Section 263 revision and treaty non-discrimination barred 100% disallowance on non-resident payments

The Tribunal considered whether revision under section 263 could be invoked where a reassessment order was alleged to be erroneous and prejudicial to the Revenue, and whether non-deduction disallowance on payments to non-residents could be enhanced to 100% under section 40(a)(i). It held that section 263 requires both error and prejudice, and that the actual prejudice condition was not satisfied. On the treaty issue, it found that a 100% disallowance for non-resident payments, when comparable resident payments attract only a 30% disallowance, is discriminatory and inconsistent with Article 26(3) of the India-USA DTAA, which prevails where more beneficial. The revisionary jurisdiction and the enhancement were therefore not sustained.

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Issues: Whether the Principal Commissioner could invoke revisionary jurisdiction under section 263 of the Income-tax Act, 1961 on the footing that the reassessment order was erroneous and prejudicial to the interests of the Revenue, and whether the disallowance for non-deduction of tax on payments to non-residents could be sustained at 100% in view of Article 26(3) of the India-USA DTAA.

Analysis: The reassessment order suffered from an error in the quantum of disallowance because it included an amount that had already been doubly considered. However, for section 263 jurisdiction to survive, the order had to be both erroneous and prejudicial to the interests of the Revenue. The Tribunal held that the rate of disallowance was the real controversy, and that the difference between 100% disallowance under section 40(a)(i) and 30% disallowance under section 40(a)(ia) had to be tested against the non-discrimination mandate in Article 26(3) of the India-USA DTAA. Relying on the binding legal position that treaty provisions prevail where they are more beneficial, the Tribunal held that a 100% disallowance for non-resident payments, when comparable resident payments attract only 30% disallowance, results in discriminatory treatment.

Conclusion: The Principal Commissioner's assumption of jurisdiction under section 263 was invalid because the prejudice condition was not satisfied. The direction to enhance the disallowance to 100% was not sustained, and the assessee succeeded on the jurisdictional challenge and the treaty-based challenge.

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