Revenue appeal dismissed as tax effect below Rs. 2 crores threshold under CBDT Circular 5/2024 for section 40(a)(i) TDS disallowance

The Bombay HC dismissed a revenue appeal concerning TDS disallowance under section 40(a)(i) for non-deduction on foreign remittances to non-residents for destination sampling and ore analysis services rendered outside India. The court applied CBDT Circular No. 5/2024 establishing threshold limits for government appeals, noting the tax effect was below Rs. 2 crores. A Division Bench previously ruled that paragraph 3.1(l) exceptions apply only to litigation arising from orders under sections 201/201(1A), not section 143(3) assessments. Since the present appeal originated from assessment under section 143(3) rather than section 201, the exclusion in paragraph 3.1(l) was inapplicable. The court bound itself to the earlier Division Bench decision and dismissed the appeal based on the threshold limits prescribed in the circular.

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1. ISSUES PRESENTED and CONSIDERED

The core legal questions considered by the Court were:

(A) Whether the Income Tax Appellate Tribunal (ITAT) erred in deleting the disallowance under Section 40(a)(i) of the Income Tax Act, 1961, relating to foreign remittance made to non-residents for destination sampling charges/ore analysis charges amounting to Rs.10,21,904, on the ground of non-deduction of tax at source under Section 195 of the Income Tax Act, 1961.

(B) Whether the ITAT was correct in holding that the criterion of the second limb of the exception clause in Section 9(1)(vii)(b) of the Income Tax Act, 1961 was satisfied in the case of the assessee.

Additionally, during the pendency of the appeal, the Court considered whether the appeal should be admitted in light of Circular No. 5 of 2024 issued by the Central Board of Direct Taxes (CBDT), which sets threshold limits for filing appeals by the Government before various appellate authorities, including the ITAT and High Courts, with the objective of reducing litigation. The question arose whether the present appeal fell within the exceptions to these monetary thresholds, particularly clause 3.1(l)(i), which relates to disputes concerning the determination of the nature of transactions impacting the liability to deduct tax at source (TDS).

2. ISSUE-WISE DETAILED ANALYSIS

Issue A: Deletion of disallowance under Section 40(a)(i) for non-deduction of tax at source under Section 195 on foreign remittance

Relevant legal framework and precedents: Section 40(a)(i) of the Income Tax Act disallows expenses if tax is deductible at source but not deducted or paid. Section 195 mandates deduction of tax at source on payments to non-residents. The question was whether the foreign remittance towards destination sampling and ore analysis charges attracted TDS under Section 195 and if disallowance under Section 40(a)(i) was justified.

Court's interpretation and reasoning: The ITAT had deleted the disallowance, holding that the payments were for services rendered outside India and thus not liable for TDS under Section 195. The Court did not expressly revisit this issue in detail but admitted the appeal on this question of law. However, the appeal was ultimately dismissed on procedural grounds related to the filing threshold and applicability of CBDT Circulars.

Key evidence and findings: The payments were made to non-residents for services rendered outside India, specifically destination sampling and ore analysis charges amounting to Rs.10,21,904. The ITAT found that the nature of the transaction did not attract TDS liability.

Application of law to facts: The ITAT applied the legal principle that tax deduction under Section 195 is required only if the income is deemed to accrue or arise in India. Since the services were rendered outside India, the ITAT concluded no TDS was required, leading to deletion of disallowance under Section 40(a)(i).

Treatment of competing arguments: The Revenue argued that TDS was applicable and disallowance was justified. The assessee contended the payments were for services rendered outside India and hence no TDS liability arose. The ITAT sided with the assessee.

Conclusion: The ITAT's deletion of disallowance under Section 40(a)(i) was correct based on the nature of the transaction and the non-applicability of Section 195 TDS provisions on payments for services rendered outside India.

Issue B: Applicability of the second limb of exception clause in Section 9(1)(vii)(b)

Relevant legal framework and precedents: Section 9(1)(vii)(b) of the Income Tax Act deals with income deemed to accrue or arise in India from royalties or fees for technical services. The exception clause provides criteria under which such income is not deemed to accrue or arise in India.

Court's interpretation and reasoning: The ITAT held that the second limb of the exception clause was satisfied, meaning the payments did not constitute income deemed to accrue or arise in India. The Court did not elaborate in the present judgment on this point but admitted the appeal on this substantial question of law.

Key evidence and findings: The payments related to destination sampling and ore analysis charges, which were for services rendered outside India.

Application of law to facts: Since the services were rendered outside India, the exception clause applied, and the income was not deemed to accrue or arise in India.

Treatment of competing arguments: The Revenue contended the payments were taxable in India under Section 9(1)(vii)(b). The assessee argued the exception applied. The ITAT accepted the assessee's position.

Conclusion: The ITAT's conclusion that the exception clause applied was correct in the facts and circumstances, leading to the non-taxability of the payments in India.

Issue C: Applicability of CBDT Circular No. 5/2024 and monetary threshold for filing appeals by the Revenue

Relevant legal framework and precedents: CBDT Circular No. 5/2024 and Circular No. 9/2024 set monetary thresholds for the Department to file appeals before appellate authorities, aiming to reduce litigation. Clause 3.1(l)(i) provides exceptions for appeals involving disputes relating to TDS/TCS matters, particularly where the nature of the transaction and liability to deduct TDS/TCS is in question.

Court's interpretation and reasoning: The Court examined a recent Division Bench decision dated 09.12.2024 which interpreted clause 3.1(l) of Circular No. 5/2024. That decision held that clause 3.1(l) excludes appeals arising from proceedings under Section 201/201(1A) (i.e., proceedings against deductors for failure to deduct tax at source). The present appeal arose from an assessment under Section 143(3), not from proceedings under Section 201.

The Division Bench had emphasized a clear demarcation between cases where the deductor failed to deduct TDS and cases where the payer failed to pay taxes. The exception in clause 3.1(l) applies only to the former category.

Key evidence and findings: The tax effect involved in the present appeal was Rs. 3,06,571/-, below the monetary threshold of Rs. 2 Crores prescribed by the Circulars. The appeal arose from assessment under Section 143(3) and not from Section 201 proceedings.

Application of law to facts: Since the appeal did not fall within the exception clause 3.1(l) and the tax effect was below the threshold, the appeal was not maintainable under the CBDT Circulars.

Treatment of competing arguments: The Revenue contended that the appeal fell within the exception in clause 3.1(l)(i) because it related to a dispute on the nature of the transaction affecting TDS liability. The Court rejected this, relying on the Division Bench's prior ruling that clause 3.1(l) does not apply to appeals arising from assessments under Section 143(3).

Conclusion: The appeal was dismissed on the ground that it did not meet the monetary threshold and did not fall within the exceptions under the CBDT Circulars, binding the Court to follow the earlier Division Bench ruling.

3. SIGNIFICANT HOLDINGS

- The Court upheld the Division Bench's interpretation of CBDT Circular No. 5/2024, specifically clause 3.1(l), clarifying that appeals arising from assessments under Section 143(3) do not fall within the exception for TDS/TCS disputes under clause 3.1(l), which is limited to proceedings under Section 201/201(1A).

- The Court stated: "What is covered by para 3.1(l) are cases springing out of a litigation from order passed under Section 201, 201(1A). However, in the appeals before the Court, the original order arises out of an assessment under Section 143(3) and a conclusion was drawn that the exclusion contemplated in para 3.1(l) would not apply."

- The Court confirmed that since the tax effect was below Rs. 2 Crores, and the appeal did not fall within the exceptions, the appeal filed by the Revenue was not maintainable and was dismissed accordingly.

- The Court did not disturb the ITAT's findings on the merits regarding the deletion of disallowance under Section 40(a)(i) and the applicability of the exception clause in Section 9(1)(vii)(b), effectively upholding the ITAT's conclusions on these issues.

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