TaxTMI 
TaxTMI 
2006 (2) TMI 220
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....sessee was incorporated as a company in India with 100 per cent foreign equity participation, pursuant to an approval granted by the Ministry of Industry, Department of Industrial Policy & Promotion, Secretariat for Industrial Assistance. M/S. Herbalife International, USA, was the foreign collaborator who obtained the approval for setting up the assessee-company in India. As per the approval of the Ministry of Industry, the Assessee should manufacture herbal products on contract basis in India and should not import these items. 3. The products of the parent USA company are sold in 58 countries worldwide. Scientists, doctors and nutritionists have developed these products with personal wellness goals in mind. Through constant research and product testing, the products are claimed to meet the highest standards set for the Industry. The parent company claims to have developed significant expertise developed over the years. The parent company desires that these standards should be achieved by the various subsidiaries throughout the world. The parent company therefore provides data processing services, record keeping, distributor/supervisor information and order and shipment processi....
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.... an expenditure of Rs. 5.83 crores as administrative fee paid during the year. This sum was paid by the assessee to M/s. HIAI as consideration for the various services it provided to the Assessee under the agreement dated 10-11-1999, the details of which have been mentioned at para 4 above. The break up of this sum of Rs. 5.83 crores on the basis of the period to which it relates to is as follows: 1-1-2000 to 31-12-2000 10,00,000 US $ 1-1-2001 to 31-3-2001 2,50,000 US $ Total 12,50,000 US $ 12,50,000 US $ is equivalent to Rs. 5.83 crores. 7. It is pertinent to mention here that the previous year of the assessee relating to assessment year 2001-02 is the period from 1-4-2000 to 31-3-2001. M/s. HIAI follows the calendar year and the annual charges payable for calendar year 2000 was 10,00,000 U.S. $. 8. As can be seen from the details of the administration fee claimed as deduction by the assessee, it includes fee for the period 1-1-2000 to 31-3-2000, which relates to the previous year relevant to assessment year 2000-01. According to the revenue, since this item of expenditure relates to the period falling within the assessment year 2000-01, the same cannot ....
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....were received from M/s. HIAI, there was a precedent on the basis of which it could reasonably estimate the expenditure under this head and it had estimated the same at 1/4th of the sum payable for a period of 12 months. The second plea of the assessee was that with effect from 1-6-2000 Foreign Exchange Regulation Act, 1973 was replaced by Foreign Exchange Management Act, 1999 ('FEMA' for short) and under the new legislation payment such as the one made by the assessee, a resident of India to a Non-Resident like M/s. HIAI was a payment on Current Account transactions and in terms of section 5 of FEMA, foreign exchange could be drawn from an authorized dealer without a necessity for a permission from RBI as was the position earlier. The assessee thus pleaded that in view of these two facts the sum payable by the assessee to M/s. HIAI could be ascertained and could therefore be said to have accrued and arisen to the assessee and therefore was an allowable expenditure. 12. Apart from this dispute with regard to whether or not expenditure relating to period 1-1-2000 to 31-3-2000 can be said to have accrued or arisen as a liability in assessment year 2001-02 and the dispute as....
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.... services and that as per the provisions of section 9(1)(vii), income by way of fees for technical services payable by a person who is resident utilized within India are deemed to be income accruing or arising in India. The Assessing Officer after making a reference to Explanation 2 to section 9(1)(vii) of the Act, defining the term "fees for technical services" observed that it includes any consideration paid for rendering any managerial, technical and consultancy services and that the nature of services rendered by M/s. HIAI to the assessee for which the sum was payable, fell within the definition referred to above. Since, there was a failure to deduct tax at source, the Assessing Officer disallowed the claim for deduction of the sum of Rs. 5.83 crores, in view of the provisions of section 40(a)(i). 15. The assessee raised a plea before the Assessing Officer that the amount paid/payable to M/s. HIAI were reimbursement of actual cost incurred by M/s. HIAI on behalf of the assessee and therefore mere reimbursement of cost will not give raise to income in the hands of M/s. HIAI which can be brought to tax in India in the hands of M/s. HIAI. The assessee also pleaded that the natu....
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....ces. Exhibit A is an annexure to the Administrative Services Agreement. Further, this matter was considered by the Reserve Bank of India while granting permission for the remittance of "Administrative Services Fees', and their communication dated 30-6-2000addressed to the appellant-company has clearly stated that the approval is for payment of "Services Fee" and that income-tax should be paid thereon as per the provisions of the Income-tax Act. In the light of the above discussion, it is clear that there is no point to point reimbursement of actual expenditure undertaken by Herbalife USA on behalf of the appellant. It is a moot point that in any technical service Agreement, what is being paid by the user is partly the cost of the man power deployed by the service provider, but that does not constitute an arrangement for reimbursement of costs or bills. If the arguments of the appellant were to be accepted, then payments to law firms, chartered accountant firms, marketing consultants etc. would all escape the provisions of section 40(a)(i) by arguing that the payer is only reimbursing them for the various labour and skill components and no element of profit is embedded ....
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....r the first time before the ITAT that provisions of Article 12(4)(a) will apply and consequently the sum in Question can be said to be fees for included services be entertained? If yes, is such a plea sustainable? (6) Can the alternative plea of the assessee that in any event in view of the provisions of Article 26(3) of the DTAA between India and USA the provisions of section 40(a)(i) of the Act cannot be applied in the instant case and consequently no disallowance can be made as has been done by the Revenue authorities. (B) If the sum in question is held to be not chargeable to tax and not disallowable under section 40(a)(i) of the Act, whether the disallowance of the said sum for the period from 1-1-2000 to 31-3-2000 can be disallowed as a prior period expense or can it be said that the liability accrued or arose to the assessee only in the previous year relevant to assessment year 2001-02? (C) Whether the sum in question claimed as expenditure relating to the period1-1-2001to31-3-2001can be allowed as a deduction? 20. At the outset, we take up for consideration the question whether in view of the provisions of Article 26(3) of the DTAA between Indi....
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.... between India and USA contemplates a situation where a person considers that actions of one or both the Contracting States result or will result for in taxation not in accordance with the provisions of the DTAA, then he may, without prejudice to other remedies available to him under the local law, present his case to a competent authority of the Contracting State of which he is a resident or national. The assessee has made a reference under the Mutual Agreement procedure provided under Article 27 of India-USA DTAA. 22. Keeping in mind the aforesaid background of the case, we now proceed to decide the question of applicability of Article 26(3) of India-US DTAA. Article 26 of India-US DTAA deals with "Non-discrimination". Article 26(1) says that Nationals of one Contracting State shall not be subjected in the other Contracting State to any taxation or any requirement connected therewith which is much more onerous, then it is on the nationals of that other Contracting State. Article 26(2) provides against discrimination in the context of a permanent establishment in the other Contracting State. Article 26(3) is a general clause providing for Indirect discrimination against a non-r....
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....hment in India. If the income is considered as having accrued or arisen to M/s. HIAI in India, yet they can be taxed in India only if they are fees for included services. Even if the payment is considered as 'fees for Technical Services' within the meaning of Income-tax Act, 1961, yet they cannot be taxed because 'fees for Technical Services' and 'fees for Included Services' under India-US DTAA have different meaning and they are not one and the same. If the Revenue wants to tax the payment by assessee to M/s. HIAI in the hands of M/s. HIAI in India it has to bring its case within the ambit of Article 12(4) of the DTAA i.e. fees for Included Services. The payment in question would therefore have to be judged in the context of the DTAA as to whether it is taxable in India or not. 25. We shall now revert to Article 26(3) of the DTAA which deals with non-discrimination. To illustrate as to what extent the non-discriminate clause would apply, we may make a reference to such clauses in the OECD Model of "Double Taxation Convention", Organisation for Economic Cooperation and Development ("OECD") is an organization, comprising of member countries, for economic c....
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....se if the sums were not deductible. A similar provision is included in the Article relation to the deduction of debts owed to residents of the other Contracting State in determining the taxable capital of the enterprise." At page 411, the following commentaries are found on Article 24(4): "This paragraph is designed to end a particular form of discrimination resulting from the fact that in certain countries the deduction of interest, royalties and other disbursements allowed without restriction when the recipient is resident, is restricted or even prohibited when he is a non-resident. The same situation may also be found in the sphere of capital taxation, as regards debts contracted to a non-resident. It is however open to Contracting States to modify this provision in bilateral conventions to avoid its use for tax avoidance purposes." 26. As already observed by us the provisions of section 40(a)(i) as it existed prior to it's amendment by Finance Act, 2003, with effect from1-4-2004provided for disallowance of payment made to a non-resident only where tax is not deducted at source on such payment at source. A similar payment to a resident does not result in disal....
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....e provisions of FERA, 1973 or rules prescribed under the said Act, no expenditure can be said to have accrued or arisen to the assessee till such time RBI grants permission for remittances to M/s. HIAI. The assessee pointed out that only on30th June, 2000the permission of RBI was received. The assessee therefore pointed out that the expenditure had accrued only in the previous year relevant to assessment year 2001-02. 27.1. The ld. counsel for the assessee reiterated the plea as was raised before the revenue authorities. Reliance was placed by him on the following decisions for the proposition that where the particular Act is prohibited under the provisions of any law without obtaining the approval of an authority then it cannot be said that until and unless such an approval is obtained, a payment which is dependent on such approval, can be said to have accrued as a liability. Nonsuch Tea Estates Ltd. v. CIT [1975] 98 ITR 189 (SC), CIT v. John Flower India Ltd [1999] 239 ITR 312 (Bom.), CIT v. Kirloskar Tractors Ltd. [1998] 231 ITR 849 (Bom.). The ld. DR on the other hand relied on the order of the revenue authorities and also placed reliance on the decision of the Hon'ble S....
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.... payment for which permission was granted by the RBI was for rendering services or for import of goods. Considering the law laid down in the aforesaid judicial pronouncements, relied upon by the ld. counsel for the assessee we are of the view that the claim of the assessee that the expenses for the period 1-1-2000 to 31-3-2000 accrued as a liability to the assessee only during the previous year and the action of the revenue authorities holding that it is a prior period expenses cannot be sustained. The expenditure claimed for this period is therefore directed to be allowed as a deduction. 29. The next point that arises for consideration is as to whether the revenue authorities were justified in disallowing the claim of the assessee for deduction in respect of fees paid to M/s. HIAI for the period relating to 1-1-2001 to 31-3-2001. As far as the fee payable for this period is concerned, the reason given by the Assessing Officer for making the disallowance was since the payment to M/s. HIAI required the consent of the RBI and since there was no evidence lo show that the assessee did apply for such permission to the RBI for the period subsequent to 31-12-2000 it was evident that th....
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....efore, hold that the claim of the assessee for deduction of the entire sum of Rs. 5,83,68,396 being administrative fee paid to M/s. HIAI should be allowed as a deduction. The Assessing Officer is directed to allow the deduction accordingly. The third ground of appeal of the assessee is allowed, to the extent and on the basis indicated above. 32. In ground Nos. 4 and 4.1 the assessee has challenged the action of the revenue authorities in disallowing the claim for deduction of expenditure of a sum of Rs. 53,63,731 being expenditure incurred for improvements carried out in respect of premises taken on lease by the assessee. The reasons given by the revenue authorities for making the disallowance was that the expenditure was of a capital nature. It is seen from the order of the Assessing Officer as well as the order of the CIT(A) that none of them have considered the nature of expenses before concluding that they were of a capital nature. The details of the expenditure are as follows: Details of leasehold improvements during the F.Y 2000-01 Date Particulars Amount Rs. 19-6-2000 Wood work, aluminium lock, wiring board 3,500.00 30-12-2000 Interior work 1....
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....ned, the same is directed to be deleted. 34. In the fifth ground of appeal the assessee has challenged the action of the revenue authorities in disallowing a sum of Rs. 5,97,184 on account of foreign exchange fluctuation loss. In the grounds of appeal the assessee has however mentioned the figure at Rs. 73,17,184 which is a mistake as admitted by the ld. AR before us. As far as this issue is concerned, the total of the loss on foreign exchange fluctuation is given at page 187 of assessee's paper book I which is as follows: Summary of foreign exchange loss transactions during the year 2000-01 Rs. On account of technical know-how fees $ 2 Million 6,720,000.00 Imports 806,243.03 Expenses on travel, communication costs etc. (55,584.90) Loan 301,674.29 Administration Fee (455,148.00) 35. It is not in dispute that the assessee has been consistently following a system of accounting for recording the exchange variation both when it is a loss as well as when there is a gain as on the last day of every financial year. It is also not in dispute that the foreign exchange fluctuation is not on capital account. According to the revenue auth....
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....ded as under: "I, therefore, based on the findings above, hold that the manufacturing and trading accounts of the assessee are not correct and complete. Its opening and closing stocks are not tallying are as per its own stock records. The production of each of the products is also not reflected correctly in the stock records, since only the balancing figure is taken. The sales in different statements submitted are varying and are not reliable. I, therefore, proceed to determine the trading income of the assessee to the best of my judgment. In the current year the assessee has debited manufacturing costs which is 28.8 per cent of its sales whereas in the preceding year the manufacturing costs was 19.6 of the sales. The sharp increase in the cost of manufacture, coupled with the inability of the assessee to reconcile its production, sales, stock write off and the opening and closing stock, further lead me to believe that the assessee has not recorded its transactions fully and truly in its books of account. Even taking into account inflation, the slump in sales in the later part of the year, etc. the increase in the cost of production is found to be disproportionate. I, ther....
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....of Chartered Accountants appointed for carrying out this exercise. The ld. Counsel has vehemently submitted that the estimation made by the lower authorities was highly unjustified and the basis adopted was not justified, on facts. It was further submitted that the profit for the year, if at all, may be increased by an amount of Rs. 72,36,139 in terms of the report of an independent firm of Chartered Accountants. 39. The ld. DR has defended the orders of the lower authorities by placing reliance on the reasonings taken by them resulting in the addition based on an estimate basis. 40. We have considered the rival submissions. At the outset, we may state that insofar as the discrepancies in the stock statements is concerned, the assessee itself does not seriously dispute that the same exist. The central explanation of the assessee for the difference is on account of the inventory software package which was introduced by the assessee in this year. Without going into the merits of the same, it is safe to deduce that the discrepancies are such so as to impact the profits declared by the assessee in its books of account. Thus, the unreliability of the manufacturing and trading resu....