in Halliburton Offshore Services Inc., held that no interest under sections 234B and 234C can be charged where tax is deductible at source under section 195. Consequently, the issue was decided against the Revenue.4. Applicability of Section 44DA Retrospectively:The assessee argued that section 44DA, introduced by the Finance Act, 2003, should be applied retrospectively as it is clarificatory in nature. The Tribunal rejected this contention, noting that section 44DA applies prospectively to agreements made after 31st March 2003, while section 44D applies to agreements made before 1st April 2003. The Tribunal cited the decision in Steel Authority of India Ltd., affirming that section 44DA is not retrospective.5. Non-Discrimination Clause under Article 24(2) of the DTAA:The assessee argued that applying section 44D amounts to discrimination under Article 24(2) of the DTAA. The Tribunal held that Article 24(2) does not apply where Article 7(3) applies, as the non-discrimination clause is not in conflict with the provisions of Article 7(3). Therefore, the contention that the determination of profits under domestic law amounts to discrimination was rejected.6. Rate of Tax Applicable to Fees for Technical Services:The assessee contended that the rate of tax should be 10% as per Article 12(2) of the DTAA. The Tribunal noted that Article 12(5) excludes the applicability of paragraphs 1 and 2 of Article 12 when the beneficial owner of the income carries on business through a PE in the other Contracting State. Thus, the income is governed by Article 7, which does not specify a rate of tax, and therefore, the domestic law rate of 20% as per section 115A applies. The Tribunal rejected the assessee's contention.Conclusion:The Tribunal upheld the orders of the CIT(A), confirming the assessment of income at 20% without allowing deductions for expenses incurred by the PE in India as per sections 44D and 115A. The Tribunal also ruled that no interest under sections 234B and 234C can be charged where tax is deductible at source. The appeals of the Revenue and the cross-objections of the assessee were dismissed.