2025 (12) TMI 199 - HC - Income Tax

SC-backed s.10A loss set-off; IPLC not royalty under s.9(1)(vi); DTAA Art.26 and s.234D; miscellaneous income eligible for s.10A/10B

HC held that losses of eligible units under s.10A could be set off against profits of non-eligible units, following the binding precedent of SC. Payments ... Deduction u/s 10A/10B - Set off of losses - Income from other units in arriving at total income - HELD THAT:- As relying on Yokogawa India Limited [2016 (12) TMI 881 - SUPREME COURT] as clearly applicable to the facts of the present case and the loss of the eligible units could be set-off against the other income of the tax payer in view of the provision relating to deduction as contained in Section 10A of the Act and it cannot be said that the decision of the Supreme Court does not apply in a case of loss-making 10A unit against the profits of non-10A unit. In respect of the previous assessment years, in assessee's own case, referred to herein above, the ITAT decided the issue in favour of the assessee and learned counsel for the Revenue could not satisfy the court that the aforesaid orders were taken to higher courts and reversed. Addition u/s 40(a)(i) - amount paid by the assessee to Sprint USA - ‘Royalty’ under Section 9 of the Act read with the Double Taxation Avoidance Agreement (DTAA) between India and United States of America- HELD THAT:- It is clear position of law, as enunciated by the Supreme Court as aforesaid, that the Explanations added vide Finance Act, 2012 cannot be treated as clarificatory in nature, as if they were in the statute book since 1.6.1976, as the provisions are expansive in nature and, in substance, not merely clarificatory. The aforesaid enunciation of law is applicable in the present case, because the assessments in question are in relation to taxability pertaining to finance years prior to introduction of Finance Act, 2012. The view taken in the case of Verizon Communications Singapore PTE Ltd v. ITO 2013 (11) TMI 1058 - MADRAS HIGH COURT] is that even if the assessee does not have an effective control over the equipment, the use of process will render payment liable to be treated as royalty was based on application of Explanations 4, 5 and 6 added by way of Finance Act, 2012 and we see from a reading of the said judgment, that the assessee's case based on decision in the case Asia Satellite Telecommunications Private Limited [2011 (1) TMI 47 - DELHI HIGH COURT] and various rulings of the Authority on Advance Rulings was rejected by holding that such decisions are of no assistance in view of the amendment which was introduced by Finance Act, 2012 by insertion of Explanations 5 and 6. In Verizon Communications Singapore PTE Ltd. [2013 (11) TMI 1058 - MADRAS HIGH COURT] the decision in the case of Poompuhar Shipping Corporation Limited [2013 (10) TMI 936 - MADRAS HIGH COURT] was relied upon, wherein for the purposes of determining whether the payments made constituted royalty, recourse was had to the meaning assigned to it by taking into consideration newly inserted Explanations 4 and 5 under the Finance Act, 2012. It was precisely on application of the newly inserted Explanations vide Finance Act, 2012, whereafter it became irrelevant whether or not the assessee has control or possession of the scientific equipment, that the claim of the assessee therein that payment made was for service and it was not a case of transfer was rejected. Therefore, to that extent, the decision in the case of Verizon Communications Singapore PTE Ltd. [2013 (11) TMI 1058 - MADRAS HIGH COURT] in our considered opinion, stands overruled and cannot be relied upon as a precedent. But for the application of newly inserted Explanations 4, 5 and 6 under Finance Act, 2012, the payment made in the present case by the assessee to Sprint USA for IPLC would not constitute 'royalty' within the meaning of that expression as provided under clause (iva) to Explanation 2 to Section 9(1)(vi) of the Act, in as much as it does not partake nature of consideration for the use or right to use a scientific equipment, applying the principle laid down in Asia Satellite Telecommunications Private Limited v. DIT (supra). Accordingly, the questions of law on this issue are answered in favour of the assessee and against the revenue. Amount paid by the appellant to Sprint USA should be subject to deduction of tax at source - If we look into the provisions contained in Section 40 of the Act along with Article 26(3) of the India-USA DTAA, it is clear that deduction in the hands of the resident on payment to a USA resident shall be on the same conditions as that of a payment made to Indian resident. In the present case, the disallowance was only in respect of payment made to non-resident. On this score, the assessee has correctly placed reliance upon the decisions of Herbalife International India (P) Ltd. [2016 (5) TMI 697 - DELHI HIGH COURT] and Mitsubishi Corporation India (P) Ltd. [2024 (2) TMI 933 - DELHI HIGH COURT] In the decision of Herbalife International India (P) Ltd [2016 (5) TMI 697 - DELHI HIGH COURT] identical issue was considered by the Delhi High Court and it was held that Section 40(a)(i) of the Act is discriminatory and not applicable in terms of Article 26(3) of the India-USA DTAA. The submission of the revenue that until 13.07.2006 there was no requirement to deduct tax on royalty payments made to a resident in India and only by way of amendment under Section 194J Act with effect from 13.07.2006 royalty was also included, does not alter the legal position in the light of the above decision. Miscellaneous income in the nature of interest on loan given to employees and sale of scrap entitled to claim deduction under Section 10A/10B - AO denied the claim by stating that miscellaneous income does not have direct nexus with the business of the eligible undertaking - HELD THAT:- Miscellaneous income in the nature of interest on loan given to employees and sale of scrap, is entitled to claim deduction under Section 10A/10B of the Act, the Assessing Officer denied the claim by stating that miscellaneous income does not have direct nexus with the business of the eligible undertaking. In India Comnet International v. ITO [2012 (9) TMI 372 - SUPREME COURT] the Supreme Court considered the decision of Menon Impex (P) Ltd. [2002 (9) TMI 75 - MADRAS HIGH COURT] where the nature of interest income derived by the assessee was from funds in connection with Letter of Credit. The Supreme Court decision turned more in respect of the claim of deduction on the interest income on foreign currency deposit account. Therefore, the said decisions do not come to the aid of the revenue, as the nature of deposits were not in the nature of interest earned on loans advanced to the employees and sale of scrap, which were in the ordinary course of business of the undertaking. Decided against revenue. Interest under Section 234D of the Act on the excess refund paid - Assessee, in fairness, submits that, by virtue of an amendment made vide Finance Act, 2012 with retrospective effect from 01.06.2003 in Explanation 2 to Section 234D of the Act, which provides that the provisions of Section 234D of the Act apply even for assessment year 2003-2004 and prior years, provided the assessment proceedings of that year is completed after 01.06.2003, and since the assessment order in this case was passed on 28.02.2006, the question of law is to be decided against the assessee. In view of the aforesaid submission made by learned counsel for the assessee, the view taken by the ITAT that the appellant is liable to pay interest under Section 234D of the Act on the excess refund paid is in accordance with law. Decided against the assessee and in favour of the revenue. 1. ISSUES PRESENTED AND CONSIDERED (1) Whether losses of units eligible for deduction under Sections 10A/10B can be set off against income from other (non-10A/10B) units in computing total income. (2) Whether payments made to a non-resident for use of International Private Leased Circuits (IPLC) constitute 'royalty' under Section 9(1)(vi) read with the applicable DTAA, and consequently are disallowable under Section 40(a)(i) for non-deduction of tax at source. (3) Whether, assuming the IPLC payments are 'royalty', disallowance under Section 40(a)(i) is barred by the non-discrimination clause (Article 26(3)) of the India-USA DTAA. (4) Whether miscellaneous income in the nature of interest on loans to employees and sale of scrap, arising in eligible units, qualifies for deduction under Sections 10A/10B. (5) Whether interest under Section 234D is leviable on excess refund where the relevant assessment was completed after 01.06.2003. 2. ISSUE-WISE DETAILED ANALYSIS Issue (1): Set-off of losses of 10A/10B eligible units against income of other units Interpretation and reasoning (a) The Court noted that earlier decisions in the assessee's own case and the Karnataka High Court's view (as affirmed by the Supreme Court) had treated Section 10A/10B as deduction provisions operating at the stage of computing business income of the eligible undertaking, independent of other units. (b) The Supreme Court's decision on Section 10A/10B was examined in detail. It was held there that: (i) post-2001, Section 10A changed from 'exemption' to 'deduction', but still operated qua each eligible undertaking; (ii) deductions under Section 10A are to be allowed at the stage of determining profits of the eligible undertaking, prior to aggregation and set-off under Sections 70-72; and (iii) the deduction is 'qua the eligible undertaking' without reference to other eligible or non-eligible units. (c) The Court rejected the revenue's contention that Section 10A(6), as amended in 2003, mandates compulsory carry forward of losses of 10A units till expiry of the tax-holiday period before any set-off. The Supreme Court judgment was held to have covered cases of loss-making eligible units and to permit adjustment of such losses against other taxable income in view of the deduction mechanism. (d) CBDT Circular dated 16.07.2013 (discussed by the Supreme Court) was relied upon to confirm that income/loss from all sources is first aggregated under Chapter IV and Chapter VI (Sections 70-72), and thereafter deductions under Sections 10A/10B are allowed, thereby permitting set-off of losses of eligible units against other income. (e) The Court noted that in earlier assessment years in the same assessee's case, the Tribunal had allowed such set-off, and there was no material to show those orders had been overturned. Conclusion (f) Losses of units eligible for deduction under Sections 10A/10B can be set off against income from other (non-10A/10B) units in computing total income. The contrary view of the lower authorities was set aside, and the issue was decided in favour of the assessee. Issue (2): Characterisation of IPLC payments as 'royalty' and disallowance under Section 40(a)(i) Legal framework (as discussed) (a) Section 5: scope of total income for residents and non-residents. (b) Section 9(1)(vi): 'income by way of royalty' deemed to accrue or arise in India, including Explanation 2, clause (iva) ('use or right to use any industrial, commercial or scientific equipment') and Explanations 4, 5 and 6 (inserted by Finance Act, 2012, with retrospective dates). (c) Section 40(a)(i): disallowance of specified payments (including royalty to non-residents) where tax is not deducted at source. (d) Section 90: effect of DTAAs; domestic law applies only to the extent it is more beneficial than the treaty. (e) India-USA DTAA: definition of 'royalties' and its interaction with domestic law. Interpretation and reasoning (f) The facts found were that the assessee, engaged in software development and export, paid Sprint USA (a non-resident) for IPLC services to transmit data internationally. The Assessing Officer and appellate authorities treated these payments as 'royalty' under Section 9(1)(vi) and disallowed them under Section 40(a)(i) for failure to deduct tax at source, relying heavily on a prior High Court decision involving another IPLC provider. (g) The Court undertook a detailed comparison between: * the earlier High Court decision on IPLC, which had treated similar payments as royalty, primarily by invoking Explanations 4, 5 and 6 to Section 9(1)(vi) as retrospective 'clarifications'; and * later jurisprudence (Delhi High Court and Supreme Court) concerning satellite/transponder and software payments, where the effect and retrospectivity of the 2012 Explanations and the primacy of DTAAs were examined. (h) It was noted that in the earlier IPLC decision, the Court: (i) applied Explanations 4, 5 and 6 to assessment years predating the 2012 amendment, treating them as clarificatory; (ii) held that control or possession over the equipment was not necessary after these Explanations; and (iii) assumed that the statutory definition of 'royalty' and the DTAA definition were pari materia and that domestic amendments were to be read into the treaty without separate analysis. (i) The Court contrasted this with later binding authority which held that: * the 2012 Explanations to Section 9(1)(vi) are not merely clarificatory but expand the scope of 'royalty' and cannot be treated as having always existed since 01.06.1976; * persons deducting tax at source cannot be expected to act on the basis of subsequently inserted, expansive Explanations for periods when such provisions were not on the statute book (lex non cogit ad impossibilia); * domestic amendments, even if retrospective, cannot unilaterally amend or expand the scope of 'royalty' under a DTAA; the treaty definition remains static unless amended bilaterally; and * where the same technical terms ('royalties', etc.) appear both in Section 9(1)(vi) and the DTAA, interpretation must be anchored in the DTAA text and OECD-based understanding, not extended by unilateral domestic amendments, unless they are more beneficial to the assessee. (j) The Delhi High Court's reasoning in a case involving satellite transponder lease was noted and approved: the 2012 Explanations could not automatically alter treaty provisions; the definition of 'royalty' in the DTAA governs for treaty cases; and control/possession and the true nature of the arrangement (service vs. use of equipment) are relevant. (k) The Supreme Court's later decision on software payments was examined. The Court held there that: (i) Explanations 4 and 6 to Section 9(1)(vi) are not clarificatory of the law as on 01.06.1976 but expand it, particularly given the evolution of technology and statutory definitions; (ii) even under domestic law, 'royalty' requires a transfer of rights in the relevant property (e.g., copyright) and cannot be extended beyond that; and (iii) under Section 90(2) and Explanation 4 to Section 90, the DTAA definition, if more beneficial, prevails over the widened domestic definition. (l) The Court observed that the earlier IPLC decision had rejected the Delhi High Court and AAR precedents primarily because those authorities were pre-2012 and did not consider Explanations 4-6. Once the Supreme Court has held those Explanations to be substantive and non-clarificatory, the very foundation for treating them as automatically applicable to prior years (and for importing them into the treaty) stands negated. (m) Applying the pre-2012 legal position (as required for the assessment years in question) and the approach in the satellite/transponder line of cases, the Court held that: * payments for IPLC capacity are, in substance, payments for services (connectivity/bandwidth); * the payer does not have possession, control, or proprietary use of any identified 'industrial, commercial or scientific equipment'; and * absent the expanded Explanations, such payments do not fall within clause (iva) of Explanation 2 to Section 9(1)(vi) as 'consideration for the use or right to use' equipment or a 'process', but are in the nature of service fees. (n) The Court expressly held that, to the extent the earlier IPLC decision treated the 2012 Explanations as clarificatory and applied them retrospectively to domestic law and DTAA interpretation for prior years, it stands overruled by subsequent Supreme Court authority and cannot be followed as a precedent. Conclusion (o) For the relevant assessment years (prior to the 2012 amendment), payments to Sprint USA for IPLC services do not constitute 'royalty' within the meaning of Section 9(1)(vi) read with clause (iva) of Explanation 2 and the applicable DTAA. Consequently, such payments were not chargeable to tax in India as royalty, and no obligation to deduct tax at source arose. Disallowance under Section 40(a)(i) on this ground was unsustainable. The issue was decided in favour of the assessee. Issue (3): Effect of India-USA DTAA non-discrimination clause on disallowance under Section 40(a)(i) Legal framework (as discussed) (a) Section 90(2): where a DTAA applies, its provisions override the Act to the extent they are more beneficial to the assessee. (b) Article 26(3) of India-USA DTAA (Non-discrimination): interest, royalties and other disbursements paid by a resident of one Contracting State to a resident of the other shall, for purposes of determining the taxable profits of the payer, be deductible 'under the same conditions' as if they had been paid to a resident of the same State. (c) Section 40(a)(i) (then applicable): disallowance of payments (including royalty) to non-residents where tax is not deducted at source. (d) Section 40(a)(ia), Section 194J (as they then stood): at the relevant time, there was no requirement to deduct tax at source on royalty payments to residents and no corresponding disallowance for such payments. Interpretation and reasoning (e) Although the Court had already held that IPLC payments were not 'royalty', it proceeded to examine this question as one of general importance. (f) The assessee contended that Article 26(3) requires that deductibility conditions for payments (including royalties) to a US resident must be identical to those for payments to an Indian resident. Under then-existing domestic law, royalty payments to residents were not subject to TDS and hence no disallowance arose for non-deduction, whereas payments to non-residents attracted disallowance under Section 40(a)(i) for failure to deduct TDS. This lack of parity in deductibility conditions violated Article 26(3). (g) The revenue argued that: (i) the absence of a TDS requirement on payments to residents until the 2006 amendment reflected sovereign fiscal policy and could not be equated with discrimination; and (ii) concern about collectability of tax from non-residents justified a stricter regime for non-resident payees. (h) The Court reiterated that under Section 90(2), where a DTAA applies, the more beneficial treaty provisions must prevail. It referred to Delhi High Court jurisprudence which had directly addressed the interaction between Section 40(a)(i) and Article 26(3) of the India-USA DTAA. (i) In those decisions, it was held that: * under then-law, payments to residents were not subject to disallowance for non-deduction of tax at source, whereas analogous payments to US residents were so disallowed; and * Article 26(3) requires that, for determining the taxable profits of the payer, such payments to US residents be deductible 'under the same conditions' as if paid to a resident; the imposition of an additional, adverse condition (mandatory TDS on non-resident payments, on pain of disallowance) constituted discrimination prohibited by the treaty. (j) The Court adopted this reasoning and held that the phrase 'under the same conditions' in Article 26(3) goes to the substantive parity of deductibility requirements, not merely to procedural aspects. Where domestic law imposes a disallowance condition only in the case of payments to non-residents, that condition cannot be applied if it results in discrimination vis-à-vis otherwise identical payments to residents. (k) The later introduction (post-13.07.2006) of a TDS requirement and corresponding disallowance for resident payments (by amendments to Section 194J and Section 40(a)(ia)) was held irrelevant for the assessment years in question and did not cure or justify earlier discrimination. Conclusion (l) Even assuming, arguendo, that the IPLC payments were 'royalty', disallowance under Section 40(a)(i) for non-deduction of tax at source would be hit by the non-discrimination clause in Article 26(3) of the India-USA DTAA, since equivalent payments to residents were not subject to the same disallowance condition. Accordingly, on this independent ground also, Section 40(a)(i) disallowance could not be sustained. The issue was decided in favour of the assessee. Issue (4): Eligibility of miscellaneous income (interest on employee loans and scrap sale) for deduction under Sections 10A/10B Legal framework (as discussed) (a) Sections 10A/10B: provide for deduction of profits and gains derived by eligible undertakings from export of articles, things or computer software. (b) Judicial interpretation distinguishing the scheme of Sections 10A/10B (exemption/deduction of undertaking-level business profits) from Chapter VI-A deductions (e.g., Sections 80HH, 80HHC, etc.). Interpretation and reasoning (c) The assessee had earned, in the relevant year, miscellaneous income comprising: (i) interest on loans given to employees; and (ii) income from sale of scrap, both arising in the course of operations of eligible units. Deduction under Sections 10A/10B was claimed on these amounts. (d) The Assessing Officer denied the claim, holding that such miscellaneous income did not have 'direct nexus' with export activity of the eligible undertaking. The first appellate authority substantially upheld this view (with limited directions on scrap), and the Tribunal failed to adjudicate this specific ground. (e) The Court referred to binding precedent where a Full Bench had held that: (i) under Sections 10A/10B, the entire income derived 'by an undertaking' from its business, including incidental income like interest on bank deposits or loans to staff, is eligible for 100% deduction; (ii) the phraseology of Sections 10A/10B and their placement (Chapter III, pre-gross-total-income stage) differentiate them from Chapter VI-A deductions based on 'derived from' language; (iii) profits and gains of the undertaking include incidental income earned in the ordinary course of its export business, such as temporary parking of surplus funds or staff loans, and such income cannot be carved out and taxed separately as 'income from other sources'. (f) Those decisions also emphasised that the incentive nature of Sections 10A/10B demands a purposive, liberal interpretation: all profits and gains of the eligible undertaking's business, including incidental receipts integrally connected with that business, fall within the deduction. (g) Applying this ratio, the Court held that: * interest on loans to employees of the eligible units is part of the business operations of the undertaking and an incidental income arising in the ordinary course of the export business; and * scrap sale arising from operations of the eligible undertaking is directly linked to its business activity and forms part of its business profits. (h) The revenue's reliance on earlier decisions dealing with interest on foreign currency deposits or letter of credit related funds was distinguished on facts: those cases did not concern interest on staff loans or scrap income arising from the core business operations of a 10A/10B eligible undertaking. Conclusion (i) Miscellaneous income comprising interest on loans to employees and scrap sale, arising from the operations of eligible units, forms part of the profits and gains of the undertaking and qualifies for deduction under Sections 10A/10B. The contrary view of the lower authorities was rejected and the issue was decided in favour of the assessee. Issue (5): Liability to interest under Section 234D Legal framework (as discussed) (a) Section 234D: levy of interest on excess refund granted at the time of summary processing where the refund is later found to be not due or not wholly due upon regular assessment. (b) Explanation 2 to Section 234D, inserted by Finance Act, 2012 with retrospective effect from 01.06.2003, clarifying that Section 234D applies to assessment year 2003-04 and earlier years where assessment proceedings are completed after 01.06.2003. Interpretation and reasoning (c) The only controversy was applicability of Section 234D to assessment year 2003-04. The assessment order in this case was passed on 28.02.2006. (d) In view of the explicit retrospective amendment in Explanation 2, the provision applies to assessments completed after 01.06.2003, even for earlier assessment years. The assessee's counsel fairly conceded that, in these circumstances, the levy of interest was in accordance with law. Conclusion (e) Interest under Section 234D is leviable on excess refund in the assessee's case, as the assessment was completed after 01.06.2003. The Tribunal's view upholding such levy was affirmed, and this issue was decided in favour of the revenue.