TaxTMI 
TaxTMI 
2014 (10) TMI 702
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....2C, is justified on the facts and in the circumstances of the case - referred to in grounds of appeal nos. 1 to 4, and subsidiary grounds of appeal set out in these main grounds of appeal; and (b) whether or not the disallowance of Rs. 102,17,16,483 under section 40(a)(i) is justified on the facts and in the circumstances of the case- referred to in grounds of appeal nos. 5 to 11, and subsidiary grounds of appeal set out in these main grounds of appeal. We will take up these issues in the same sequence. Issue 1: Correctness of ALP adjustment of Rs. 68,15,17,853 Background 3. So far as ALP adjustment of Rs. 68,15,17,853 is concerned, the relevant material facts are like this. Mitsubishi Corporation India Pvt. Ltd. (MCI, in short) is a wholly owned subsidiary of Mitsubishi Corporation Japan (MCJ, in short) - one of the leading sogo shosha establishments in Japan. While 'sogo shosha', a Japanese expression, can be transliterated as a 'general trading' and sogo shosha companies are, therefore, generally described as 'general trading companies', the true connotations of sogo shosha companies are quite different from a typical general trading company as c....
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....o is 1.13, the international transactions entered into by the assessee are at arm's length price. 5. The approach so adopted by the assessee was rejected by the TPO. The TPO was of the considered view that under rule 10B(4), the data to be used in comparability of an uncontrolled transaction with an international transaction shall only be of the related financial year, though an exception could be made out for data of two immediately preceding financial years only if such data reveals facts which could have an influence on the determination of transfer prices in respect of international transaction being compared. It was in this background, and supported by a detailed analysis of the legal position as also judicial precedents on this issue, the TPO rejected the use of multiple year data. 6. The TPO was also of the view that since the assessee has used berry ratio as PLI, entire international transactions relating to sales and service of commodities have remained out of PLI, and that, most importantly, the cost of sales is not included in the denominator of PLI used. The TPO was further of the view that the legal provisions, as set out in the Income Tax Act, 1961 or the In....
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....n regulatory or financial matters. It was also noted that, as stated in the transfer pricing study, "the presence of assessee in India provides AEs a medium of communication through which they can compete with their competitors eyeing similar business in India". The TPO was of the view that "the assessee has performed all the critical functions, assumed significant risks and used both tangible and unique intangibles developed by it over a period of time". He then summarized the FAR analysis as follows: Functions performed by the assessee: -Purchasing activities: Mitsubishi India places orders with related party vendors after receiving orders or projections from its customers -Distribution activities: In some of the principal transactions, Mitsubishi India warehouses Inventory at public bonded warehouses and maintains sufficient Inventory as per agreement with customers. It performs Inventory control and ships goods to customers. Mitsubishi India's customers sometimes arrange for their own shipping and handling. -Sales marketing and after sales activities: In principal transactions, the Group Companies coordinates in negotiating prices with Mitsubishi India's cus....
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....ontrol over contracted manufacturer and quality control over manufacturing process, (6) scheduling of the product and order tracing, (7) packaging and labelling, (8) quality control, (9) consignment of goods,(9) consignment of the goods, (10) transportation of goods to the port of departure, and (11) random quality check prior to shipping. The TPO observed that "since risks largely follow functions, in this case the assessee has borne all the major risks association with the above referred functions" as also the following major business risks - single customer risk (because, as per contract, the assessee could not work for any unrelated customer), sourcing risk, risk associated with development and use of intangibles, risk associated with quality of service, and capacity utilization risk. The TPO was of the view that that "the assessee has used its assets, including human assets (technical manpower) to discharge the functions referred to above". The TPO was of the view that "the assessee has developed a supply chain management intangible over a period of time which is all about having the right product in the right place, at the right price, at the right time and in the right condi....
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....tangibles. 10. It was also noted that as a result of transfer of manufacturing and procurement activities from high cost economies to a low cost economy like India, considerable locations savings have accrued to the AEs but the compensation model, which provides for a mark up on costs, does not take into account the benefits from the locational savings. As for the use of berry ratio, the TPO finally rejected the same for two main reasons - first, that the scheme of section 10B(1)(e)(i) does not permit the same, and - second, that berry ratio is unsuitable for the situations involving unique intangibles (like supply chain intangibles and human assets intangibles) and since it is highly sensitive to the costs and the treatment of costs may vary from accounting policies in different comparables and it is difficult to make appropriate adjustments in respect of such variations in accounting treatment. The TPO was of the view that berry ratio is de facto cost plus method, as accepted in one of the observations made by Charley H Berry, author of this ratio, himself - which was reproduced by the TPO, the assessee cannot resort to the use of this ratio when the assessee has consciously c....
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....he same and duly considered factual matrix of the case as also the applicable legal position. Shri M. S. Syali, Senior Advocate, alongwith Shri Tarandeep Singh, appeared for the assessee and Shri Peeysh Jain and Shri Y K Verma, Commissioner - Departmental Representatives, appeared for the revenue. The position in the immediately preceding assessment year- views of the coordinate bench: 14. We must begin by taking note of the fact that an identical adjustment, so far as buy-sell segment is concerned, made by the Assessing Officer in the assessee's own case for the immediately preceding assessment year, had come up for consideration before a coordinate bench of this Tribunal, and the coordinate bench, vide order dated 23rd August 2013 (now reported as 63 SOT 162), has remitted the matter back to the assessment stage by observing as follows: 10. The second ground of the assessee is on the issue of transfer pricing adjustment. The nature of assessee's business as described in the DRP order is to undertake (sogo shosha) activities i.e. role of a trade intermediary. The purchases are made by the assessee are recorded as such in its books of accounts and there after when ....
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....ns of sale and purchase. 8. It was submitted by the learned counsel that its functional profile was not that of a trader but that of a service provider. It was explained that the assessee places orders for purchase with its parent company on the basis of confirmed orders from its customers. It was submitted that in substance the assessee only front ends the transactions of its parent company. The assessee is, thus, not exposed to the risk of carrying any inventory and/or deploying any significant working capital. Accordingly, it was claimed by assessee that the cost of goods sold should not be taken into consideration while computing the profit margins which should be calculated on the operating costs and the appropriate ratio to be considered for comparing with other entities would be the ratio of net revenue to operating costs. 9. The said contentions had also been advanced by the assessee before the ITAT. In the alternative, the assessee had submitted, before the ITAT, that if the transactions of buying and selling were considered to be trading then the ALP should be determined in comparison with companies which were similarly situated. 10. The Tribunal had considered t....
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....sment year 2006-07, in respect of which the above decisions were rendered, the dispute was confined to the trading transactions. In the assessment year before us, however, the assessee has undertaken two types of transactions, i.e. - (a) service/commission transactions, in which MCI has acted as a mere facilitator for transactions; and (b) trading/buy sell transactions, i.e. where assessee takes flash title of the goods momentarily while buying the goods against confirmed orders and then selling the same to third parties. As regards service/commission transactions, the assessee collects information such as market data and financial conditions of such entities, and these activities are carried on by the assessee based on broad strategies and guidelines provided by the AEs. These are the activities, according to the learned counsel, in which functions and risks are minimal. As regards the trading transactions, the assessee enters into transactions on principal to principal basis with AEs as also non AEs but as the assessee takes flash title of the goods only momentarily and buys goods based on confirm back to back orders, the value addition, even in buy sell segment, is akin to that ....
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....tends that its usage is most appropriate to the facts and circumstances of this case. In the kind of peculiar activity that the assessee is involved in, it would be, according to the learned counsel, wholly irrelevant to take into account, in computing the PLI, the cost of goods sold or value of goods sold. Learned counsel then points out that the reasons assigned for rejecting the berry ratio are not legally sustainable. He submits that it is incorrect that use of berry ratio is not permitted under rule 10B(1)(e)(i) as there is no specific prohibition on use of berry ratio, and that since the so called unique intangibles on account of supply chain and human assets are pure figments of imagination of the TPO and these vague allegations cannot restrict the use of berry ratio. Learned counsel submits that there is nothing unique about these intangibles of supply chain and human assets, as anyone engaged in trading will have a vendor development and the human resources taking care of this aspect of the matter. He points out that the intangibles, in order to be taken into account for profitability of the assessee on trading with its AEs, should be unique intangibles, not present in the....
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....edressal Panel, the DRP has not at all adjudicated on these grievances. This issue is also now, according to the learned counsel, covered in favour of the assessee inasmuch as in the case of Li & Fung India Pvt Ltd (supra), Hon'ble High Court has rejected similar contentions, which were also raised without any cogent material to support the same, raised in that case. In any event, as per provisions of Section 92 C(3) r.w.s. 92CA(1), the TPO can determine the ALP of a transaction only when there is any material nor information so as to satisfy fulfilment of conditions set out in 92 C(3) (a) to (d). In support of this proposition, reliance is placed on a decision of the coordinate bench in the case of Mentor Graphics v. DCIT (18 SOT 76). It is thus urged that while the matter can indeed be remitted to the file of the Assessing Officer, clear directions need to be given in the light of the settled legal position as set out above and treating the commission and service fee segment as per the settled legal position. 18. Learned Departmental Representative, on the other hand, relied upon the orders of the authorities below and took us through the same. He contended that since the ....
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....ed counsel for the assessee, in his rejoinder, submitted that the subject matter of adjudication before us travels much beyond what was adjudicated in the preceding assessment year, that there is benefit of guidance available on legal issues from the Hon'ble Courts above as also by the coordinate benches, and that, therefore, simply remitting the matter to the assessment stage will result in inordinate delays in resolving the core dispute. It is also submitted that now that we are in seisin of the matter, and it is clearly discernible that perceptions of the parties on some peripheral key issues do not have any meeting ground, the right course will be to give specific directions in the matter so as the assessment reaches finality sooner rather than later. Our analysis: Disparities in facts of the immediately preceding assessment year and the assessment year before us: 20. We find that, as learned counsel rightly points out, so far as the decision for the assessment year 2006-07 is concerned, it is confined only to the trading activities of the assessee and it does not deal with service fee/commission segment. As the coordinate bench itself has observed in so many words....
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....as or general trading companies. These companies are unique in the world of commerce and play an important role in linking buyers and sellers for products ranging from bulk commodities, such as grain and oil, to more specialized products like industrial equipment. 'Sogo' means general and 'shosha' is a trading company, hence the sogo shosha handle a wide range of products. They are characterized firstly by colossal sales, secondly by diversity of goods traded (from noodles to missiles), engage in both import and export with every major market in the world, and thirdly by global reach of their network 2.3 Profile of Mitsubishi India MCI is wholly owned subsidiary of MCJ. MCJ is a general trading company and the group plays an important role in linking buyers and sellers for products in a variety of industry segments. MCI is considered to be a low risk activity and the primary source of activity is in the nature of commission earned on the traded goods. (Emphasis by underling supplied by us) 23. A plain look at the above analysis of profiles shows that even the TPO does not dispute that (a) MCI is a low risk activity in the field of trading, (b) MCJ gro....
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....omprise the conglomerate or sogo shosha. Unlike typical Western trading companies and Japan's some 9,000 other trading companies, the sogo shosha are distinguished by their international networks, their trade of numerous commodities, and their large market shares. For example, a sogo shosha may control about 10 percent of Japan's trade, handle a range of 10,000 to 20,000 products including food, clothing, automobiles, and appliances, and have a network of over 200 offices throughout the world. Although developing and industrial countries have experimented with the sogo shosha system, few, if any, have succeeded in completely replicating the Japanese organization. The major sogo shosha include Mitsubishi, Mitsui, C. Itoh, Sumitomo, Marubeni, Nichimen, Kanematsu-Gosho, and Nissho Iwai Corp. In the late 1990s the sogo shosha controlled about 10 percent of the world's exports and over 50 percent of Japan's overall trade, according to Marketing Intelligence and Planning. The sogo shosha are also characterized by their ability to issue large volumes of credit and to help small manufacturers buy and sell goods in the global market. These trading companies serve as inter....
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....ifficult to know about or understand but universally acknowledged as a powerful force in the economy", but one common thread in all descriptions of 'sogo shosha', whatever be the source, is sheer complexity of its business model, range of its activities and integrated link it provides between the buyer and seller. When such is the description of the core business activity of the MCJ, and the role of the assessee is restricted to a support function by way of a trading, as it is held to be, this kind of a trading, as assessee is held to have carried out, cannot be equated with activities of a normal trader. If there is no parallel to sogo shosha as a business model, there cannot obviously be a parallel to trading activity under this business model. 27. No doubt that the assessee before us, i.e. MCI, is playing only a small role of linking the buyers with sellers, either as a service activity or even as a trader, but the importance of the activity of sogo shosha being pursued by the group lies in the admittedly lower trading margin that sogo shosha trading operates on and in relatively lesser importance of the trading activity in overall scheme of a complex interdependent s....
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....gful by adopting a profit level indicator which ignores the impact of vital dissimilarities in inventory levels between the assessee and the comparables. We will deal with this aspect of the matter a little later. Impact of Hon'ble High Court's directions on comparability adjustments between a normal trader and sogo shosha 30. We are alive to the fact that, in the immediately preceding assessment year, decision of the Tribunal was against the assessee on this issue inasmuch reconsideration of functional profile of the assessee was specifically rejected in the order dated 4th April 2014 passed by the Tribunal, on rectification petition filed by the assessee. However, we have also noted that Hon'ble High Court, in order dated 4th July 2014, have construed Tribunal's observations to the effect that "appropriate comparables would have to be considered for determination of the ALP" as implying that "entities which are similarly placed as the assessee including in respect of their functional and risk profile as well as working capital exposure would be chosen as comparables" which essentially involves reconsideration of profile of the assessee vis-à-vis the p....
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....efore the midpoint, i.e. closer to X rather than with Y) 33. Yet, clearly, there is still a difference between normal trading and sogo shosha trading, and one vital aspect of this difference is that in the present sogo shosha trading there are no inventories at all. Any comparison exercise, which takes into account the impact of inventories or cost of inventories, will, therefore, end up making the comparison useless. Does zero inventory level affect exclusion of cost of inventories in PLI determination 34. Once it is not in dispute, as is the position in that case, that the trading activity involved carried on by the assessee is a back to back operation, without any value addition to inventories or without any functions performed on the inventories, and is, that sense, without any risks associated with inventories, the cost of inventory being included in the cost base of the assessee cannot be justified on the economic principles, even as this cost of sales may have to be entered into books of accounts in compliance to the accounting principles and accounting standards. 35. In the cases in which no economic risk for inventories is assumed, in which these inventories do....
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....analysis is concerned, it is wholly justified to exclude the cost of inventories in formulae adopted for the ALP determination. 39. That exclusion, however, proceeds on the assumption that there is a vital nexus between inventory levels and profitability. Economic nexus between inventory levels and profitability 40. The fact that there is a clear relationship between the inventory levels and margin levels is also evident from the stand taken by the CBDT that where inventory levels are 10% of turnover or less, the permissible tolerance range is much less at 1/3 of permissible range where the inventory levels are more than 10% of the turnover. On economic principles, profit is reward for the functions performed, assets employed and risks assumed, and, going by that principle, for the same functions of trading performed, when assets employed are lesser and risks assumed lower, the profit reward should also be correspondingly lower. In the case of the assessee before us there are no functions performed with regard to inventory and no risks assumed with respect to inventory. To that extent, going by the pure economic theory, profit, which as we have noted above is nothing but a....
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....is similar to that of the uncontrolled comparables". So far as Indian TP provisions are concerned, the PLIs set out in rule 10B(1)(e)(i) are only illustrative inasmuch as it ends with the expression "or having regard to any other relevant base" but there is no prohibition as such on the use of this ratio. However, having regard to the use of this ratio worldwide, and for the reasons we will set out in detail in a short while, the use of this ratio cannot be eliminated from the India transfer pricing practices altogether. 46. In the July 2010 version of OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations, berry ratio is specifically recognized as follows: 2.100 "Berry ratios" are defined as ratios of gross profit to operating expenses. Interest and extraneous income are generally excluded from the gross profit determination; depreciation and amortisation may or may not be included in the operating expenses, depending in particular on the possible uncertainties they can create in relation to valuation and comparability. 2.101 The selection of the appropriate financial indicator depends on the facts and circumstances of the case, see paragra....
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....s evident from the underlined portion of the OECD approach, highlighted above, berry ratio can be particularly useful in the situations in which the entity is engaged in the business as a trade intermediary, the value of services performed by the entity is adequately reflected by operating expenses, the value of functions performed and assets employed in the controlled transactions is not proportionate to sales and when the entity does not perform any significant operations such as manufacturing or processing. Typically, a low risk high volume trading business involving back to back trading without any value addition to the goods traded, which is what MCJ is engaged in and the MCI is contributing to, satisfies all these tests. We are in agreement with the approach adopted by the OECD document in this regard. Going by this approach, and, applying the tests laid down above, it does indeed seem that berry ratio could be appropriate in the present case. 48. Berry ratio is increasingly finding specific acceptance in many jurisdictions. While it is use in US for long, in Japan, even as berry ratio was used in APAs earlier as well, the 2013 amendment to the transfer pricing regulations....
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....ed as gross profit to operating expenses. There are some variants to this ration but that aspect of the matter is not really relevant for the present purposes. 51. The underlying assumption for applicability of berry ratio is that the return to the tested party should be commensurate with his operating expenses and the value of goods dealt in was irrelevant for this purpose. While this proposition so laid down was in the case of a limited risk distributor without any value addition to the goods or significant risks associated with inventories, we are of the considered view that it is equally useful in a case in which the business entity is engaged in trading, with zero or low inventory levels, and particularly as it does not involve any unique intangibles or value addition to the goods traded. 52. The answer to the fundamental question of whether a taxpayer should be entitled to a return on the value of goods handled by it, would actually depend on the functions performed and the related risks borne by it, with respect to the goods; and not on whether the taxpayer has taken title to the goods, shorn of the assessee's FAR profile. 53. Clearly and undisputedly, on the fa....
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.... the media carrying the advertising agency in planning and designing that advertising. If we use a cost plus method, and the Berry ratio is a cost plus method, we want a measure of the costs of the firm involved, i.e. the distributor or advertising agency in these examples, not something that measures only the value of the product distributed, or the value of the exposure provided by radio, television or print media". 6.5 It is contended that the Berry ratio is merely a variant of the cost plus method. If one were to think of the gross margins earned by a distributor as analogous to a firm's total revenues available to a distributor, and the operating expenses incurred to distribute products as analogous to the firm's total costs, then the ratio of gross margin to operating expenses would capture the mark-up on operating expenses that is afforded to the distributor. 6.6 The Berry ratio can also be applied to service providers, as it can be conceptualized as the mark-up earned on the costs of provision of services, by subtracting one from the Berry ratio expressed in unit terms as follows:- Berry ratio - 1 = GP/VAE - 1 = (GP-VAE)/VAE = OP/VAE wherein GP = gros....
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....he inventory levels are also extremely low, at least with respect to the goods traded, since the nature of activity does not require maintenance of inventories and there is sufficient lead time between order being received and the actual procurement activity. There are no other factors, in addition to the operating costs, which affect direct relationship between operating costs and operating profits. Therefore, except in a situation in which significant trade or marketing intangibles are involved or in a situation in which there is further processing of the goods procured before selling the same or in a situation which necessitates employment of assets in infrastructure for processing or maintenance of inventories, the use of berry ratio does seem to be quite appropriate. 59. As we make the above observations, we also make it clear that in case the assessee is not able to find other comparables with significantly low or zero inventory levels, it does not prejudice the interests of the revenue authorities in any manner. The reason is this. When a comparable has an additional risk associated with inventories, which is not present in the case of the assessee, the profits achieved b....
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.... internal page 30; paper-book page 242) and thus presence of some traits of CPM, by itself, does not render this ratio inapplicable as long as it fits with the scheme of rule 10B(1)(e), which, as we will see now, it does fit in. The Assessing Officer's observations about assessee's conscious choice of TNMM, and, for that reason, inapplicability of berry ratio, which is a based on CPM principles, are thus irrelevant and ill conceived. As a matter of fact, if this TP report at all indicates anything in this regard, it indicates that even when assessee selected TNMM, the assessee was very well aware that TNMM with berry ratio will be most suitable in the present case, and there is no legally sustainable objection to the stand so taken by the assessee in the TP study. TPO's other objections to application of Berry Ratio 63. We have noted that the TPO has raised three other objections with respect to the berry ratio, i.e. (a) use of berry ratio is not permitted under rule 10B(1)(e)(i) as it does not deal with costs incurred, sales effected or assets employed or to be employed; (b) use of berry ratio is not appropriate to the facts of this case as there are unique intan....
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....ificant unique intangibles, which are acquired by the assessee at a specific cost, which have significant replacement cost or which are developed otherwise than as a bye product of carrying out routine business activities of the assessee. As we have noted elsewhere in this order, not only that there should be intangibles in use in the business and owned by the assessee but such intangibles should be unique-unique to the assessee which are not found in the comparables. A trained workforce, unless it has significant development cost or replacement cost, is a routine business intangible which almost all comparables will have. Cost classification issues in application of berry ratio 67. As regards the alleged unsuitability of use of berry ratio due to operational difficulties due to variations in accounting policies, it is sufficient to take note of the fact that coordinate benches of the Tribunal have upheld the use of berry ratio in appropriate cases, including the case of GAP International Sourcing India Pvt Ltd (supra), and that no specific issues are raised by the TPO with regard to operational difficulties in the cases of selected comparables. The problem, thus, is hypothet....
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....couple of examples, are lower than in the location where the activities were initially performed. It follows that the savings have to be with respect to the activities and operations performed, which MNE was earlier performing at another location, and not with respect to the costs of purchases. Therefore, if an assessee is able to buy a product or service at a lower price vis-à-vis price in another jurisdiction, including the domicile jurisdiction, such purchases of goods or services per se donot give rise to a locational saving for the purpose of ALP determination. In the present case, the price advantage to the assessee, on account of sourcing his purchases from India, thus may not amount to any locational savings at all, but then, as we could make out from a perusal of material on record, that precisely is the case of the TPO. No doubt "United Nations Practical Manual on Transfer Pricing for Developing Countries" does include 'locational savings' in its comparability analysis and defines it as "net cost savings that an MNE realizes as a result of relocation of operations from a high cost jurisdiction to a low cost jurisdiction" but then it is not even TPO's ca....
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....s of the present case that aspect of the matter is wholly academic in effect. Human asset intangibles and supply chain intangibles- correctness of TPO's stand 71. Coming to TPO's observations that the compensation model adopted in this case does not provide for meeting the costs of developing supply chain intangibles and human assets intangibles, but the intangible so developed by the assessee are routine intangibles developed only during the course of work carried out by the assessee and any other intangibles, other than the ones developed in the course of this business, are owned by the AEs and not the assessee company. It is only when intangibles are owned by the person, using these intangibles or transferring these intangibles per se, that the question for compensating for use or transfer of intangibles arise. There is nothing to corroborate and support the vague generalization that cost plus method does not "capture the compensation for development and use of intangibles". It is not even the case of the TPO that these intangibles were acquired or developed by the assessee by incurring certain specific costs and such costs are not taken into account in the compens....
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....ax authorities should base their conclusions on specific facts, and not on vague generalities, such as "significant risk", "functional risk", "enterprise risk" etc. without any material on record to establish such findings. If such findings are warranted, they should be supported by demonstrable reason, based on objective facts and the relative evaluation of their weight and significance ". These observations equally apply to the fact situation before us as well. As learned counsel for the assessee very aptly puts it, all these intangibles, as perceived by the TPO, are more of his figment of his imagination rather than based on any cogent material. The use of intangibles cannot be inferred or assumed. It is to be demonstrated, on the basis of cogent material, by the revenue authorities. Itacha Industries decision by the US Court of Appeal and its relevance to the ALP determination: 74. As for the US Court of Appeal decision in the case of Ithaca Industries (supra), referred to and relied by the TPO in support of the proposition that a trained workforce is also an intangible asset and it should be factored in the TP analysis, this decision was concerned with the question, as t....
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.... on determination of the ALP, as we have noted earlier as well, not only an intangible should exist but it should also be a unique intangible giving an edge to the business in which such an intangible is used. 77. A trained workforce, in the absence of any specific and significant features attached to it, significant training or development costs related thereto or significant replacement cost, cannot treated as a unique intangible having impact on determination of arm's length price. An assembled workforce, even without any identifiable direct costs in raising the same, can at best be taken into account only when it has significant replacement costs, such as in the case of construction activities, for determination of the arm's length price. The situation that we are dealing with is qualitatively different. 78. Learned TPO's reliance on Itacha Industries decision (supra) is thus wholly irrelevant for the purpose of the determination of ALP which is the issue in appeal before us. While assembled workforce could always be an intangible asset, as held in the said case, such an intangible asset gets into ALP computation only when such an intangible asset has a signif....
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.... reference to cost incurred by it, and not by any other entity, either third party vendors or the AE. Textually, and within the bounds of the text must the AO/TPO operate, Rule 10B(1)(e) does not enable consideration or imputation of cost incurred by third parties or unrelated enterprises to compute the assessee's net profit margin for application of the TNMM. Rule 10B(1)(e) recognizes that "the net profit margin realized by the enterprise from an international transaction entered into with an associated enterprise is computed in relation to costs incurred or sales effected or assets employed or to be employed by the enterprise ..." (emphasis supplied). It thus contemplates a determination of ALP with reference to the relevant factors (cost, assets, sales etc.) of the enterprise in question, i.e. the assessee, as opposed to the AE or any third party. The textual mandate, thus, is unambiguously clear. 40. The TPO's reasoning to enhance the assessee's cost base by considering the cost of manufacture and export of finished goods, i.e., ready-made garments by the third party venders (which cost is certainly not the cost incurred by the assessee), is nowhere supported by ....
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....erned, the matter stands restored to the file of the TPO but in the terms indicated above. Correctness of disallowance, under section 40(a)(i), of Rs. 102,17,16,483 84. So far as this issue is concerned, the relevant material facts are like as follows. During the relevant previous year, the assessee made payments to following associated enterprises for purchase of goods: Sl No. Particulars Amount (Rs) 1. Mitsubishi Corporation, Japan 9,180,507 2. MC Metal Service Asia (Thailand) 489,550,760 3. Metal One Corporation, Japan 497,373,422 4. Mitsubishi Corporation, Singapore 93,345 5. Metal One Asia Pte Ltd, Singapore 17,472,633 6. MC Tubular Inc, USA 3,376,808 7. Thai MC Company Ltd. Thailand 2,373,391 8. Petro Diamond Japan Corporation, Japan 2,295,618 Total 1,021,716,483 85. The Assessing Officer begun by taking note of the tax history of the case of Mitsubishi Corporation- Japan, parent company of the assessee company, in India. It was noted that MCJ had a liaison office in India but when a survey was conducted in the business premises of this liaison office, it was fo....
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....ed to deduct tax at source from these payments to non-residents, in terms of the mandate of section 195, which casts responsibility of deducting tax source from any payments, chargeable under the provisions of the Act, to the non-residents. The Assessing Officer was of the view that since assessee has failed to deduct tax at source from these payments, the same are required to be allowed in computation of income from business. Reliance was also placed on the decision of Hon'ble Supreme Court in the case of Transmission Corporation of India Ltd v. CIT (239 ITR 587). As regarding assessee's contention that section 40(a)(i) was discriminatory in character as no such disallowance was required to be made if the payments for purchases are made to a resident, and as such liable to be read down by the virtue of non-discrimination provisions set out in the respective tax treaties, the Assessing Officer contended that neither such a disallowance constituted a discrimination, nor, in any event, it was open to a resident assessee to invoke provisions of a tax treaty. As regards assessee's reliance on a decision of the coordinate bench, in the case of Herbalife India Pvt Ltd v. ACIT....
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....so no material on record to show that revenue's claim of their having PE in India is negated by the judicial authorities; and -(c) foreign entities which have PE in India and there is no dispute about its taxability in India as such. Disallowance under section 40(a)(i) in respect of payments made, without deduction of tax at source, to the foreign entities which did not have any permanent establishment in India and there is material on record to show that revenue's claim of their having PE in India is negated by the judicial authorities 88. Let us first take up the first segment i.e. disallowance in respect of payments made to the foreign entities which did not have any permanent establishment in India and there is material on record to show that revenue's claim of their having PE in India is negated by the judicial authorities . We find that so far as payments made to the non-resident entities, set out at point no. 2,3 and 5 of the chart reproduced earlier, i.e. payment of Rs. 48,95,50,760 to MC Metal Services Asia (Thailand), payment of Rs. 49,73,73,422 to Metal One Corporation (Japan) and payment of Rs. 1,74,72,633 to Metal One (Asia) Pte Ltd (Singapore) are co....
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.... in India. This finding has been given on the basis that there is no evidence or justification forth coming from the Revenue to show that the assessee has a PE in India. On this account alone, the Hon'ble Court did not interfere in the matter. What follows from this decision is that there has to be evidence on record that the assessee has carried on some essential activities of business from the LO. The Court found that no such evidence was coming from the side of the Revenue which means that such evidence has to be brought on record by the Assessing Officer. In this case the Assessing Officer has ruled that only selective and sketchy information has been furnished by the assessee in the course of assessment. This is in fact correct, and it may be a cleaver way of presenting facts. However, the Assessing Officer has not taken any step to bring on record information that the activity was beyond the limit prescribed by the RBI. No doubt that the ld. CIT, DR referred to three pages in the paper book which, according to him, furnish a definite clue that India office was engaged in price negotiation. However, that is not correct as quotations were made on the basis of instructions f....
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....f these entities are not taxed in India. Under these circumstances we have to necessarily hold that the payments made for purchases from these entities are not taxable in India as these entities have not held as having a P.E. in India and hence the provisions of S.195 are not attracted and consequently the disallowances made u/s 40(a)(ia) of the Act are bad in law. 89. When it was pointed out to the learned Departmental Representative, he fairly accepted that there is no change in the factual position with respect to these companies and the findings of the Tribunal, on this aspect of the matter, will hold good for this assessment year as well. He, however, made it clear that he is not conceding the point as it may be further in appeal and he nevertheless places his reliance on the orders of the Assessing Officer and the DRP in this regard. 90. We find that once it is an undisputed position that the recipient entities did not have any permanent establishment in India and the transactions in question, as in these cases, are of purchases simplictor, the payments made to entities cannot give rise to any income taxable in India. It is so for the reason that it is only when the rec....
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.... its taxability in India, is on the revenue authorities. The existence of PE cannot be inferred on assumed on the basis of some vague and sweeping generalizations as have been made in this case. In the landmark Special Bench decision in the case of Motorola Inc. v. DCIT (95 ITD SB 259), a Special Bench of this Tribunal had observed that "DTAA is only an alternate tax regime and not an exemption regime" and, therefore, "the burden is first on the Revenue to show that the assessee has a taxable income under the DTAA, and then the burden is on the assessee to show that that its income is exempt under DTAA". It is thus wholly inappropriate to proceed on the basis of assumption that since the recipient entities were following certain business model, these entities must be having a PE in India. Such an approach, as adopted by the revenue authorities on this aspect of the matter, cannot meet any judicial approval. 93. In any case, as has been observed by Hon'ble Supreme Court, in the case of KP Varghese v. ITO (131 ITR 597), nobody can be expected to prove a negative as it would be to cast an impossible burden upon him to establish a negative. Expecting the assessee to prove that t....
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....he assessee in deducting tax at source under section 195 and there is no cause of action for disallowance under section 40(a)(ia). In view of these discussions, we deem it fit and proper to direct the Assessing Officer to delete the impugned disallowance under section 40(a)(ia) in respect of payment of Rs. 93,345 to Mitsubishi Corporation Singapore, payment of Rs. 33,76,808 to MC Tubular Inc USA, payment of 23,73,391 to Thai MC Co Ltd, Thailand, and payment of Rs. 22,95,618 to Peto Diamond Corporation, Japan. Disallowance under section 40(a)(i) in respect of payment made, without deduction of tax at source, to a foreign entity which has a PE in India and which is taxable in India in respect of such payments 96. That leaves us with only disallowance under section 40(a)(ia) in respect of one payment of Rs. 91,80,507 to MCJ. 97. So far disallowance of payments made, without deduction of tax at source, to an entity which have a PE in India and which has accepted the tax liability in respect of the transactions in question, is concerned, i.e. MCJ, assessee's defence is in seeking deduction neutrality, so far as payments made to these Japanese tax residents are concerned, vi....
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....ould be taxable in the hands of 'H' in India only if it was a payment for included services within the meaning of article 12(4) of the said DTAA and not taxable in India otherwise. The sum in question could not be taxed as business income, since 'H' admittedly did not have a permanent establishment in India. If the income was considered as having accrued or arisen to 'H' in India, yet it could be taxed in India only if it was fees for included services. Even if the payment was considered as 'fees for technical services' within the meaning of the Act, yet it could not be taxed because 'fees for technical services' and 'fees for included services' under India-US DTAA had different meaning and they were not one and the same. If the revenue wanted to tax the payment by assessee to 'H' in the hands of 'H' in India, it had 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 was taxable in India or not. [Para 24]. The provisions of section 40(a)(i), as it existed prior to it....
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....ion of the Tribunal in the case of Automated Securities Clerance Inc. (supra). In this context we find that the Special Bench of the Tribunal in the case of Rajeev Sureshbhai Gajwamni (supra) also considered the issue and held as follows: "Section 90(2) provides that where the Central Government has entered into an agreement with the Government of any country outside India or specified territory outside India for grant of relief of tax or avoidance of double taxation, then in relation to the person to whom such agreement applies, the provisions of this Act shall apply to the extent they are more beneficial to the person. In a nutshell, this provision makes it obligatory in respect of a person to whom the DTAA applies that the assessment shall be made in accordance with the DTAA, but if any provision of the Act is more beneficial to the person, then he shall be granted benefit under the Act. In common parlance this principle is known as 'Treaty Override". What it means is that the assessment of such a person shall be made in accordance with the provision contained in the DTAA. However, if any provisions of the Act are found to be more beneficial, then the assessment shall be ....
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....ter software, a new section 80HHE has been inserted in the Act for providing tax concession similar to the earlier section 80RRe. Nothing was found in the circular which could be of aid in interpreting article 26(2). Further, reference was made to Circular No. 333, dated 2.4.1992, issued in respect of the "Treaty Override". The heading of the Circular is 'Specific provision made in double taxation avoidance agreement - whether it would prevail over general provisions contained in the Income-tax Act'. In Para 3, it is mentioned that where double taxation avoidance agreement provides for a particular mode of computation of income, the same should be followed, irrespective of the provisions in the Income-tax Act, which is the basic law, i.e., the Income-tax Act will govern taxation of income. The case of the revenue on the basis of this Circular was that since there was no provision in the DTAA analogous to section 80HHE, the assessee was not entitled to the deduction. The interpretation placed on the circular by the revenue was misplaced. The reason is that the wording of article 26(2) of the DTAA is to the effect that if a US enterprise is carrying on a business in India,....
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....smuch as while there is no tax deduction at source requirements from purchases from residents, there is a tax deduction at source requirement from the non-residents. Learned counsel submits that if assessee makes purchases from a resident assessee and does not deduct tax at source, the purchases will qualify to be tax deductible as there is no tax deduction at source requirement from such payments. However, if assessee makes purchases from a non resident and does not deduct tax at source, the purchases will cease be tax deductible in case the income embedded therein is held to be taxable in India. It is this discrimination, according to the learned counsel, that the assessee is aggrieved of. 100. Learned Departmental Representative, however, does not give up even as he recognizes that there is a direct decision on this assessee, in assessee's own case, in favour of the assessee. While he admits that the issue is indeed covered in favour of the assessee by coordinate bench's decision for the immediately preceding assessment year, he submits that this aspect of the matter deserves reconsideration. In addition to the elaborate submissions made by the learned Departmental Re....
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....notations and scope, and what is decided in the context of one type of discrimination does not necessarily apply in the context of the other type of discrimination. In a written note filed at the time of hearing, the submissions of the Departmental Representative, on this point, are summed up as follows: 2. It has been claimed that disallowance under section 40a (i) is bad in law in view of the non-discrimination clause i.e. Article 24(3) of the DTAA between India and Japan. Reliance is placed on the order of the Hon'ble ITAT in its own case for AY 2006-07. 3. The Revenue submits that the order of the Hon'ble ITAT cannot be relied for this year for the reasons given below. 4. The reasoning of the Hon'ble ITAT is given in paragraphs 9.1 to 9.4 of the order for assessment year 2006-07. The sole basis of the Hon'ble ITAT for deciding the issue is the order of the Hon'ble ITAT Delhi Bench in the case of Herbalife International India Private Limited (101 ITD 450 (Del) = (2006-TII-ITAT-INTL). Paragraph 22 of that order is reproduced in paragraph 9.1 and 9.2 hold that the propositions laid down I this decision are squarely applicable to the transactions with M....
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....ble Justice Bhagwati wrote that "The doctrine of stare decisis should not deter the court from overruling an earlier decision, if it is satisfied that such a decision is manifestly wrong or proceeds upon a mistaken assumption in regard to the existence or continuance of a statutory provision or is contrary to another decision of the Court. Kindly refer to pages 148 to 158 of the Revenue's PB). Paragraphs 2 (page 150) and paragraph 19 (page 156) of the order are relied. 7. In the present case, the Revenue is arguing not to overrule the decision for AY 2006-07 but humbly praying for not to follow as that decision was given based on mistaken assumption and not considering the applicability of amended law for AY 2006-07. 8. In the above matter, the Revenue also relies on the judgment of the Hon'ble Apex Court in the case of Sun Engineering Works (P) Ltd [1992] 198 ITR 297 (SC). Paragraph 37 on page 12 of the order is relied upon. 9. It is further submitted that paragraph 9.4 of the order of the ITAT in case of the assessee for AY 2006-07 refers to the decisions in cases of Automated Securities and Rajeev Sureshbhai Gajwani dealt with non-discrimination issues in relati....
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....mentary on paragraph 4 of Article 24 (pages 106 to 108 of the Revenue's PB). This document is available on the ITAT website www.itatonline.org. 14. It is humbly submitted that paragraph 4 of Article 24 of the United Model Tax Convention is similar to paragraph 3 of Article dealing with non-discrimination in the US and Japan treaty (kindly refer to page 106 of the Revenue's PB). Page 108 of the Revenue's PB contains a copy of the UN Commentary on paragraph 4 of Article 24 of the UN Model Convention. The purpose of introducing the provision is explicitly stated therein. It applies in a situation while the deduction of interest, royalties and other disbursements are restricted or prohibited. This refers to regulatory restrictions like imposed by the Central Bank of a country or under any other law or regulations. For example say payments were earlier restricted under RBI Regulations in regard to royalties (kindly see pages 114 to 125 of the revenue's PB). In view of the provisions of paragraph 4, the deduction for claims could have been made even if the payments of royalties or interest or fee for technical services could not be allowed under FEMA Regulations. 15....
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....iminated because no Indian company will make purchases from non-resident because its purchase are subjected to disallowances under section 40a (i) and not purchases from residents. If this analogy is applied in the USA then the partnership discriminates Indian partners and no firm will then keep Indian partners. Such an argument is farfetched and has no logic. 21. Explanation further states that the term other disallowances is understood to include a reasonable allocation of executive and general administrative expenses, research and development expenses and other expenses incurred for the benefit of a group of related persons which includes the person incurring the expenses. This indicates that the paragraph covers expenses which may be subjected to restrictions/prohibitions but does not cover any temporary disallowances that are made to ensure compliance of the provisions of tax laws. Disallowances under section 40a (i) are to ensure compliance 22. Provisions of section 40a (i) of the Act are to ensure compliance of TDS provisions. It covers cases where the tax is either not deducted or after deduction is not paid as required under the provisions of Chapter XVVII-B of th....
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....ollection and recovery provisions 26. Provisions of Chapter XVII-B are collection and recovery provisions (Deduction of Tax at Source) and do not determine the taxability of amount paid or the income that arise due to these payments. If any amount is deducted in excess then the payee can claim refund for the same. Provisions of section 190 of the Act are explicit on the issue. 27. Provisions of TDS are not discriminatory because the same apply to residents as well as non-residents. They need to deduct tax if payments are made to residents or non-residents. 28. Similarly, no resident can claim discrimination under paragraph 3 of non-discrimination article because the disallowance under section 40(a)(ia) will be made in case of residents as well as non-residents. It cannot be the case that disallowances are made in case of residents only. Such disallowances are also required to be made in case of non-residents if they fail to deduct or deposit the TDS as required by provisions of section 195 of the Act. 29. The contention that a resident will not make a purchase from nonresident vis-à-vis resident because in case of non-resident tax is required to be deducted and i....
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....rcement actions and tax can be collected from them, however, no such enforcement actions is possible in case of non-residents. A selected reference to Kluwer Book by Kees Van Raad on "Non-discrimination in International Tax law" part of Series on International taxation. 33. Page 174 of the Book states that, "The provision protects resident enterprises against the practice of-particularly Latin American- States to disallow as a deduction from taxable profit certain payments made to non-residents. This practice apparently stems from the fear of these States that the national tax basis will be eroded by shifting income abroad through payments by a resident taxpayer to related non-resident company". (Page 174 of the Book). Effect of insertion of second proviso to Section 40(a)(ia) and impact of non discrimination clause, in India Japan DTAA, on extending this benefit to the Japanese tax resident entities receiving payments from India 102. During the course of this hearing, learned Departmental Representative was asked whether, given the facts of this case and given the developments in law, this issue has not become academic. It was pointed out to the learned Departmental Re....
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...., 2004 alone are applicable", even the coordinate bench was essentially aware that the principle laid down in this case will cease to be relevant post insertion of section 40(a)(ia). It was submitted that his grievance against this principle implicit in the arguments of the learned counsel that disallowance is a discriminatory in the light of Herbalife decision. As for the second proviso to Section 40(a)(ia) being discriminatory to non-residents in the absence of similar provision in Section 40(a)(i), learned Departmental Representative very fairly submitted that it is inherently impossible, no matter how much one strives for it, to visualize all possible real life situations when legislation is drafted. He accepts that similarly placed assesses making payments to non-residents, i.e. where recipients have taken into account the related receipts in computation of their income and duly filed their income tax return under section 139(1) in respect of the same, will be placed at a disadvantage but hastens to add that it cannot be for this Tribunal to supply casus omissus, even if there be any. As regards the principles laid down by the coordinate bench in the case of Gupta Overseas (su....
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....s, including specifically in the case of DaimlerChrysler India Pvt Ltd (supra), wherein it is held that even in the Indian tax residents are eligible for treaty protection in appropriate situations. As for the reliance on observations made in Automated Securities Clearance decision, these observations, even if can be construed against the assessee, are no longer good in law in view of the subsequent special bench decision. Learned counsel points out that even the author of the said decision has, in a later decision authored by him in the case of Gupta Overseas (supra), acknowledged this position and followed the special bench decision declining to be guided by Automated Securities decision which he himself had authored a few years ago. As for the argument that the issue of deductibility of purchases from non residents being discriminatory not having been dealt with in the order of the coordinate bench, learned counsel submits that a judicial authority can only decide an issue on which there is a difference in the stand of the parties and when assessee's claim of this discrimination was not disputed by the Assessing Officer on this count, there could not have been any occasion t....
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.... paid taxes thereon. In such a situation, and in view of the fact that when similar payments in similar situation to a resident taxpayer disallowance under section 40(a)(ia) will not be attracted in view of second proviso to the said provision read with decision of this Tribunal in the case of Rajeev Kumar Agarwal (supra), the disallowance being made in respect of these payments to Japanese tax residents will be a clear violation of Article 24(3) of India Japan tax treaty. Learned counsel for the assessee places his reliance on the decision of Gupta Overseas (supra) by a coordinate bench of this Tribunal. Learned counsel makes elaborate submissions in support of his stand that second proviso to section 40(a)(ia) is discriminatory inasmuch as it only applies to the resident taxpayers . It is pointed out even if a non resident taxpayer files his return of income in India and takes into account the payments, from which taxes were not deducted at source, in his computation of income, the payments made to such non resident taxpayer will continue to be hit by the disallowance under section 40(a)(i) while similarly placed domestic enterprises will not be hit by disallowance under section ....
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....company for the purposes of the Act and is incorporated under the Indian laws. Therefore without going further into this contention, the objection of the applicant is rejected ab initio" 105. When we asked learned Departmental Representative as to how does he defend DRP upholding AO's action of denying treaty protection to assessee on the ground that the assessee was an Indian tax resident, he submitted, after a long pause, that he has nothing to add to whatever has been stated by the authorities below. His gracious silence was perhaps far more eloquent than spirited defence by the DRP. Our analysis of this preliminary objection 106. We find that a similar objection raised by the revenue authorities came up for adjudication before a coordinate bench of this Tribunal, in the case of DaimlerChrysler India Pvt Ltd (supra), and the coordinate bench, rejecting this objection, observed as follows: ......A plain reading of the above treaty clauses shows that, in broad terms, the discrimination, which is prohibited under the treaty, is (a) nationals of the other Contracting State vis-a-vis nationals of the host State in the same circumstances and same conditions; (b) PE of ....
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....ng treaty protection in one Contracting State must belong to the other Contracting State. In the case of nationality non-discrimination clause, i.e. under art. 24(1), the assessee must be national of the other Contracting State, though resident or not. In the remaining two situations, i.e. non-discrimination against payments made to the residents of the other Contracting State, i.e., under art. 24(3), non-discrimination against capital held by the residents of the other Contracting State, i.e. under art. 24(4), it is not at all necessary that the assessees, in whose cases this non-discrimination is invoked, should be resident of, or even national of, the other Contracting State. In this view of the matter, we are unable to accept the plea of Mr. Kapila that since assessee before us is not resident of the other Contracting State, the assessee cannot seek treaty protection against discrimination, even if there be any. (Emphasis, by underlining, supplied by us) 107. We are in considered agreement with the views so expressed by the coordinate bench. In any case, the stand of the AO proceeds on the fallacy that non-discrimination protection is being invoked for the assessee before....
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.... Nationals of a Contracting State shall be subjected in the other Contracting State to any taxation or any requirement connected therewith which is other or more burdensome than the taxation and connected requirements to which nationals of that other Contracting State in the same circumstances are or may be subjected. This provision shall, notwithstanding the provisions of article 1, also apply to persons who are not residents of one or both of the Contracting States. 2. The taxation on a permanent establishment which an enterprise of a Contracting State has in the other Contracting State shall not be less favourably levied in that other Contracting State than the taxation levied on enterprises of that other Contracting State carrying on the same activities. This provision shall not be construed as obliging a Contracting State to grant to residents of the other Contracting State any persona....
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....nce purposes. 74. Paragraph 4 does not prohibit the country of the borrower from applying its domestic rules on thin capitalisation insofar as these are compatible with paragraph 1 of Article 9 or paragraph 6 of Article 11. However, if such treatment results from rules which are not compatible with the said Articles and which only apply to non- resident creditors (to the exclusion of resident creditors), then such treatment is prohibited by paragraph 4. 75. Also, paragraph 4 does not prohibit additional information requirements with respect to payments made to non-residents since these requirements are intended to ensure similar levels of compliance and verification in the case of payments to residents and non-residents (Emphasis by underlining supplied by us) 110. We are in considered agreement with the above analysis of the scope of the deduction neutrality clause in non-discrimination provision in the Indo Japan DTAA. 111. It is thus clear that so far as payments made to Japanese non-residents is concerned, there cannot be any discrimination so far as deductibility of the payments in the hands of the person making the payment is concerned. If appropriate tax withh....
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....e Inc (supra), is in particular respect of the Indo US tax treaty. This school of thought proceeded mainly on the basis of equality in treatment in treaty partner jurisdiction, even though it has been specifically clarified in the case of DaimlerChrysler India Pvt Ltd (supra), by the same bench consisting of the same coram that "...the decision in the case of Automated Securities Clearance Inc. (supra) was given in the context of Indo-USA Tax Treaty in which differentiation on the ground of reasonableness is institutionalized in the treaty and the Technical Explanation to the US Model Tax Treaty" and that "Whether or not the same principles will apply in the case of India's tax treaties with other countries is yet to be examined." The same principle does not therefore necessarily apply to other tax treaties. Be that as it may, in the case of the Automated Securities Clearance (supra), the Tribunal had, inter alia, observed as follows: Scope of non-discrimination clauses in the tax treaties 34. The expressions 'discrimination' and 'non-discrimination' are not defined in the tax treaties, but, as noted by Brian J. Arnold and Michael J. McIntyre, in their oft....
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....ernal Revenue Service from a foreign as from a domestic enterprise. Similarly, it would not be a violation of para 2 to impose penalties on persons who fail to comply with such a requirement [see, e.g., ss. 874(a) and 882(c)(2)]. . . Sec. 1446 of the Code imposes on any partnership with income that is effectively connected with a US trade or business the obligation to withhold tax on amounts allocable to a foreign partner. In the context of the Model Convention, this obligation applies with respect to a share of the partnership income of a partner resident in the other Contracting State, and attributable to a US PE. There is no similar obligation with respect to the distributive shares of US resident partners. It is understood, however, that this distinction is not a form of discrimination within the meaning of para 2 of the article. No distinction is made between US and non-US partnerships, since the law requires that partnerships of both US and non-US domicile withhold tax in respect of the partnership shares of non-US partners. Furthermore, in distinguishing between US and non-US partners, the requirement to withhold on the non-US but not the US partner's share is not dis....
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....mination articles, e.g., Arts. 15 and 16, which are exclusively for the citizens, but Art. 14 of the Constitution of India specifically prohibits discrimination against any person, whether citizen or not, by guaranteeing that "the State shall not deny to any person equality before the law or the equal protection of the laws within the territory of India". While construing the scope of this right to equality, Hon'ble Supreme Court of India has time and again held that notwithstanding wide scope of this constitutional guarantee, art. 14 does not rule out classification for the purpose of legislation. In Kedar Nath Bajoria v. State of West Bengal AIR 1953 SC 404, 406, Hon'ble Supreme Court has observed that "the equal protection of laws guaranteed by Art. 14 of the Constitution of India does not mean that all laws will have to be general in character and universal in application and that the State is no longer to have the power of distinguishing and classifying persons or things for the purposes of classification". A valid classification must be reasonable, and it must always rest upon some real and substantial distinction bearing reasonable and just relation to the needs in r....
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.... 113. Not only that the above decision was treaty specific in the context of Indo US tax treaty and did not automatically to the other tax treaties entered into by India, a special bench of this Tribunal, in the case of Rajeev Sureshbhai Gajwani (supra) ruled that differentiation simplicitor is enough to invoke the non-discrimination clause even in Indo US tax treaty by observing as follows: 8.3 Having considered the rival submissions, we may now deal with them. In so far as the status of Commentary on OECD Model Convention is concerned, for interpretation of DTAA, it is clear from the decisions referred to by the learned counsel that the commentary does not lay down any binding precedent. The commentary contains the views of the author about the Model Convention. This view can be taken as an argument by the assessee but finally, it will be for the Courts or the quasi judicial authorities in India to decide as to whether the views expressed by the author are in conformity with the intent and purpose of the DTAA or not. In the case of P.V.A.L. Kulandagan Chettiar (supra), the Hon'ble Supreme Court has held that taxation policy is within the power of the Government and s. 90 ....
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....rride". The heading of the circular is "specific provision made in DTAA-whether it would prevail over general provisions contained in the IT Act". In para 3, it is mentioned that where DTAA provides for a particular mode of computation of income, the same should be followed irrespective of the provisions in the IT Act, which is the basic law, i.e., the IT Act will govern taxation of income. The case of the learned Departmental Representative on the basis of this circular is that since there is no provision in the DTAA analogous to s. 80HHE of the IT Act, the assessee is not entitled to the deduction. We are of the view that the interpretation placed on the circular by the learned Departmental Representative is misplaced. The reason is that the wording of art. 26(2) is to the effect that if a US enterprise is carrying on a business in India, it shall not be treated less favourably than an Indian enterprise carrying on the same business for the purpose of taxation. It follows automatically that exemptions and deductions available to Indian enterprises would also be granted to the US enterprises if they are carrying on the same activities. Thus, following the decision in the case of P....
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....ed Departmental Representative is that various deductions under ss. 80HHE, 10A or 10B are area specific or industry specific. However, he was not able to carry this argument any further. The case of the learned counsel is that the provision contained in s. 80HHE is industry specific and the assessee is not precluded in any manner from conducting this business in India. We agree with this view as no debate seems to be feasible in this regard. Therefore, we are of the view that the assessee is carrying on the activities of export of software. An Indian company or any other resident person carrying on the business of export out of India of computer software or its transmission from India to a place outside India by any means is entitled to deduction under s. 80HHE. Therefore, the deduction admissible to an Indian company or a person resident in India will be allowable to the assessee also. (Emphasis by underlining supplied by us now.) 114. The views so expressed by the special bench bind us in the division bench. The strength of the hierarchical judicial system that we have in India is in each lower tier of judicial forum giving way to the higher wisdom of the superior judicial ....
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....oordinate bench of this Tribunal, while dealing with provision regarding disallowance of payments made to a resident assessee without deduction of tax at source, has, inter alia, observed as follows: 4. Let us first take a look at the legislative amendment of section 40(a)(ia), vide Finance Act 2012, and try to appreciate the scheme of things as evident in the amended section. Second proviso to Section 40(a)(ia), introduced with effect from 1st April 2013, provides, that "where an assessee fails to deduct the whole or any part of the tax in accordance with the provisions of Chapter XVII-B on any such sum but is not deemed to be an assessee in default under the first proviso to sub-section (1) of section 201, then, for the purpose of this sub clause, it shall be deemed that the assessee has deducted and paid the tax on such sum on the date of furnishing of return of income by the resident payee referred to in the sa id proviso". In other words, as long as the assessee cannot be treated as an assessee in default, the disallowance under section 40(a)(ia) cannot come into play either. To understand the effect of this proviso, it is useful to refer to first proviso to section 201(1),....
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....e the provisions workable has to be treated as retrospective notwithstanding the fact that the amendment has been given effect prospectively ". It was held that if the consequences sought to be remedied by the subsequent amendments were to be treated as "intended consequences", the amendment could not be treated as retrospective in effect. The special bench then proceeded to draw a line of demarcation between intended consequences and unintended consequences, and finally the retrospectivity of first proviso was decided against the assessee on the ground that this special bench was of the considered view that " the objective sought to be achieved by bringing out section 40(a)(ia) is the augmentation of TDS provisions" and went on to add that " If, in attaining this main objective of augmentation of such provisions, the assessee suffers disallowance of any amount in the year of default, which is otherwise deductible, the legislature allowed it to continue ". It was further observed that "this is the cost which parliament has awarded to those assessees who fail to comply with the relevant provisions by considering overall objective of boosting TDS compliance"(Emphasis by underlining s....
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....ny, embedded in such expenditure being brought to tax, if applicable. In effect, thus, a deduction for expenditure is not allowed to the assessees, in cases where assessees had tax withholding obligations from the related payments, without corresponding income inclusion by the recipient. That is the clearly discernible bigger picture, and, unmistakably, a very pragmatic and fair policy approach to the issue - howsoever belated the realization of unintended and undue hardships to the taxpayers may have been. It seems to proceed on the basis, and rightly so, that seeking tax deduction at source compliance is not an end in itself, so far as the scheme of this legal provision is concerned, but is only a mean of recovering due taxes on income embedded in the payments made by the assessee. That's how, as we have seen a short while ago, Hon'ble Delhi High Court has visualized the scheme of things - as evident from Their Lordships' reference to augmentation of recoveries in the context of "loss of revenue" and "depriving the Government of the tax due and payable". 8. With the benefit of this guidance from Hon'ble Delhi High Court, in view of legislative amendments made f....
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....w the expenditure, due to non-deduction of tax at source, even in a situation in which corresponding income is brought to tax in the hands of the recipient. The scheme of Section 40(a)(ia), as we see it, is aimed at ensuring that an expenditure should not be allowed as deduction in the hands of an assessee in a situation in which income embedded in such expenditure has remained untaxed due to tax withholding lapses by the assessee. It is not, in our considered view, a penalty for tax withholding lapse but it is a sort of compensatory deduction restriction for an income going untaxed due to tax withholding lapse. The penalty for tax withholding lapse per se is separately provided for in Section 271 C, and, section 40(a)(ia) does not add to the same. The provisions of Section 40(a)(ia), as they existed prior to insertion of second proviso thereto, went much beyond the obvious intentions of the lawmakers and created undue hardships even in cases in which the assessee's tax withholding lapses did not result in any loss to the exchequer. Now that the legislature has been compassionate enough to cure these shortcomings of provision, and thus obviate the unintended hardships, such an ....
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.... under section 139(1), related income tax return. It is also elementary that so far examining discrimination to the non resident Japanese taxpayers is concerned, the right comparator will be a resident Indian taxpayer. As we are examining the issue of deduction parity, we have to examine the position of deductibility in respect of a similar payment, i.e. without deduction of tax at source, made to a resident Indian taxpayer. To this extent, in the light of the legal position prevailing as on now and as there is no binding judicial precedent contrary to coordinate bench decision in the case of Rajeev Kumar Agarwal (supra), there is indeed an element of discrimination, in terms of Article 24(3) of the India Japan DTAA, in the deductibility of payments made to resident entities vis-à-vis non-resident Japanese entities. Clearly, therefore, it will be contrary to the scheme of the tax treaties in question that if rigour of disallowance of a payment, on account non-deduction of tax at source from the related payment, is to be relaxed in the situations in which the resident recipient has taken the said amount into account in computation of income, paid taxes on the income so comput....
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....s proviso in held to retrospective in effect, i.e. with effect from 1st April 2005, in the case of Rajeev Kumar Agarwal (supra) and as no contrary decision has been brought to our notice, this provision will be equally applicable in the assessment year before us as well. What holds good for section 40(a)(ia) on a conceptual note, so far as deincentivizing non deduction of tax at source is concerned, must hold equally good for section 40(a)(i) as well. As was noted by a coordinate bench in the case of Rajeev Kumar Agarwal (supra), on a conceptual note, primary justification for disallowance under section 40(a)(ia) is that such a denial of deduction is to compensate for the loss of revenue by corresponding income not being taken into account in computation of taxable income in the hands of the recipients of the payments. Such a policy motivated deduction restrictions should, therefore, not come into play when an assessee is able to establish that there is no actual loss of revenue. This disallowance does indeed deincentivize not deducting tax at source when due for deduction, but, so far as the legal framework is concerned, this provision is not for the purpose of penalizing for the ....
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....in this assessment year. Whether Herbalife decision, for the assessment years in which section 40(a)(ia) is on the statute, is good in law or not is wholly irrelevant because, for the detailed reasons set out above, even when section 40(a)(i) is applicable, the disallowance under section 40(a)(i) can be invoked on the peculiar facts of this case. It would not be appropriate for us to get into this issue which has been, given our findings above, rendered academic. Our conclusion on disallowance under section 40(a)(i) 119. We thus hold that, so far as second grievance raised by the assessee before us is concerned, the Assessing Officer was indeed in error in law and on facts in making a disallowance of Rs. 102,17,16,383. Accordingly, we direct him to delete the impugned disallowance. Our parting observations 100. Before we part with the matter, we would like to place on record our appreciation for very able assistance by both the parties before us. We may add that even though learned Departmental Representative did very vehemently contended that we should simply remit the matter to the assessment stage, on the same lines as in the immediately preceding assessment year and....