2009 (2) TMI 259 - AT - Income Tax

Payments to Parent Company Deemed Reimbursements; Not Taxable Under Section 195. Section 42 Overrides Section 40(a)(i) Provisions.

The Tribunal allowed the assessee's appeals, holding that payments made to its parent company were reimbursements without a profit element, thus not ... Disallowance of expenditure u/s. 40(a)(i) - failed to deduct tax at source u/s. 195 - expenditure incurred by the parent company in connection with the business activity carried on by the assessee in India - assessee is a non-resident company incorporated at Australia engaged in prospecting for and production of mineral oils in India - exploration and production activities are carried out by the assessee in various contract areas under the production sharing contract (PSC), a multi-party agreement between the assessee, the other joint venture partners and the Government of India - agreements approved by the Parliament as per the requirements of the provisions of s. 42 - stand of the assessee is that the payments were made by way of reimbursement of the expenditure incurred by the parent company in connection with the activities carried on by the assessee - HELD THAT:- The auditors of the parent company have certified that such payments represented the actual expenditure. There is no reason to disbelieve the auditor's certificate which was filed before the lower authorities. This is also corroborated by the provisions of s. 3.1.4 of the psc. Clause (ii) of this section refers to payments to be made to affiliates of the contractor. The parties to the PSC are bound to comply with the provisions contained in the PSC. Therefore, the assessee could only reimburse the actual expenditure incurred by the parent company. Accordingly, we are of the view that the payment by the assessee was by way of reimbursement of expenses. Whether any sum paid by way of reimbursement of expenses can be said to be income chargeable to tax in the hands of the recipient? - Various High Courts and the Benches of the Tribunal have held that no income can be said to accrue or arise from the sum received by way of reimbursement of expenses. Same view was taken by the Hon'ble Delhi High Court in Industrial Engineering Projects (P) Ltd.'s [1992 (7) TMI 38 - DELHI HIGH COURT] as well as the Hon'ble Calcutta High Court in Dunlop Rubber Co. Ltd.'s [1982 (2) TMI 24 - CALCUTTA HIGH COURT]. Similar view has also been taken by the Tribunal in the case of Enron Oil & Gas International [2008 (10) TMI 258 - ITAT DELHI-G]. Accordingly, it is held that no income accrued or had arisen to the parent company from the payments by way of reimbursement of expenses. Hence, the provisions of s. 195 were not applicable to the facts of the present case. Consequently, the assessee was not required to deduct tax at source. Hence, the AO was not justified in disallowing the payments made by the assessee to its parent company by way of reimbursement of expenses. We also find force in the contention of the ld counsel for the assessee that income of the assessee is to be computed as per the special provisions of s. 42 and consequently no disallowance can be made by invoking the provisions of s. 40 (a)(i). Though it is not a non obstante provision, yet it is a special provision relating to the computation of the income of an assessee engaged in the business of prospecting for or extracting or producing mineral oils in India. It is a settled legal provision that general provisions must give way to the special provisions. Scope of s. 42 has been recently analysed by the Hon'ble apex Court in the case of CIT vs. Enron Oil & Gas India Ltd.[2008 (9) TMI 3 - SUPREME COURT], From the observations held; It is clear that: (i) Sec. 42, being a special provision, is a code by itself for computing the income from business of providing for, or production of mineral oil in India, (ii) it provides that the assessee would be entitled to deduct any expense which is referred to in the PSC, whether capital or revenue in nature. If the expenditure claimed as deduction is in accordance with the provisions of PSC then it has to be allowed as per the decision of the Hon'ble apex Court. The fact that even capital expenditure is allowable as deduction u/s. 42 itself shows that it overrides the provisions of s. 37. Thus, the scheme of the Act makes it clear that the provisions of s. 42 would prevail over general provisions of computing the income contained in ss. 30 to 38. Hence, in our opinion, the provisions of s. 40 cannot be invoked where the income is to be computed u/s. 42. There is no dispute that the payment was made by the assessee as per the provisions of the PSC. Particular reference can be made to s. 3.1.4 of the PSC. Therefore, in our view, the assessee is entitled to deduction in respect of payment made by it to its parent company. The orders of the CIT(A) are therefore set aside and consequently the additions sustained by him are deleted. The appeals of the assessee stand allowed. Issues Involved:1. Disallowance of expenditure under Section 40(a)(i) of the Income Tax Act, 1961 due to non-deduction of tax at source under Section 195.2. Interpretation and applicability of Section 42 versus Section 40(a)(i).3. Reimbursement of expenses and its taxability under Section 195.4. Validity of notice issued under Section 148.Detailed Analysis:1. Disallowance of Expenditure under Section 40(a)(i):The primary issue in these appeals is whether the lower authorities were justified in disallowing the expenditure under Section 40(a)(i) on the ground that the assessee failed to deduct tax at source under Section 195. The assessee, a non-resident company, made payments to its non-resident parent company as reimbursement for expenses incurred in connection with its business activities in India. The AO disallowed these payments, arguing that the assessee failed to deduct tax at source as required under Section 195.2. Interpretation and Applicability of Section 42 versus Section 40(a)(i):The assessee argued that Section 42, a special provision for computing income in the business of prospecting, extraction, or production of mineral oils, should prevail over the general provisions of Section 40(a)(i). The CIT(A) and AO held that Section 42 does not override Section 40(a)(i) and that the payments covered by Section 42 are still subject to the provisions of Section 40(a)(i). However, the Tribunal concluded that Section 42 is a special provision and a complete code by itself for computing income from the business of mineral oils, thus overriding the general provisions of Section 40(a)(i).3. Reimbursement of Expenses and its Taxability under Section 195:The assessee contended that the payments were mere reimbursements of expenses incurred by the parent company, without any profit element, and thus not subject to tax deduction under Section 195. The Tribunal agreed, citing various High Court decisions that reimbursement of expenses does not constitute income chargeable to tax. The Tribunal emphasized that if no profit element is embedded in the payment, Section 195 does not apply, and consequently, the disallowance under Section 40(a)(i) is not justified.4. Validity of Notice Issued under Section 148:The assessee challenged the validity of the notice issued under Section 148 for the assessment year 1999-2000. However, this ground was given up by the assessee during the proceedings.Conclusion:The Tribunal held that the payments made by the assessee to its parent company were by way of reimbursement of expenses and did not involve any profit element. Therefore, the provisions of Section 195 were not applicable, and the AO was not justified in disallowing the payments under Section 40(a)(i). Additionally, the Tribunal concluded that Section 42, being a special provision, overrides the general provisions of Section 40(a)(i) for computing income in the business of mineral oils. Consequently, the orders of the CIT(A) were set aside, and the additions sustained by him were deleted. The appeals of the assessee were allowed.