2025 (9) TMI 723 - HC - Income Tax

Where foreign entities lack a PE, DTAA governs under s.90(2), so s.195 TDS and s.40(a)(i) disallowance not applicable

HC held for the assessee that where foreign entities lack a PE in India, the DTAA provisions govern and are more beneficial under s.90(2), rendering the ... Applicability of section 40(a)(i) in view of the provisions of the DTAA - applicability of TDS u/s 195 when no PE in India - HELD THAT:- As decided in Mitsubishi Corporation (India) Pvt. Ltd. [2024 (2) TMI 933 - DELHI HIGH COURT] the respondent/assessee could have taken recourse to the DTAAs qua the reformulated question since the provisions contained therein were more beneficial. [See Section 90(2) of the Act.] Therefore, the business connection test had no relevance once it was established that foreign companies did not have a PE in India. Decided in favour of assessee. ISSUES PRESENTED AND CONSIDERED 1. Whether disallowance under Section 40(a)(i)/40(a)(ia) can be sustained where payments to related non-resident entities are not chargeable to tax in India by reason of the non-discrimination/equal-treatment clause in an applicable DTAA. 2. Whether the statutory obligation to deduct tax at source under Section 195(1) arises merely on remittance to a non-resident or only when the sum is 'chargeable under the provisions of the Act'. 3. Whether the Assessing Officer/Dispute Resolution Panel's finding that the foreign associated enterprises have a permanent establishment or business connection in India can be sustained on the facts, and whether such findings are determinative for the TDS/Section 40 disallowance. 4. Whether earlier judicial authority decided in the context of the unamended Section 40(a) (pre-amendment) is applicable to the assessment year in question. ISSUE-WISE DETAILED ANALYSIS Issue 1 - Applicability of Section 40(a)(i)/40(a)(ia) where a DTAA non-discrimination/equal-treatment clause applies Legal framework: Section 40(a)(i)/(ia) disallows deductions where tax required to be deducted at source has not been deducted in respect of sums chargeable under the Act; Section 90(2) provides that an assessee entitled to benefits under a DTAA may invoke the more beneficial rule. Precedent treatment: The Tribunal's deletion of the disallowance relied on the equal-treatment/non-discrimination clause of the applicable DTAAs; the majority view in an earlier multi-judge decision dealing with identical factual matrix was followed. Interpretation and reasoning: The Court reasoned that where a DTAA's non-discrimination/equal-treatment clause is more beneficial and results in the foreign entity not being taxable in India (i.e., not having a PE), the condition precedent for invoking Section 195 and consequently Section 40 disallowance-chargeability to tax in India-is absent. The AO's drawing of inference of PE by analogy across group entities (because one group company had a LO/PE) was rejected where there was no separate order or finding that the other entities had a PE; chargeability must be determined for each entity on its own facts. Ratio vs. Obiter: Ratio - Where DTAA provisions (equal-treatment/non-discrimination) render payments not chargeable to tax in India, Section 195 obligation does not arise and Section 40 disallowance cannot be sustained. Obiter - Observations on the inapplicability of Article 9 to the purchases context were explanatory of why transfer-pricing provisions did not govern the Section 40 issue. Conclusions: The Tribunal was correct in deleting the disallowance under Section 40(a) for payments to entities not held to have a PE and where the DTAA non-discrimination clause applied; Section 90(2) mandates application of the more beneficial provision. Issue 2 - Scope of obligation under Section 195(1): 'chargeable under the provisions of the Act' Legal framework: Section 195(1) requires deduction from any sum payable to a non-resident that is 'chargeable under the provisions of this Act'; Explanation 2 clarifies historical scope; Supreme Court authority emphasises chargeability as the trigger. Precedent treatment: The Court relied on authoritative precedent holding that Section 195 is limited to sums chargeable under the Act (G.E. India Technology) and that Transmission Corporation (a composite-transaction case) does not broaden Section 195 to all remittances. Interpretation and reasoning: The Court reiterated that obligation to deduct TDS arises only if the payment is a trading receipt or contains an element of income chargeable in India; mere remittance abroad, absent chargeability, does not trigger Section 195. In composite payments where an income component is clearly chargeable, the payer may be obliged to deduct on the proportionate taxable element, or seek a Section 195(2) determination. Ratio vs. Obiter: Ratio - Section 195(1) must be read with charging provisions (ss.4,5,9); TDS obligation is limited to sums chargeable under the Act. Obiter - Critique of a wide departmental construction that would require TDS on all remittances, leading to absurd consequences. Conclusions: Section 195 did not apply where payments for purchases to the specified foreign entities were not chargeable to tax in India; reliance on Transmission Corporation was misplaced as that case concerned composite contracts with an admitted taxable element. Issue 3 - Existence of PE/business connection and consequences for TDS and Section 40 disallowance Legal framework: Chargeability depends on presence of a PE/business connection; DTAAs govern PE determination and equal-treatment clauses constrain domestic application where more beneficial. Precedent treatment: The Tribunal's fact-specific findings that certain foreign entities did not have a PE in India were upheld in line with prior coordinate decisions and the majority view in the related multi-judge decision. Interpretation and reasoning: The Court held that the AO's inference-drawing PE for several group entities by analogy from one entity with a LO/PE-was impermissible without separate findings/orders declaring those entities taxable in India. Once the Tribunal concluded (on facts) that specific entities lacked a PE, the business connection test became irrelevant for the purpose of Section 195/40 inquiry because chargeability was absent. Ratio vs. Obiter: Ratio - A finding of PE/business connection must be established entity-wise; absent such a finding, neither Section 195 nor Section 40 disallowance can be sustained. Obiter - Remarks on the impropriety of inferring PE across entities based on similarity of business model without factual findings. Conclusions: The Tribunal correctly reversed the AO/DRP findings on PE/business connection for the relevant foreign entities; such reversal removes the predicate for TDS and Section 40 disallowance. Issue 4 - Applicability of decisions rendered in the context of unamended Section 40(a) Legal framework: Legislative amendments (FA 2004, FA 2014) altered the reach of Section 40(a); applicability of prior decisions depends on the statutory text in force for the assessment year. Precedent treatment: The Court noted contentions that earlier High Court decision (involving unamended Section 40(a)) is distinguishable, but held that the majority view in the multi-judge decision addressing the factual matrix and applicable law for the assessment year controls. Interpretation and reasoning: Where the statute has been amended for later years, earlier contrary authority may not apply if it arose under a different statutory regime; however, the controlling majority authority dealing with the same assessment year/facts governs the present appeal. Ratio vs. Obiter: Ratio - Applicability of prior decisions is governed by the statutory provisions in force for the relevant assessment year; decisions rendered under an unamended provision are not automatically applicable to years governed by an amended provision. Obiter - Discussion of legislative history explaining why purchases were brought within Clause (ia) only by FA 2014. Conclusions: The proposed question premised on earlier unamended-Section authority did not require separate consideration because the majority decision addressing the applicable statutory position and facts governs the matter. Overall disposition The Court upheld the Tribunal's deletion of the Section 40 disallowance and dismissed the appeal against the Revenue; delay in filing and re-filing was condoned. The key legal propositions affirmed: (i) TDS under Section 195 is triggered only where the sum is chargeable to tax in India; (ii) Section 40 disallowance cannot be sustained absent chargeability; (iii) DTAA provisions (including non-discrimination/equal-treatment) and Section 90(2) apply to afford the more beneficial rule; and (iv) PE determinations must be entity-specific and cannot be inferred by analogy without findings.