Treaty treatment of technical service fees through a permanent establishment: gross taxation, domestic rate control, and no advance-tax interest.

Fees for technical services effectively connected with an Indian permanent establishment were treated as business profits under Article 7, but deductions remained subject to domestic law; Section 44D, as a non obstante provision, barred expense deductions for the relevant years, so the receipts were computed on a gross basis. The treaty's 10% cap under Article 12(2) did not apply once Article 12(5) routed the income to Article 7, and the applicable rate was governed by Section 115A. Because tax was deductible at source, no advance tax default arose and interest under Sections 234B and 234C was not chargeable.

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Issues: (i) Whether fees for technical services received through a permanent establishment in India were to be computed on a net basis by allowing expenses under Article 7(3) of the India-Germany DTAA, or on a gross basis under Section 44D of the Income-tax Act, 1961; (ii) Whether the tax on such receipts was restricted to 10% under Article 12(2) of the DTAA or governed by Section 115A of the Income-tax Act, 1961; (iii) Whether interest under Sections 234B and 234C of the Income-tax Act, 1961 was leviable.

Issue (i): Whether fees for technical services received through a permanent establishment in India were to be computed on a net basis by allowing expenses under Article 7(3) of the India-Germany DTAA, or on a gross basis under Section 44D of the Income-tax Act, 1961.

Analysis: Article 12(5) excluded the application of Article 12(1) and 12(2) where the beneficial owner carried on business through a permanent establishment in India and the receipts were effectively connected with that establishment, in which case Article 7 applied. Article 7(3) allowed deductions only according to the domestic law of the State in which the permanent establishment was situated. Section 44D, being a non obstante provision, expressly prohibited deductions against royalty or fees for technical services for the relevant assessment years and therefore controlled the computation under the domestic law. Section 44DA was prospective and did not apply retrospectively to agreements covered by Section 44D.

Conclusion: The receipts were taxable on gross basis and no deduction of expenses was allowable under Article 7(3) read with Section 44D.

Issue (ii): Whether the tax on such receipts was restricted to 10% under Article 12(2) of the DTAA or governed by Section 115A of the Income-tax Act, 1961.

Analysis: Once Article 12(5) applied, the receipts were taken out of Article 12(1) and 12(2) and were to be dealt with under Article 7. Article 7 dealt with computation of business profits but did not prescribe a special treaty cap on the rate of tax. The applicable domestic provision therefore governed the rate, and Section 115A prescribed the rate for the relevant category of income. The treaty cap in Article 12(2) could not be imported into an assessment governed by Article 7.

Conclusion: The rate of tax was not restricted to 10% and was governed by Section 115A.

Issue (iii): Whether interest under Sections 234B and 234C of the Income-tax Act, 1961 was leviable.

Analysis: The income was subject to tax deduction at source under Section 195. Where tax is deductible at source, the assessee is not required to pay advance tax, and interest for default in advance tax payment is not chargeable.

Conclusion: Interest under Sections 234B and 234C was not leviable.

Final Conclusion: The challenge to allowance of expenses and the treaty-based 10% rate failed, while the deletion of interest under Sections 234B and 234C was sustained, resulting in dismissal of both the Revenue appeal and the assessee's cross-objections.

Ratio Decidendi: Where treaty computation of fees for technical services is routed through the business profits article and the applicable domestic law contains a non obstante prohibition on deductions, the domestic restriction prevails; and where tax is deductible at source, no advance-tax interest is chargeable.

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