Prototype engine supply treated as purchase, not technical services, so no withholding tax default arose.

Payments to a foreign supplier for prototype engines were characterised as consideration for purchase, not fees for technical services, because the contract read as a whole showed a composite supply of engines with documentation, testing and related deliverables. References to technical requirements, intellectual property and copying restrictions were treated as incidental to the supply and not a separate service engagement. Explanation 2 to section 9(1)(vii) was construed narrowly, and the mere fact that the engines embodied design or know-how did not convert the payment into technical fees. As the sum was not taxable as technical services, no tax was deductible under section 195 and section 201 default did not arise.

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Issues: Whether payments made to the foreign supplier for AL-551 prototype engines were consideration for purchase of engines or fees for technical services under the Income-tax Act.

Analysis: The contract was read as a whole to ascertain the real nature of the transaction. The arrangement required the foreign supplier to develop and deliver three prototype engines, together with documentation, testing and related deliverables, for use in the assessee's aircraft. The contractual references to technical requirements, intellectual property and restrictions on copying were treated as incidental to the supply of the engines and not as a separate engagement for rendering technical services. Explanation 2 to section 9(1)(vii) was construed narrowly, and payment was held not to be for technical services merely because the supplied engines embodied design, know-how or scientific results. On this view, the assessee was not obliged to deduct tax at source under section 195 and could not be treated as a defaulter under section 201.

Conclusion: The payments were held to be consideration for purchase of prototype engines and not fees for technical services, and the assessee succeeded.

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