2025 (8) TMI 1437 - AT - Income Tax

Payments to Australian service provider not FTS; s.90(2) benefits upheld, s.40(a)(i) disallowance deleted; TP uses LIBOR+200bps

ADP Private Limited Versus The Deputy Commissioner of Income Tax, Circle-1 (1), Hyderabad

ADP Private Limited Versus The Deputy Commissioner of Income Tax, Circle-1 (1), Hyderabad - TMI ISSUES PRESENTED AND CONSIDERED 1. Whether payments made to a non-resident for marketing, implementation and administration support constitute 'Fees for Technical Services' under section 9(1)(vii) of the Income Tax Act and/or are taxable under the India-Australia Double Taxation Avoidance Agreement (DTAA) (Article 12) by virtue of the 'make-available' clause, thereby attracting withholding obligation under section 195 and disallowance under section 40(a)(i). 2. Whether a payer (resident) must seek a non-deduction certificate under section 195(2) in every case where tax is not withheld, and whether failure to obtain such certificate justifies disallowance under section 40(a)(i) when the payment is not chargeable to tax in India. 3. Whether trade receivables from associated enterprises (AEs) that are overdue constitute an international transaction requiring arm's length benchmarking; if so, whether imputed interest is warranted, whether netting of overdue payables against overdue receivables is permissible, and the appropriate benchmark rate to compute imputed interest (SBI-PLR v. LIBOR + basis points). ISSUE-WISE DETAILED ANALYSIS Issue 1 - Characterisation of payments as FTS (section 9(1)(vii)) and DTAA (Article 12) applicability Legal framework: Section 9(1)(vii) defines 'Fees for Technical Services' as consideration for rendering managerial, technical or consultancy services (including provision of personnel); section 90(2) mandates application of the domestic law or DTAA, whichever is more beneficial; DTAA Article 7 (business profits) taxes a non-resident in India only if it carries on business through a Permanent Establishment (PE) in India; Article 12(3)(g) treats payments for services as 'royalty' only to the extent they 'make available' technical knowledge, experience, skill, know-how or processes enabling independent application by the recipient. Precedent treatment: The Tribunal relied on authorities holding that mere rendering of technical services is insufficient for treaty taxation under Article 12(3)(g); the service provider must transfer technical knowledge/know-how enabling the recipient to apply the technology independently in future (citing decisions such as Guy Carpenter and De Beers, and relevant ITAT precedents like Sandvik Australia). These precedents are followed and applied. Interpretation and reasoning: The Tribunal examined the service agreement description (marketing support, implementation and administration support) and found no evidence that technical knowledge, skill, know-how or processes were made available to the recipient such that it could independently apply the technology. The continuity of services and absence of evidence of transfer indicate the services remained ongoing support rather than a make-available transfer. In the absence of a PE in India, Article 7 excludes taxation of business profits; Article 12(3)(g)'s 'make-available' requirement is not satisfied, so treaty-based taxation as royalty/FTS fails. The Tribunal also found no material establishing the payments to be FTS under domestic law in a manner that would attract tax in India. Ratio vs. Obiter: Ratio - where payments to a non-resident are for ongoing support that do not transmit technical knowledge/know-how enabling independent application, such receipts do not fall within Article 12(3)(g) and are not taxable under DTAA; consequently section 195 withholding and section 40(a)(i) disallowance are inapplicable. Observations on factual features of the agreement (continuity of services, absence of make-available elements) are factual ratio for this case; broader statements about the limits of section 195(2) are part ratio and part authoritative guidance. Conclusion: Payments for the described business support services do not constitute FTS or royalty under the DTAA; therefore, they were not chargeable to tax in India and cannot be disallowed under section 40(a)(i) for non-deduction under section 195. The Tribunal directed deletion of the addition made under section 40(a)(i). Issue 2 - Obligation to apply for non-deduction certificate under section 195(2) Legal framework: Section 195 imposes withholding when sums payable to non-residents are chargeable to tax in India; section 195(2) permits the payer to obtain a certificate limiting or eliminating withholding where sums are chargeable to tax. Precedent treatment: The Tribunal applied the statutory text and settled principle that section 195(2) is engaged only if the sum is chargeable to tax under domestic law read with the DTAA; it followed decisions holding that a payer is not obliged to seek a no-deduction certificate in every case where tax is not withheld if the sum is not chargeable to tax. Interpretation and reasoning: The Tribunal held that the Assessing Officer erred in treating failure to seek a non-deduction certificate as a stand-alone ground for disallowance when the underlying payment was not chargeable to tax. Section 195(2) obligation arises in cases where the payer reasonably expects the sum to be chargeable to tax and seeks a certificate for reduced withholding; it does not impose a prophylactic duty to obtain a certificate in every cross-border payment scenario. Ratio vs. Obiter: Ratio - non-deduction certificate requirement under section 195(2) does not arise where the payment is not chargeable to tax under domestic law/DTAA; absence of an application cannot convert a non-taxable payment into a taxable one for purposes of section 40(a)(i). Conclusion: The Assessing Officer and DRP erred in disallowing payments on the ground that the payer should have obtained a section 195(2) certificate when the payments were not chargeable to tax; disallowance on this basis was set aside. Issue 3 - Imputed interest on overdue receivables from Associated Enterprises (international transaction benchmarking, netting, and benchmark rate) Legal framework: The expanded definition of 'international transaction' (section 92B amendments) includes intra-group receivables; such transactions require transfer pricing benchmarking against arm's length comparables; adjustments may include compensation for delayed payments (imputed interest) where appropriate. Precedent treatment: The Tribunal relied on authorities recognizing overdue receivables from AEs as international transactions requiring benchmarking; prior decisions permit netting of receivables and payables only where they concern the same AE and adequate documentary proof is furnished; precedents also support use of internationally accepted interest benchmarks (e.g., LIBOR) for foreign-currency receivables. Interpretation and reasoning: The Tribunal rejected the taxpayer's arguments that absence of interest charged to third parties, being debt-free, or use of entity-level TNMM obviated benchmarking of receivables from AEs. It held (i) receivables from AEs are international transactions irrespective of third-party practice; (ii) netting is permissible only where receivable and payable relate to the same AE and supporting evidence is produced - not demonstrated here; (iii) aggregation/entity-level benchmarking applies only where transactions are interlinked and proof of interconnection is shown. On the choice of benchmark, the Tribunal found SBI-PLR inappropriate for foreign-currency cross-border receivables and directed adoption of LIBOR + 200 basis points as internationally acceptable benchmark for imputing interest on overdue foreign receivables. Ratio vs. Obiter: Ratio - overdue intra-group receivables are international transactions requiring arm's-length benchmarking; netting is permissible only with evidence that receivables and payables relate to the same AE; LIBOR-based rates are appropriate for benchmarking foreign-currency overdue receivables rather than domestic prime lending rates. Observations rejecting entity-level aggregation in absence of demonstrated interconnection are specific to facts but provide guiding principles. Conclusion: The Tribunal upheld imputation of interest on overdue receivables from AEs in principle but directed recomputation using LIBOR + 200 basis points (instead of SBI-PLR). Netting was disallowed for lack of specific evidence; entity-level aggregation was found inapplicable absent proof of interlinked transactions. The appeal was partly allowed accordingly.