TaxTMI 
TaxTMI 
2014 (10) TMI 943
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....2,46,50,197 under section 92C, is justified on the facts and in the circumstances of the case - referred to in grounds of appeal nos. 1 to 3, and subsidiary grounds of appeal set out in these main grounds of appeal; and (b) whether or not the disallowance of Rs. 143,32,82,361 under section 40(a)(i) is justified on the facts and in the circumstances of the case- referred to in grounds of appeal nos. 4 to 10, and subsidiary grounds of appeal set out in these main grounds of appeal, and (c) whether disallowance of Rs. 2,33,728 under section 14A is justified on the facts and in the circumstances of the case - referred to ground of appeal no. 11 . We will take up these issues in the same sequence. Covered by our order dated 21st October 2014 3. Learned representatives fairly agree that so far as first two issues in this appeal are concerned, the outcome of this appeal will be the same as our decision on the assessee's appeal for the assessment year 207-08, which was heard alongwith this appeal. Vide our order dated 21st October, 204, we have disposed of the said appeal, dealing with the first two issues in this appeal, and held as follows: Issue 1: Correctness....
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.... Membership and subscription 6,99,453 8. Reimbursement of expenses 2,67,78,928 The proceedings at the assessment stage: 4. The Transfer Pricing Officer further noted that the assessee has used TNMM (Transactional Net Margin Method) as the most appropriate method, and that the PLI (profit level indicator) selected is 'Berry Ratio' which, as stated in the transfer pricing study, benchmarks gross profit and/ or net revenues (after subtraction of any potential cost of sales) against operating expenses. The assessee's claim was that since MCI's three year's average berry ratio is 1.19, whereas in the case of 22 comparables set out in the report, using three year data, the average berry ratio is 1.14 and adjusted average berry ratio 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 except....
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....with the TPO. 7. As the Transfer Pricing Officer rightly noted, the main issue in this case is adjudication on the question "whether ...(the assessee).. is being adequately compensated" for the functions performed by the assessee. The TPO then proceeded to analyze functions of the assets, risks assumed by the assessee and assets employed by the assessee. He noted that, as set out in paragraph 3.4 of the transfer pricing study, the assessee has provided the services for (a) facilitating communication between buyer and seller; (b) arranging freight, insurance and custom clearance through third parties; (c) collecting market information; (d) identifying potential customers (in import transactions only) or suppliers (in export transactions only); and (e) advising an associated enterprise or third party in 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 us....
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.... the product and enhanced profitability of the AE" but adequate compensation for these unique intangibles is not reflected in the compensation to the assessee. In other words, according to the TPO, these intangibles have increased profit potential of the AEs and the same should be reflected in increased margins to the assessee. These unique intangibles were stated to be (a) supply chain intangibles, and (b) human assets intangibles. As for the supply chain intangibles, it was noted that the MCJ is "one of Japan's leading sogo shoshas or general trading companies" which "deals in products ranging from bulk commodities such as grain and oil, to specialized equipment. It was noted that functions of the assessee included, apparently in the case of sourcing the goods, (1) identification of contacted manufacturer, (2) qualifying the contract manufacturer, (3) identifying appropriate source of goods, (4) warehousing the goods, (5) control 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 ....
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....owed a very nominal markup (which does not include cost of development and use of intangibles) without allocating any profit component for development and use of unique intangibles by the assessee which has resulted in huge commercial and strategic advantage to the AE in the form of low cost of goods, high profit margin and assured timely supply of quality goods i.e. these intangibles have enhanced the profit potential of the AE, without any corresponding markup to the assessee. In the light of these facts, I am of view that cost plus model used by the AE is not the most appropriate method because it does not capture the compensation for the development and use of intangibles by the assessee. These facts lead to the irresistible conclusion that the remuneration model used in this case does not provide compensation to the assessee at the arm's length price as the model does not include compensation form development and use of intangibles. 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, wh....
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....value of international transitions for the FY 2006-07. The assessing officer shall enhance the income of the assessee by Rs. 68,15,17,853. The Assessing Officer may examine issue of initiation of penalty u/s 271(1)(c) of the Act in accordance with Explanation 7 of the same. No adverse inference is drawn in respect of other transactions undertaken by the assessee during FY 2006-07. The assessee was given adequate opportunity including oral hearing as per details at Col.7 at Page 1 of this order 12. Aggrieved with the ALP adjustment of Rs. 68,15,17,853 consequently proposed by the Assessing Officer, on the basis of the TPO's order, assessee carried the grievance before the Dispute Resolution Panel but without any success. Accordingly, the Assessing Officer framed the assessment by making addition in respect of, inter alia, this ALP adjustment. The assessee is not satisfied and is in appeal before us. 13. We have heard the rival contentions on this transfer pricing dispute, perused the material on record in respect of the same and duly considered factual matrix of the case as also the applicable legal position. Shri M. S. Syali, Senior Advocate, alongwith Shri Tarand....
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.... With these observations this ground is allowed for statistical purposes. The position in the immediately preceding assessment year- esteemed views of Hon'ble High Court: 5. The views so expressed by the coordinate bench were challenged by the assessee before Hon'ble Delhi High Court, and upholding the stand so taken by the coordinate bench- though with a clarification, Hon'ble Delhi High Court, vide judgment dated 4th July 2014 [now reported as 48 taxmann.com 45 (Del)], has observed as follows: 7. The international transactions reported by the appellant are of four kinds; services, commission, cost to cost reimbursement as well as from sale of products imported from the Associated Enterprise. While, there is no dispute as to the international transactions resulting in receipts as commission and cost to cost reimbursement for rendering service, the assessee seriously contests the addition made on account of transactions of sale and purchase of goods. The assessee is aggrieved by the margin of 19.6% being applied with respect to transactions of sale and purchase. 8. It was submitted by the learned counsel that its functional profile was not that o....
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....Mitsubishi Corporation are done on a principal to principal basis. We find no infirmity with the reasoning of the ITAT that such transactions are akin to trading and cannot be considered activities of a commission agent or a broker. However, the learned counsel for the assessee has expressed his apprehension that in view of the findings of the ITAT, the assessee is likely to be treated as an ordinary trader and compared with other traders who may not be similarly situated. We do not find any ground for such apprehension as the ITAT has made it clear that appropriate comparables would have to be considered for determination of the ALP. This would obviously mean 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. 12. We accordingly find no reason to interfere with the order of the Tribunal. The appeal is accordingly dismissed with the above clarification. (Emphasis by underlining supplied by us) Rival contentions: 16. Learned counsel points out that so far as assessment year 2006-07, in respect of which the above decisions were ....
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....ndicator (PLI), as has been adopted by the assessee. Our attention is invited to the fact that the authorities below have duly accepted the uniqueness of business model of the assessee group and made elaborate observations to the effect that it is a low risk and high volume business model. When this is the admitted position, and it is also not in dispute that it is a case of back to back trading with no inventory risks involved, according to the learned counsel, there cannot be any justification for including the cost of inventories in PLI computation. It is submitted that the PLI adopted by the assessee, i.e. berry ratio, takes care of this critical aspect. It is pointed out that, for all these reasons, berry ratio is the most appropriate PLI in the present case particularly as, beyond any doubt or controversy, assessee does not carry any inventory risk and its actual financial risk is confined to the operating costs minus inventory costs, i.e. operating expenses. Learned counsel relies upon the literature filed by the assessee, in support of the relevance and utility of berry ratio on the facts of this case, and contends that its usage is most appropriate to the facts and circums....
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....s this segment is concerned, to give specific directions to the effect that the costs borne by the AEs with respect to the sales are to be excluded from the cost base of the assessee. It is the submitted that the TPO has made some factually inaccurate comments, based on pure surmises and conjectures, with respect to alleged ownership of supply chain management intangibles and human assets intangibles. It is submitted that these intangibles are figments of his imagination of the TPO and the onus is on the revenue authorities to show, based on material on record, that these intangibles exist. It is submitted that the assessee was not even put to notice, in the proceedings before the TPO, in respect of these inferences. It is further submitted that there is no basis for TPO's coming to the conclusion that profit on account of location savings ought to have been taxed in India and that the compensation model of the appellant did not include profit attributable to the assessee due to locational savings. It is further contended that despite the assessee having raised grievances against these findings before the Dispute Redressal Panel, the DRP has not at all adjudicated on these grievanc....
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....h flash title of the goods has changed for a short while or not, the nature of business activity remains the same. As regards the use of intangibles, learned Departmental Representative relied upon the observations made by the TPO and justified the same. It was thus submitted that delivery supply chain management and human assets are important intangibles and the assessee's compensation model, which clearly does not take account adequate compensation for developing these intangibles, cannot be accepted as an arm's length price for the services rendered by the assessee. Learned Departmental Representative contends that all these issues, as being raised by the assessee now, are indeed open issues which can be agitated before the TPO and that there is no need for any further directions beyond the directions given by the coordinate bench in the immediately preceding assessment year. We are thus urged to follow the orders of the coordinate bench, in letter and in spirit, and to remit the matter to the file of the TPO for adjudication de novo in the light of the observations made in the said order. 19. Learned counsel for the assessee, in his rejoinder, submitted that the subjec....
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....hat extent, facts of the assessment year before us are a little different vis-à-vis the facts of the immediately preceding assessment year which were before the coordinate bench. The nature of assessee's trading activity: 21. We have also noticed that even with respect to the trading transactions, which were claimed by the assessee to be in the nature of a service rather than a trading activity, Hon'ble Court has taken note of assessee's apprehension that the assessee may be "treated as an ordinary trader and compared with other traders who may not be similarly situated" and clarified that the assessee will only be compared with such 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". 22. The Transfer Pricing Officer himself has, at page 2 of the order, set out the profile of the MCJ, the holding company, and MCI, the assessee before us, as follows: 2.2 Profile of the Group Mitsubishi Corporation ("MC") is one of the Japan's leading sogo shoshas or general trading companies. These companies are unique in ....
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....osha is something much more than a general trader. As the TPO himself has rightly noted, sogo shosha is a unique business model in the world of commerce. As a corollary to this observation, it is an admitted position that a sogo shosha cannot be equated with a general trading company in all material respects. Sogo shosha has been described as follows at www.referenceforbusiness.com : A sogo shosha is a form of industrial organization and a kind of vertically integrated trading company that originated in Japan and for the most part has remained unique to Japan. At the center of these organizations is a trading company that arranges financing, coordinates activities, and handles marketing functions for the companies in its group of companies. These subordinate companies may be considered operating companies, because they specialize in certain types of business. Since World War II, Japan has emerged as one of the dominant world traders in part because of the sogo shosha. While the term sogo shosha is Japanese for "general trading company," the term generally refers to the entire group of operating companies that comprise the conglomerate or sogo shosha. Unlike typica....
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..... There are really no other comparable firms, though the Governments in United States and elsewhere have become convinced that there should be. ..... These huge Japanese companies (names are set out, including that of the assessee's parent company) .....share pattern of business strategy, operations and organization that are very different from those of other types of business firms. Defining their business is an elusive goal, for their activities donot fit into any of the conventional categories. They could be called commodity traders, wholesalers, bankers and manufacturers, miners, venture capitalists and many other labels but none of these conveys a true picture of the substance of their activities. 26. There could indeed be somewhat varying perceptions on the precise connotations of 'sogo sosha' as a business model, and, as Prof Yoshino, in his above mentioned book, states at page 3, "Even in Japan, the sogo shosha is indeed regarded as a mysterious entity, difficult 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 ....
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....to, inter alia, its monthly inventory level being less than 10% and prescribes a lower tolerance range at one third the level of normal tolerance range. Of course, this notification is in the context of tolerance range, prescribing lesser tolerance range for the whole traders implying that the margin of profits for wholesalers must move in a lower range which can only happen when margins are also lower vis-à-vis margins in wholesale trading, but this also indicates that lower inventory levels lead to lower inventory risks and generally resultant lower profit levels also. There is thus a direct relationship between the normal inventory levels and the normal profitability. 29. It is beyond dispute and controversy that the comparables carrying on the trading activity similar to assessee group's trading activity are difficult to find. Here is a case in which true comparables are difficult, or almost impossible, to find and, therefore, a way is to be found to find such comparison meaningful 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 t....
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....sessee are "akin to trading" was given in the context of question before the bench as to whether the activities were in the nature of trading or in the nature of commission agent. If trading activity and commission agent activity are two ends of a broad spectrum of activities dealing in goods and commodities, and these ends are plotted by mark X and mark Y, sogo shosha activity, is somewhere between these two extremes and between the point X and point Y. The location of this point, as implicit in coordinate's bench observation that sogo shosha is akin to trading and it cannot be bracketed with commission agent or broker, is closer to point X. There can be no dispute with this proposition at this stage; that is an uncontroverted finding of fact. This can be shown in the following way: Mid point Between X and Y X____________________________________ Y (If X is trading and Y is commission agency, as held by the Tribunal in immediately preceding assessment year, Sogo shosha is in the shaded area above- somewhere between X and Y but before the midpoint, i.e. closer to X rather than with Y) 33. Yet, clearly, there is still a difference between ....
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....d accounting principles, so far as determination of arm's length price is concerned, the accounting principles have to make way for economic principles. 38. The reason is not difficult to seek. While accounting principles primarily contribute the financial information inputs and mechanism for financial analysis, economic principles lay down the foundational principles on the basis of which such inputs and mechanism are to be used in transfer pricing analysis. The very fundamental economic concept, which is foundation for the arm's length price determination, is that all business entities, irrespective of their inter se relationship, should make profit from a transaction and such a profit should be commensurate with "functions performed, risks assumed and assets utilized". This exercise, by definition, cannot exalt the accounting entries to a status that these accounting entries, dehors the FAR analysis, determine the arm's length price. Whatever be the call of accounting and legal principles, once we come to the conclusion that cost of inventories is not a material factor so far as FAR analysis is concerned, it is wholly justified to exclude the cost of inventories in form....
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.... 43. There is an interesting discussion on this aspect of the matter in assessee's TP study, a copy of which was placed before us in the paperbook. It does recognize that looking to the FAR analysis of the assessee's activities, the of the CPM may be appropriate, the method employed in determining ALP has to be used with certain modification which take it within definition of Transaction Net Margin Method but has berry ratio as the PLI. In plain words, thus, the mechanism suggested to eliminate the impact of uniqueness of assessee's business model is use of berry ratio as a PLI in TNMM analysis. Berry ratio: connotations and its background 44. Simply put, berry ratio is ratio of gross profit to the operating expenses. 45. Unlike in Indian TP regulation, wherein no specific ratios are prescribed, US Regulation 482-5(b)(ii)(4)(B) accepts this PLI as one of the "financial ratios that may be appropriate" to measure the arm's length price, even though it puts a rider that, "reliability under this profit level indicator also depends on the extent to which the composition of tested party's operating expenses is similar to that of the uncontrolled comparables....
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.... * The taxpayer does not perform, in the controlled transactions, any other significant function (e.g. manufacturing function) that should be remunerated using another method or financial indicator. 2.102 A situation where Berry ratios can prove useful is for intermediary activities where a taxpayer purchases goods from an associated enterprise and on-sells them to other associated enterprises. In such cases, the resale price method may not be applicable given the absence of uncontrolled sales, and a cost plus method that would provide for a mark-up on the cost of goods sold might not be applicable either where the cost of goods sold consists in controlled purchases. By contrast, operating expenses in the case of an intermediary may be reasonably independent from transfer pricing formulation, unless they are materially affected by controlled transaction costs such as head office charges, rental fees or royalties paid to an associated enterprise, so that, depending on the facts and circumstances of the case, a Berry ratio may be an appropriate indicator, subject to the comments above. (Emphasis by underlining supplied by us) 47. As evident from the u....
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.... functions. Berry's key insight in the case was that distributors should earn a return commensurate to the distribution services performed and that the value of the products being distributed, in other words, was irrelevant. The implicit emphasis was thus on the service element even in trading activity, and in the costs incurred on rendering this service rather than in the value of goods traded. That was a case in which the assessee was simply involved in distributorship function without much risks, though certainly much more risks than in a back to back trading, associated with inventories or with uncertainties of normal trading. The key contribution to the economic activity was recognized as performing the distributorship function rather than the value of goods sold. Accordingly, distributors must achieve a particular gross profit in order to compensate them for their services, the costs of which are accounted for, almost entirely, in their operating expenses. To reflect the reality of distributors' economic significance and to provide an arm's length return to DuPont's Swiss subsidiary, Berry utilized a ratio that has since been named in his honor and is computed....
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....], a coordinate bench has upheld the use of this ratio. While taking note of the contentions of the assessee in this case, the coordinate bench has, inter alia, observed as follows: 6.4 Ld. counsel then referred to the well recognized Berry ratio in determination of ALP. Berry ratio also propounds that routine distributors should earn a return commensurate to the distribution services performed, measured as a percentage of the value-adding (operating) expenses incurred by them. The value of the products being distributed, in other words, is irrelevant. Distributors must achieve a particular gross profit in order to compensate them for their value-adding services, the costs of which are accounted for in their value-adding (operating) expenses. An excerpt from the article by Dr. Berry on this aspect reads as under:- "Similarly, the cost of goods sold is excluded from the cost base because the measure indicates the value of the merchandise distributed, not the service rendered by the firm that distributes the merchandise. It was for exactly the same reason that I excluded in the case of advertising agencies, the cost of advertisement placement. The placement cost is ....
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....stantial impact on the operating profits, and thus dilute this direct relationship, could be factors like (a) in terms of functions - processing and value addition to the goods; (b) in terms of assets - fixed assets such as machinery, inventory, debtors and otherwise high assets, including intangible assets; and (c) in terms of risks - risk associated with holding inventories. In a diagram form, this relationship could be as follows: 57. In our considered view, to sum up, in a situation in which a business entity does not assume any significant inventory risk or perform any functions on the goods traded or add any value to the same, by use of unique intangibles or otherwise, the right profit level indicator should be operating profit to operating expenses i.e. berry ratio. In such a situation, no other costs are relevant since (a) the cost of goods sold, in effect, is loses its practical significance, (ii) there is no value addition, and, accordingly, there are processing costs involved, and (iii) there is no unique intangible for which the business entity is to be compensated. 58. In typical cases of pure international trading, there is neither any processing of....
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....cessary comparability adjustments to the same, we consider it appropriate to deal with this issue, particularly from the point of view whether use of this ratio will address, in whatever limited measure, the financial impact of variations between a normal trader and assessee's trading activity as sogo shosha subsidiary in which, as claimed by the assessee, no funds are blocked in the inventories or cost of sales, and, whether, in such a situation, computation of return on the value of goods will not lead to an exorbitant return on the operating expenses or value added expenses which is all that the assessee has de facto borne. Use of berry ratio when assessee is following TNMM 62. One of the reasons of the TPO's rejection of the berry ratio is that the berry ratio is de facto cost plus method and that the assessee cannot resort to the use of this ratio when the assessee has consciously chosen the TNMM as most appropriate method. While on this objection, it is interesting to take note of the fact that in the transfer pricing study itself it has been noted that "even though principles of the CPM may be appropriate, it cannot be used in this analysis for the reasons ....
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....s relevant. When cost of inventory is excluded from the cost base, for all practical purposes, cost bases consists only of the operational costs. In our considered in a situation in which trading is on back to back basis without anything actually going to the current assets and flash title of goods is held only momentarily, it could indeed actually be a relevant base as to what are the operating costs or value added expenses - particularly when, as we have noted above, no resources are used in the inventories. Use of berry ratio when tested party has high level of current assets 66. As for the objection regarding use of this ratio only in the situations in which current assets are not significant, there cannot indeed be much dispute with this proposition on principle but there is nothing on the record to evidence that there are high current assets in the present case either. Such vague generalities, as resorted to the TPO, cannot be sustained in law. There is no mention about any specific element of assets which can be related to high current assets. The TPO has mentioned about use of intangibles but on the question of intangibles as well, for the reasons we will ....
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.... the assessee being so significantly different that the very comparability is not possible. The apprehensions are premature. We, therefore, see nothing wrong in principle in use of berry ratio in the case of an assessee like the one before us though, in the absence of any specific comparables before us, it is not possible to visualize and deal with the difficulties with regard to variations in, and impact of, accounting policies in such cases. Having said that, we must may also reiterate that when we are only dealing with trading activities of the tested party and the comparables, without any processing or other costs, the occasion for any impact of significant variations in the accounting policies does not arise. There can be little scope of differences in approach so far as trading costs are involved, TPO's stand on locational savings not being accounted for 70. We have also noted that the TPO has also taken up a point regarding locational savings which, according to him, 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. It is elementary that locational ....
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....to which location savings are either retained by a member or members of the MNE group or are passed on to independent customers or suppliers; and (iv) where location savings are not fully passed on to independent customers or suppliers, the manner in which independent enterprises operating under similar circumstances would allocate any retained net location savings. We are in considered agreement with this approach but then no such exercise, as suggested in the above four step process, has been carried out in the present case, nor is there any concrete finding even about something as fundamental as existence of locational savings. The TPO has raised some murmurs of locational savings being present in this case but such vague generalities are devoid of legally sustainable foundation. The allocation of location savings comes into play only when these savings are not directly passed on to the independent customers and thus add to the profits of the group as a whole. However, in a situation in which the group is only a facilitator, as sogo shosha business model apparently envisages, there may not be any locational savings to the group. These locational savings may at best be derived by....
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....ties. There is no unique intangible pointed out in this case. Any comparable involved in the similar activity will essentially have the same intangibles, and no adjustments can be justified or warranted in the cases of routine intangibles. In view of these discussions, as also bearing in mind entirety of this case, the action of the TPO is devoid of any legally sustainable merits on this count as well. 72. The particular business model which gives rise to this edge, assuming that there is indeed an edge, to the assessee is a result of group synergy and intangibles as a result of such group synergy cannot, therefore, be assigned to the assessee alone. In any event, when the impact of group synergy is taken into account, it is only when it consists of deliberate concerted action benefits, and not when it merely consists of the passive association benefits. There is no such suggestion of deliberate concerted action benefits in the present case. 73. In any event, as observed by Hon'ble Delhi High Court, in Li & Fung's case (supra), the assesse may have "developed experience and expertise which the Tribunal has held to be human capital and supply chain intangibles but ....
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....e intangible is a significant unique intangible or not. When all business entities involved in that line of activity have the same or materially similar intangible asset, such an intangible asset cannot have any impact on the determination of the arm's length price of activity involving such intangibles. 76. In the case before us, it is not the case of the TPO that the assessee had acquired the asset of trained workforce at a cost which is not factored in the arm's length price or even that the assessee has incurred any significant costs for developing the workforce which is not factored in the arm's length price. All that the assessee has incurred as costs are the routine staff costs and all such costs are already factored in the arm's length price. No matter which PLI is adopted, these operating costs will anyway be taken into account. The question of its being a unique intangible, justifying a separate specific adjustment in the ALP, arises only when it is acquired or developed at a cost which find no mention in the TP analysis. A trained workforce is an intangible asset and it is on the basis of this asset that the assessee carries out his business activity but that in....
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....submissions. We have laid down the broad principles which, in our humble understanding, will be appropriate to this fact situation. However, it is for the field authorities to examine and quantify the impact of these principles on the actual ALP determination. That aspect of the matter will have to be examined afresh at the assessment stage. Service fee/ commission segment of assessee's activities 80. Coming to the service fee/ commission segment, we have noted that as regards the service fee/ commission segment, the TPO has re-characterized the same as trading activities as he was of the view that the right course of action will be to treat the same as equivalent to trading segment, because what the assessee has disclosed as service/ commission income is infact trading income. Accordingly, the cost of goods sold by the AEs, which was Rs. 2927,92,05,406, was also to be included in cost base of the service/commission segment and then ALP was recomputed. So far as this aspect of the matter is concerned, the issue is now covered in favour of the assessee by Hon'ble jurisdictional High Court's decision in the case of Li & Fung wherein Their Lordships....
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....r Lordships, we hold that the adjustments carried out in the cost base of ALP computation, in respect of service fee/ commission segment, are indeed devoid of legally sustainable merits. We direct the Assessing Officer to delete these adjustments. Once this notional adjustment is deleted, the ALP determination is to be done on the basis of the commission/ service fees. As we have stated earlier in this order as well, in the course of proceedings before us, the assessee has filed fresh computation of the ALP which attempts to demonstrate that, if notional adjustments made by the TPO are deleted, no ALP adjustment will be warranted. However, we are not inclined to go into verifications which must take place at the assessment stage. Conclusion on commission /service fees segment of assessee's activities 82. Accordingly, we deem it appropriate to uphold the grievances of the assessee in principle, as the terms above, delete the notional adjustments by TPO's adopting cost base of the AEs in assessee's ALP determination, and remit the matter to the file of the TPO for the necessary factual verifications on impact of this corrections. Accordingly, the matter stands resto....
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....ative Group, Energy Business Group, Metals Group, Machinery Group, Chemicals Group and Living Essentials Group continue to work under the liaison office of MCJ, though sometimes overlapping with MCI, and there is no difference in their functioning so far as business model is concerned. All these complex factual aspects, which are relevant to us only from the point view of revenue's contention that the payments made to the MCJ and its affiliates were taxable in India, were discussed in detail in the assessment order. A reference was then made to Metal One Corporation and its affiliates and it was noted that this group was following the same business model, that, though it was a separate entity, it was assigned to deal with metal business earlier being carried on by metal division of MCJ and that the Metal One Corporation must also, therefore, be held to have a PE, and consequent tax liability, in India. The Assessing Officer noted that these entities, even though non-resident, are taxable in India "in the light of their business model and their presence in India" under the provisions of the Income Tax Act, 1961, as also under the provisions of relevant DTAA as these entities have a ....
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....he India Japan Double Taxation Avoidance Agreement. The AO was thus of the view that since these vendors had a permanent establishment in India and that the assessee had an obligation to deduct tax at source from the payments made to these non-resident vendors, and, since the assessee has failed to discharge these tax withholding obligations, these payments cannot be allowed as a deduction in computation of business income. The assessee did raise a grievance before the DRP but without any success. The AO thus proceeded to make the impugned disallowance of Rs. 102,17,16,483. The assessee is aggrieved and is in appeal before us. 86. We have heard the rival contentions, perused the material on record and duly considered facts of the case in the light of the applicable legal position. Shri M. S. Syali, Senior Advocate, alongwith Shri Tarandeep Singh, argued for the assessee on these issues as well while, so far as these aspects in the present appeals are concerned, now Shri Sanjeev Sharma, Commissioner - Departmental Representatives (International Taxation), made his submissions for the revenue. 87. We find that there are three broad categories of non-resident entitie....
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.... and philosophy. Metal One Corp is also functioning in India by way of a so called liaison office and the said L.O. is undertaking core activity of creating a market chain for vendors and customers in metal market. Therefore on the lines of taxability of MC, Metal One Corporation's income is also chargeable to tax in India. From the business model discussed above, it is apparent that it does not make any difference if the trading is down through the business model discussed above, it is apparent that it does not make any difference if the trading is down through/with an entity based in Singapore or Thailand. The said offices also function in similar manner in respect of entire group of locating and negotiating with potential buyer and seller in metal market. The tax residency certificate etc. are of no consequence in such a business model. " 9.6 The Delhi "E" Bench of the Tribunal in the case of Metal One Corpn. (supra) for the Assessment Year 2008-09 considered the issue whether the assessee M/s Metal One Corporation has a P.E. in India. At para 6.6 to 6.8 it was held as follows : "6.6. We may now consider the decision in the case of Sofema SA. The finding of....
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....e is not available on record. There is no evidence that this order was shown to the assessee and it was given a chance to rebut the inference of similarity of functioning. It is also not mentioned as to what finally happened to that order. Therefore, we are of the view that these observations do not constitute any foundation for coming to any conclusion for or against the assessee. Therefore, we are of the view that the India office does not constitute PE of the assessee in India. The result is that the assessee succeeds on ground No.1." 9.7 In the above decision the Tribunal has concluded that Metal One Corporation does not have a P.E. in India. The Assessing Officer on the analogy that the functions of Metal One Asia Pte.Ltd. Thailand are similar to that of Metal One Corporation, drew an inference that Metal One Asia Pte. Ltd. have a P.E. in India. Similar inference has been drawn in the case of MC. Tubular Inc. USA, Petro Diamond Corp. Japan and Miteni Japan. As the ITAT had, in the case of Metal One Corpn. (supra) held that the entity does not have a P.E. in India, on the facts and circumstances of the case, the ratio applies to all other entities other than M....
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....ndation of impugned disallowances ceases to hold good in law. By no stretch of logic, therefore, payments made to these entities can be disallowed under section 40(a)(i) on the ground that taxes have not been deducted at source from these payments. The disallowances of payments of Rs. 48,95,50,760 to MC Metal Services Asia (Thailand), of Rs. 49,73,73,422 to Metal One Corporation (Japan) and of Rs. 1,74,72,633 to Metal One (Asia) Pte Ltd Singapore, accordingly stand deleted. Disallowance of payments under section 40(a)(i) made to the foreign entities, without deduction of tax at source, which may not have any permanent establishment in India but there is no material to establish that fact and there is also no material on record to show that revenue's claim of their having PE in India is negated by the judicial authorities. 91. In the second segment, we take up disallowance of payments made to the foreign entities which may not have any permanent establishment in India but there is no material to establish that fact and there is also no material on record to show that revenue's claim of their having PE in India is negated by the judicial authorities. So far as this ....
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....anese enterprise. It is not only a case of completing assessment based on a hypothetical assessment of an imaginary fact situation, it is building a foundation of assessment by resorting to fiction upon fiction inasmuch as it is assumed that the vendor in question must be having a PE in India, for which there is no factual support on record, but it is also assumed that such a non-existent PE must also be dealing in the same or similar products as sold by that vendor. Such a fertile imagination may indeed help as inputs for investigation but it does no good to assessment of income which must be based on cogent material on record. We are unable to see any legally sustainable merits in this approach. On the basis of these assumptions, as made by the Assessing Officer and which we find to be unsustainable in law and on facts, tax liability of recipients cannot be inferred. In any event, normal purchases from non-resident companies based in Thailand, Singapore and USA, as these vendors are, cannot give rise to taxability of income from such purchases, in the hands of the non-resident vendor, unless such non-resident companies have a permanent establishment in India. The onus to....
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.... is a tax resident of Thailand and Metal One Asia Pte Ltd. a tax resident of Singapore, the common argument of the assessee is that the Non discrimination Clause of the DTAA entered into between India and USA in the case of Mc. Tubular Inc. USA and DTAA between India and Japan in all other cases apply. We now examine this contention. 9.1 The Delhi Bench of the Tribunal in the case of Herbalife International (P.) Ltd. (supra), held as follows: "22. 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, than 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-resident. The provisions of section 40(a)(i), as it stood prior to it's amendment by the Finance Act, 2003 with effect from 1.4.2004, applied to payments by an assessee outside India to a non-....
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....and says that deduction should be allowed on the same condition as if the payment is made to a resident. Thus, this clause in DTAA neutralizes the rigour of the provisions of section 40(a) (i). By virtue of the provisions of section 90(2), the law, which is beneficial to the assessee to whom the DTAA applies, should be followed. Therefore, in view of article 26(3) of Indo-US DTAA, the Assessing Officer could not seek to invoke the provisions of section 40(a)(i) to disallow the claim of the assessee for deduction even on the assumption that the sum in question was chargeable to tax in India. [Para 26]" 9.2 The propositions laid down in this decision are squarely applicable to the transactions with MC. Tubular Inc. USA, as this is covered by the Indo-US DTAA. 9.3 The Non Discrimination Clause under Indo-Japan DTAA reads as follows: "Except where the provisions of paragraph 1 of article 9 (Associated Enterprises), paragraph 7 of article 11 (interest) and paragraph 8 of article 12 (Royalties and Fees for Included Services) apply, interest, royalties and other disbursements paid by a resident of a contracting state to a resident of the other contracting state ....
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....ting this paragraph, it is also necessary to examine the contents of paragraph (3) of article 7. This paragraph deals with deduction of expenses incurred for the purpose of the business of the PE, including a reasonable allocation of executive and general administrative expenses, research and development expenses, interest and other expenses inc urred for the purpose of the enterprise as a whole. On consideration, it is seen that these provisions were not material insofar the facts of the instant case were concerned because there was no dispute about the computation of income which included deduction of expenses from the income earned by the PE. Therefore, it was necessary to examine and interpret the intent and purpose of the paragraph (2) of article 26. In simple language and taking into account the facts of case, the language employed in the provisions means that taxation of a PE of the USA shall not be less favourable than the taxation of a resident enterprise carrying on the same activities. [Para 8.1]. Insofar as the status of commentary on the OECD Model Convention is concerned, for interpretation of the DTAA, it is clear that the commentary does not lay down any bi....
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....ted Securities Clearance Inc. (supra) does not help the Revenue. Thus on the ground of Non Discrimination the disallowances of purchases in the case of (i) MCJ, (ii) MOCJ, (iii) Mc.Tubular Inc, USA, (iv) Petro Diamond Corp. Japan and (v) Miteni, Japan are to be deleted. Rival contentions 99. Learned counsel for the assessee takes us through the orders of the authorities below and the order of the Tribunal, in assessee's own case, for the immediately preceding assessment year. Learned counsel also takes us through a coordinate bench's decision in the case of DaimlerChrysler India Pvt Ltd Vs DCIT (29 SOT 202) in support of the proposition that it is not a condition precedent for the assessee to be a resident of the treaty partner country in order to seek treaty protection. It is submitted that discrimination is against the entities which are tax residents of treaty partner jurisdictions inasmuch as the payments made to these entities is discriminated vis-à-vis payments made to similarly situated domestic business entities. It is this discrimination against the tax residents of treaty partner jurisdictions that is being sought to be nullified. He also takes us....
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....ction 40(a)(ia) was not on the statute. It was in this backdrop that section 40(a)(i) was held to be discriminatory vis-à-vis non-residents. However, subsequently, though much before even this decision was rendered, law was amended and such an inequity, even if that be so, was removed. As the law stands now, whether payments are made to non-residents without compliance with tax withholding requirements or payments are made to residents without compliance with tax withholding requirements, the fate is the same i.e. both the categories of payments are disallowed in computation of business income of the person making such payments. As for learned counsel's point that there is no tax deduction at source requirements from payments made to Indian residents on account of purchases, and that any such requirement in the case of non-residents will thus be discriminatory, there is no discussion whatsoever on this aspect of the matter in the order under reference nor has it been even specifically taken up by the assessee before the authorities below. The coordinate bench was simply swayed by the Herbalife decision, and there is not even a whisper of a discussion on this aspect of the ma....
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.... order of Herbalife is not applicable for the year under consideration and it was even not applicable for AY 2006-07. Paragraph 22 of the order in case of Herbalife clearly stated that "the provisions of section 40(a)(i), as it stood prior to its amendment by the Finance Act, 2003 with effect from 1.4.2004, applied to payments by an assessee outside India to a non-resident only. After 1.4.2004, the provisions apply equally to both resident and non-resident. In the instant appeal, the provisions of section 40a (i) as it existed prior to 1-4- 2004 alone were applicable". The decision in case of Herbalife clearly stated that after 1.4.2004, the provisions apply equally to both resident and non-resident. Therefore, as the year under appeal is AY 2007-08, the Revenue relies on the decision of Herbalife to contend that the ratio is in favour of the Revenue for AY 2007-08 and there is no discrimination. 6. It is humbly submitted that the Hon'ble ITAT for AY 2006-07 fell in error and committed an error in applying the decision in case of Herbalife wrongly and in fact the decision was in favour of the Revenue. It is humbly submitted that such a decision which was wrongly arrived at....
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....ssees vis-à-vis Japnese non-resident assessees, even this argument is legally untenable. There is no such discrimination on the facts of this case and this arguments proceeds on the fallacious assumption that there is no tax deduction requirement from purchases from resident assesses, when made under a contract as was the case of purchases from Japanese non-resident assessees. He also prayed that this written arguments may please be taken on the record so that, even if we follow the decision of the coordinate bench in the immediately preceding assessment year, Hon'ble Courts above may have the benefit of examining revenue's perspectives on this aspect of the matter. However, for the reasons we will set out in a short while, it not necessary to go into all these fine points, so strenuously argued by the learned Departmental Representative, though we must reproduce extracts, from the written submission filed by the learned Departmental Representative, as follows: Paragraph 1 of non-discrimination Article does not apply 11. This paragraph applies to situations when the Nationals of a Contracting State are subjected in the other Contracting State to an....
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....ce of the provisions of deduction of tax at source and payments thereof. This is separately discussed below in this submission. 17. Paragraph 2 of the Commentary on paragraph 4 (kindly refer to page 108 of the revenue's PB) further explains the reasons of restrictions. Deductibility of disbursements made abroad by foreign owned corporations (meaning subsidiaries of foreign companies) conditional on the recipient being taxed in such countries. Meaning deduction will not be allowed if the payments are not subjected to tax in the country of recipient. US Treasury Department Technical Explanation of the Convention and Protocol between the USA and the Republic of India for the avoidance of Double Taxation and Prevention of Fiscal Evasion. 18. This explanation pertaining to Article 26 is attached (pages 109 to 113 of the Revenue's PB). 19. It is submitted that the DTAA is an international agreement. The interpretation adopted by the USA also equally applies in India as the obligations and its effect is reciprocal. If the USA interprets some portion of its law and Regulations (which do not have corresponding provisions in Indian law) are not affected or....
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....s deduction in computing the income chargeable to tax for that year. Therefore, the purpose of these provisions is not to provide a different taxation system or any connected requirements but to ensure the effective compliance of the TDS provisions. Now even the Act has been amended 23. Act has been amended effective 1.4.2004 (duly taken note in the case of Herbalife by the Hon'ble ITAT) to provide for similar disallowances for ensuring compliance of TDS provisions in regard to payments to residents (section 40 (a)(ia)). Tax is deductible under various sections of Chapter XVII-B of the Act out of various payments to residents. The deduction for these payments is not allowed under section 40a (ia) of the Act if the tax is either not deducted or after deduction the same is not paid to the government account. 24. These provisions are compliance provisions only as the payer is under obligation to deduct tax and authorised to do so far and on behalf of the Government. It is a great obligation and such deductors act as an arm of the government. A great responsibility is cast on them to deduct the tax and not to use the same for their business use but to pay to ....
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....ions 30. The deduction of tax out of payments from non-residents and residents are not under the same conditions. Residents and non-residents are subjected to different requirements and enforcement provisions. Question of territorial jurisdiction is also important. The Act does not empower the tax authorities to enforce compliance in case of non-residents as in case of residents. Indian Act has no direct application in a foreign territory. Provisions of section 195 and section 40(a)(ia) have proper justifications as to ensure collection of tax out of payments to non-residents. They can claim refund if excess tax is deducted. 31. In case of residents the AO can take actions under section 131, 132, 133A and 133(6) of the Act. Such an actions are not possible in case of non-residents. In some cases (Section 115), the non-residents are not requiring to file tax returns. Residents and nonresidents are not under the same conditions. 32. The non-discrimination clause is not intended to offer the protection to resident or non-resident so as to encourage them to disobey the law of the land or reward them for non-compliance of law. The purpose of non-discrimination....
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....nt has already included the receipt in question in computation of its business income in India and paid taxes thereon, and in the light of second proviso to Section 40(a)(ia) having been held to be retrospective with effect from 1st April 2005, there seems to be no valid ground to discriminate against a non-resident assessee. Learned Departmental Representative was asked to address on this aspect of the matter, on the justification for difference in treatment of non-resident recipients vis-à-vis resident recipients in disallowances under section 40(a)(i) vis-à-vis 40(a)(ia), and on the impact of non-discrimination clause in Indo Japan tax treaty on this, what seems to us to be, a somewhat discriminatory practice. Learned Departmental Representative was also asked to take into account, in his submissions, two decisions of the Tribunal - one, in the case of Rajeev Kumar Agarwal Vs ACIT (149 ITD 363), wherein it is held that insertion of second proviso to Section 40(a)(ia) is to be treated as effective from 1st April 2005; and - second, in the case of DCIT Vs Gupta Overseas [30 ITR (Trib) 738], wherein, following special bench decision in the case of Rajeev Sureshbhai Ga....
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.... payments made to non-residents without deduction of tax at source. In rejoinder, learned counsel for the assessee reiterated that it is indeed true that the decision of Tribunal, in the case of Automated Securities Clearance (supra), is not relevant for deciding the issue in appeal before us but then this decision was relied upon by the revenue authorities in support of their rejection of treaty protection but now that the view so taken by a division bench is reversed by a Special bench of the Tribunal in the case of Rajeev Sureshbhai Gajwani (supra), this decision is being termed as irrelevant. The reference to Rajeev Sureshbhai Gajwani's case was made by the assessee because the decision relied upon by the Assessing Officer was disapproved in this case. If nothing turns on this case, the Assessing Officer had no reasons to reject the treaty protection demanded by the assessee because the only defence available to the Assessing Officer was this decision of the Tribunal. Learned counsel further submitted that whether or not treaty protection is available in respect of the deduction neutrality, this issue is no longer res integra, inasmuch as Herbalife decision (supra) lays down th....
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....e assessee, whether or not there is any income embedded in it, tax is required to be deducted at source. If this kind of a discrimination is permitted, non-discrimination clauses in the tax treaties will be rendered meaningless. Learned counsel then moves on to legislative amendments in section 40(a)(ia) by the virtue of Finance Act 2012 and by inserting second proviso to section 40(a)(ia). It is pointed out that in view of this amendment, when an assessee makes a payment, even without deducting tax at source, to the resident assessee but resident assessee takes into account such receipt in its computation of income and files the income tax return under section 139(1) in respect of income so computed, no disallowance under section 40(a)(ia) can be made. However, in corresponding provision for payments made to non-resident assessees, i.e. under section 40(a)(i), when an assessee makes payments to non-resident assessees without deducting tax at source and even if the recipient takes into account such receipts in his computation of business income and files income tax under section 139(1) in respect of the same, the disallowance will be made nevertheless. Learned counsel submits that ....
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....oposition put to the parties, learned Departmental Representative reiterated his earlier submissions and contended that a differentiation in treatment for deductibility particularly when it is warranted by reasonable basis, as is the case, cannot be treated as differentiation and that it is not open to us to supply any omissions in the legislation, even if there be an element of differentiation therein, which is wholly permissible under the law and in tax treaties, on the ground that such an omission leads to discrimination to the residents of a treaty partner jurisdiction. It is submitted that we cannot supply an omission no matter how desirable the provision be. He submits that now that taxability of income embedded in a payment in India is beyond doubt or controversy, and there is no dispute that the assessee has not deducted tax at source from the said payment, there is no escape from the conclusion that the assessee ought to have deducted tax at source from such a payment and that the assessee's failure to do so has to be necessarily visited with disallowance under section 40(a)(i). We are thus once again urged to confirm the action of the Assessing Officer on this point and d....
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....indirectly, held by one of more residents of the other Contracting State vis-a-vis other similar enterprises of the host State. These four types of discriminations are quite distinct in character and in scope. In the first category of discrimination, which is sought to be prohibited by art. 24, all that is relevant is that national of one of the Contracting State should not be discriminated against, for the reason of the nationality, in the other Contracting State. As evident from the plain wordings of the art. 24(1), it is not even necessary that a person seeking treaty protection under this clause should be resident of any of the Contracting States. In the second category, the discrimination is prohibited against the PEs of the other Contracting States. That of course implies that an enterprise of a Contracting State has a PE in the other Contracting State, which, in turn, requires that in order to claim non-discrimination in the host State, the PE must belong to an enterprise of the other Contracting State. In the third category of non-discrimination provisions, payments made to the residents of the other Contracting State vis-a-vis payments made to the residents of the host Sta....
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....domiciled in Japan are concerned. The treaty protection is thus being sought in respect of the Japanese tax residents- even though it does affect deductibility of payments made to them in India, and, to that limited extent, it has impact on determination of taxable income in the hands of the Indian tax residents. The benefit of deduction neutrality, in Indian tax laws, in respect of payments made to Japanese tax residents does affect the assessment to an Indian resident because the deduction parity is ensured in India, when there is a discrimination, by reading down the disabling provisions, but the subject matter of treaty protection is Japanese tax resident. There is thus no legal infirmity in the treaty protection canvassed by the assessee. We may also add that there is a series of decisions on this issue, starting with path-breaking decision in the case of Herbalife (supra) and including other oft quoted decisions in the cases of Asianet Communications Ltd Vs DCIT (38 SOT 158), B4U International Holdings Limited Vs DCIT (52 SOT 545), Central Bank of India Vs DCIT (42 SOT 450), DCIT Vs Lazard India Ltd (41 SOT 72), DCIT Vs Incent Tours Pvt Ltd (53 SOT 308), Millennium Infocom Te....
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....r controlled, directly or indirectly, by one or more residents of the other Contracting State, shall not be subjected in the first-mentioned Contracting State to any taxation or any requirement connected therewith which is other or more burdensome than the taxation and connected requirements to which other similar enterprises of the first-mentioned Contracting State are or may be subjected. 5. In this article, the term "taxation" means taxes which are the subject of this Convention. 109. Article 24(3) of India Japan DTAA, which is materially similar to the first limb of Article 24(4) of UN Model or OECD Model convention. Elaborating upon the scope of this provision, the OECD Model Convention Commentary, which is reproduced with approval and concurrence in the UN Model Convention Commentary as well, observes as follows: 73. This paragraph is designed to end a particular form of dis- crimination 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 foun....
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....e process of interpretation but that principle does not restrict implementing the tax treaty provision when such implementation requires a legal provision to be held inapplicable for an assessee, where it is otherwise applicable on that assessee, or where such implementation of tax treaty provision requires a legal provision to be extended to an assessee, who is otherwise not eligible for the same. There are any number of judicial precedents on this issue where a legal provision, such as section 14A, section 40(a)(i), section 44 C etc, has been held to be inapplicable for an assessee, even though these provisions were applicable on that assessee as evident from a plain reading of the related legislative provision, because of the treaty provisions, and where a legal provision, such as section 80HHE, has been held to be applicable even when the assessee was, on a simple reading of the legislative provision, was not eligible for the same. We are unable to uphold this plea of the learned Departmental Representative. Differentiation Vs discrimination- legal position 112. In all fairness to the learned Departmental Representative, there indeed was a school of thought th....
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....ent concerned, the grounds of differential treatment are unreasonable, arbitrary or irrelevant. Whether a distinction is unreasonable, arbitrary or irrelevant is a matter of judgment......" 35. It is thus clear that in order to establish discrimination, not only that a taxpayer has to demonstrate that he has been subjected to different treatment vis-a-vis other taxpayers, but also that the ground for this differentiation in treatment is unreasonable, arbitrary or irrelevant. 36. This principle on reasonableness of the differential treatment is also evident from the Technical Explanation issued by the treaty partner State, i.e. US, to art. 26(2) its Model Convention which, barring the opening words "except where the provisions of para 3 of art. 7 (business profits) apply" is exactly the same as art. 26(2) of Indo-US tax treaty. This Explanation, inter alia, observes as follows: "..........There are cases, however, where the two enterprises would not be similarly situated and differences in treatment may be warranted. For instance, it would not be a violation of the non-discrimination protection of para 2 to require the foreign enterprise to provide informa....
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....nt establishment tax)". A permanent establishment tax, which is levied in the US, obviously puts an additional tax burden on the PEs of Indian enterprise vis-a-vis US enterprise, and yet it is not construed as an act of discrimination against the PEs of Indian enterprise. This strengthens our interpretation that to make out a case for discrimination, demonstrating differential treatment, by itself, cannot suffice. In our considered view, to establish a case discrimination, it is to be established that the basis of differentiation lacks any coherent relationship with the object ought to be achieved by the legal provision which is alleged to be discriminatory. 39. The Technical Explanation on the US Model Convention having recognized that "there are cases, however, where the two enterprises would not be similarly situated and differences in treatment may be warranted", what becomes very important and crucial is to take note of the dissimilarities in the position of a PE of the US company vis-a-vis an Indian enterprise, and to test reasonableness on the limitations on incentive deduction under s. 80HHE in the light of these dissimilarities. 40. This approach is quite....
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....tax treaty constitute a set of special rules providing protection against discrimination against nationals or residents of another Contracting State. Learned authors, however, hasten to add as follows : ".........However, not all differences in tax treatment, either between nationals of the two States or between residents of the two States, are violations of the prohibition against non-discrimination. Rather, the non-discrimination provisions .....would apply only if the nationals or residents of two States are similarly situated. Thus.....(it) does not cover indirect indiscrimination and does not introduce an all encompassing non-discrimination rule......." 42. In the light of the above discussions, we are of the considered view that a differential treatment to the PE of the US tax resident, by itself, cannot be treated as covered by the scope of rule prohibiting non-discrimination. The true test for deciding whether or not there is a non-discrimination is whether or not the resident enterprise and the PE of the other Contracting State, who are similarly situated, get the same tax treatment or not. There could indeed be different tax treatments to the PE....
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....er the same conditions. This provision shall not be construed as preventing a Contracting State from charging the profits of a PE which an enterprise of the other Contracting State has in the first-mentioned State at a rate of tax which is higher than that imposed on the profits of a similar enterprise of the first-mentioned Contracting State, nor as being in conflict with the provisions of para 4 of art. 7 of this Convention." Therefore, in our considered view it will be unnecessary for us to refer to the Commentary on OECD Model Convention, decision of any foreign jurisdiction or other jurisdiction if the provisions contained in the DTAA are capable of clear and unambiguous interpretation. Accordingly, we consider it unnecessary to examine the commentary or the technical explanation for coming to a conclusion in the matter. 8.4 The learned Departmental Representative referred to the Board Circular No. 621, dt. 19th Dec., 1991, issued after introduction of s. 80HHE in the IT Act. Reference is made to para No. 34 of the circular which states that with a view to provide fiscal incentives for export of computer software, a new s. 80HHE has been inserted in the Act f....
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.... of general nature, and if provisions in the Act come in conflict with the treaty, the provisions of the Act are applicable only to the extent they are more beneficial to the assessee; if not, the provisions of the treaty shall prevail. The case of the learned Departmental Representative is that this decision has been rendered under s. 44C and, therefore, it is distinguishable. To our mind, the decision harmonises provisions of the treaty and the provisions contained in s. 44C of the Act. Similar exercise is involved in this case as the provisions of the Act and the treaty are required to be interpreted in a harmonious manner. Therefore, the ratio of this decision is applicable to the facts of the case before us. 8.6 There is also a dispute regarding the words "same activities" used in art. 26. The case of the learned counsel is that the assessee is engaged in the business of export of software in the same manner in which a number of Indian enterprises are exporting software. The fact that the assessee has been allowed to export software shows that the business does not fall in the prohibited category. Accordingly, the assessee's case has to be compared with the case of an....
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....e payment is a sine qua non for business deduction so far as payments to non-residents are concerned, unless there is a similar pre-condition for deductibility of related expenses to the payments to residents as well, that disabling provision cannot be enforced in respect to payments made to non-residents either. We may also add that, as opined in the UN and OECD Model Convention Commentaries, with which we are in considered agreement, deduction neutrality clause in non-discrimination provisions is designed to primarily seek parity in eligibility for deduction between payments made to the residents and non-residents. Payment of related Indian income tax by recipient foreign entity and its impact on the impugned disallowance 115. In the present case, we are dealing with a situation in which payment has been made to a non-resident taxpayer but the said non-resident taxpayer has taken into account the receipts in question in his business income and has already filed his income tax return under section 139(1), a copy of which is also produced by the learned Departmental Representative in support of his contention that the recipient non-resident indeed had a tax liabil....
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....ted in any loss to the exchequer, and this fact can be reasonably demonstrated, the assessee cannot be treated as an assessee in default. The net effect of these amendments is that the disallowance under section 40(a)(ia) shall not be attracted in the situations in which even if the assessee has not deducted tax at source from the related payments for expenditure but the recipient of the monies has taken into account these receipts in computation of his income, paid due taxes, if any, on the income so computed a has filed his income tax return under section 139(1). There is also a procedural requirement of issuance of a certificate, in the prescribed format, evidencing compliance of these conditions by the recipients of income, but that is essentially a procedural aspect of the matter. The legislative amendment so brought about by the Finance Act, 2012, so far as the scheme of disallowance under section 40(a)(ia) is concerned, substantially mitigates the rigour of, what otherwise seemed to be, a rather harsh disallowance provision. 5. As for the question as to whether this amendment can be treated as retrospective in nature, even in the case of Bharti Shipyard (supra)- a s....
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....so put in a word of caution by observing that, "the provision should be interpreted in a fair, just and equitable manner". Their Lordships thus recognized the bigger picture of realization of legitimate tax dues, as object of Section 40(a)(ia), and the need of its fair, just and equitable interpretation. This approach is qualitatively different from perceiving the object of Section 40(a)(ia) as awarding of costs on the "assessees who fail to comply with the relevant provisions by considering overall objective of boosting TDS compliance". Not only the conclusions arrived at by the special bench were disapproved but the very fundamental assumption underlying its approach, i.e. on the issue of the object of Section 40(a)(ia), was rejected too. In any event, even going by Bharti Shipyard decision (supra), what we have to really examine is whether 2012 amendment, inserting second proviso to Section 40(a)(ia), deals with an "intended consequence" or with an "unintended consequence".7. When we look at the overall scheme of the section as it exists now and the bigger picture as it emerges after insertion of second proviso to section 40(a)(ia), it is beyond doubt that the underlying objecti....
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....the provisions workable has to be treated as retrospective notwithstanding the fact that the amendment has been given effect prospectively". Revenue, thus, does not derive any advantage from special bench decision in the case Bharti Shipyard (supra). 9. On a conceptual note, primary justification for such a disallowance 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 deincentivize not deducting tax at source, when such tax deductions are due, but, so far as the legal framework is concerned, this provision is not for the purpose of penalizing for the tax deduction at source lapses. There are separate penal provisions to that effect. Deincentivizing a lapse and punishing a lapse are two different things and have distinctly different, and sometimes mutually exclusive, connotations. When we appreciate the object of scheme of section 4....
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....ect from 1st April, 2005, being the date from which sub clause (ia) of section 40(a) was inserted by the Finance (No. 2) Act, 2004. 10. In view of the above discussions, we deem it fit and proper to remit the matter to the file of the Assessing Officer for fresh adjudication in the light of our above observations and after carrying out necessary verifications regarding related payments having been taken into account by the recipients in computation of their income, regarding payment of taxes in respect of such income and regarding filing of the related income tax returns by the recipients. 116. It is thus clear that no disallowance can be made in respect of payments made to a resident assessee, even without applicable deduction of tax at source, as long as related payments are taken into account by the recipients in computation of their income, and taxes in respect of such income are duly paid and related income tax returns are duly filed by the resident recipients under section 139(1). However, as section 40(a)(i) does not have an exclusion clause similar to second proviso to Section 40(a)(ia), so far as payments made to non-residents, without deduction of applic....
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....d in Article 24(3) of Indo Japan DTAA which, subject to the exceptions set out therein which are admittedly not applicable on the facts of this case, provides that, "interest, royalties and other disbursements paid by an enterprise of a Contracting State to a resident of the other Contracting State shall, for the purpose of determining the taxable profits of such enterprise, be deductible under the same conditions as if they had been paid to a resident of the first-mentioned Contracting State". When we interpret these words in the present context, it follows that the payments made by an Indian enterprise to a resident of Japan shall be deductible, in the assessment of India enterprise, under the same conditions as if the payments were made to the Indian residents. Any deviations from this non-discrimination principle are to be read down in view of clear mandate of section 90(2). 117. In view of the above discussions, in our considered view, second proviso to Section 40(a)(ia) is also required to be read into Section 40(a)(i), in the cases where related payments are made to the tax residents of Japan, inasmuch as long as the Japanese tax residents have taken into account th....
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....to deductibility of payments made to residents without deduction of tax at source, deduction neutrality under Article 24(3) of Indo Japan DTAA requires the same to be read into the scheme of deduction conditions under section 40(a)(i) so far lapses in deducting tax at source in respect of payments made to the non-residents, covered by Indo Japan DTAA, are concerned. In view of the evidences brought on record by learned Departmental Representative himself, it not in dispute that the MCJ has taken into account the impugned payments into account in computing the income liable to tax in India, paid taxes on the same and duly filed, under section 139(1), related income tax return. In view of this factual position, and in the light of legal position discussed above, the impugned disallowance of Rs. 91,80,507 is also deleted. 118. As we have deleted this disallowance under section 40(a)(ia) on the short ground that the MCJ, the recipient, has taken into account the related payments in computing its business income in India, paid taxes on the same and duly filed, under section 139(1), its income tax return in India, we see no need to deal with the issue whether Section 40(a)(i) it....
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....he issue as to how the remanded matter is to be decided afresh. Of course, whatever we decide is, and shall always remain, subject to the judicial scrutiny by Hon'ble Courts above but our endeavour should be to facilitate and expedite that process of such a judicial scrutiny, if and when required, by analyzing the issues in a comprehensive manner in the light of arguments before us and the material on record. It was possible in this particular case because of, as we have noted earlier as well, very able assistance by the parties before us. Conclusion on the first two issues 4. We see no reasons to take any other view of the matter than the view so taken by us for the immediately preceding assessment year. Learned representatives have fairly accepted that there is no difference in material facts of the case except for the variations in quantum of disallowances. In this view of the matter, and in the light of our above observations which will apply mutatis mutandis on this assessment year as well, while we remit the matter regarding determination of ALP, in the light of our observations as above, to the assessment stage, we delete the disallowance under section 40(a....
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....of 2014, Commissioner of Income Tax (Ii) Kanpur, Vs. M/s. Shivam Motors (P) Ltd.decided on 05.05.2014. In the said decision it has been held: "As regards the second question, Section 14A of the Act provides that for the purposes of computing the total income under the Chapter, no deduction shall be allowed in respect of expenditure incurred by the assessee in relation to income which does not form part of the total income under the Act. Hence, what Section 14A provides is that if there is any income which does not form part of the income under the Act, the expenditure which is incurred for earning the income is not an allowable deduction. For the year in question, the finding of fact is that the assessee had not earned any tax free income. Hence, in the absence of any tax free income, the corresponding expenditure could not be worked out for disallowance. The view of the CIT(A), which has been affirmed by the Tribunal, hence does not give rise to any substantial question of law. Hence, the deletion of the disallowance of Rs. 2,03,752/- made by the Assessing Officer was in order". 9. In view of the esteemed views of Hon'blle Courts above, it was indeed not open to ....