TaxTMI 
TaxTMI 
TaxTMI 
2014 (10) TMI 943
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....nces 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 of ALP adjustment of Rs. 68,15,17,853 Background 3. So far as ALP adjustment of Rs. 68,15,....
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....ppropriate 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 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 ....
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....ssets 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 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 activi....
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....hain 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 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 in....
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....kup 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, 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....
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....sed 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 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 Augus....
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....bursement 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 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 compa....
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.... 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 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 provid....
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....erry 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 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 r....
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....ces. 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 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 Vs DCIT (18 SOT 76). It is thus urged that while the matter can i....
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....ore 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 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....
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....k 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 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 ....
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....ey 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 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 a....
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....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 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 o....
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...., 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 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 esse....
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....iately 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 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.....
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....e 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 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 ....
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....composition of tested party's operating expenses 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 fact....
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....lining supplied by us) 47. As 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....
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.... in his honor and is computed 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 und....
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....the activities of 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 where....
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....ibles. The 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 ach....
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....ernal 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 intangibles like suppl....
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....angibles, 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 hypothetical problem at th....
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....wer 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 visà- 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 case that any business operations have b....
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....he 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 compensation model. In the process of carrying on a bu....
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....s, 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 this judgment states in so many words, "whether an assembled wor....
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....e 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 significant value such as by way of replacement cost, cost of acquiring the same or cost of developing th....
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....ithin 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 the TNMM under Rule 10B(1)(e) of the Rules. Having determined that (TNMM) to be the most appropriate method, the only rules and nor....
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.... 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 found that the liaison office was carrying on core business activity, and, accordingly, MCJ conceded taxability of its business profits in India. The AO noted the MCJ typically op....
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....able 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 Vs 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 Vs ACIT (101 ITD 450), the same was rejected by placing reliance on decision of another coordinate bench in the case of Automated Securities Clearance Inc vs ITO (49 SOT 333) wherein in the context ....
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....ut 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 concerned, there is a categorical finding that these entities had not have any permanent establishment in India. Dealing with this aspect of the matter, a coordinate bench of this Tribunal, for the immediately pre....
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....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 from the Head Office. Some more information was added about internal dispute in the case of TOPY. But that does not form an essential part of the business of the sale of iron/iron material and iron product by the ass....
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....ng 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 recipient has a PE in India under article 5 of India Japan tax treaty, it's income from trading can be brought to tax in India only when such an income is "directly or indirectly" attributable to such a PE. This condition....
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....the case of Motorola Inc. vs. 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 Vs 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 the recipient did not have a PE in India is also expecting the assessee to establish a negative, which, as noted above, is an impossible burden to discharge. 94. We have noted that in the DRP order, there is also a mention about the limited....
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....owance 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, vis-à-vis payments made to the resident entities. It is in this respect that the assessee's case hinges on non-discrimination clause. The position in the immediately preceding assessment year 98. We find that so far as the issue on non-discrimi....
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....mittedly 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's amendment by Finance Act, 2003 with effect from 1-4-2004, provided for disallowance of payment made to a non resident only where tax is not deducted at source on such payment at source. A similar payment to a resident does not result in disallowance in the even....
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....t 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 made in accordance with the provisions contained in the Act. Since according to the assessee, the provisions of the Act were not more beneficial to him, he was to be assessed under the DTAA. In this connection, article 26(2) provides that except where the provisions of....
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.....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, 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 an Indian enterprises would also be granted to the US enterprises if they are c....
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....ses 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 Representative during the course of the hearing, he has also filed exhaustive written submissions. The thrust of his argument that there are no independent findings on the non-discrimination issue by the coordinate bench and the coordinate bench has simply relied upon the Herbalife decision (supra) of t....
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....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 MC. Tubular Inc. USA, as this covered by the Indo-US DTAA. Paragraph 9.3 holds that the wording of non-discrimination Clause in Indo-Japan DTAA is para materia with the wording used in Non-discrimination clause in the Indo-US DTAA and this is not disputed by the Revenue. Hence, we hold that the propositions laid down in the case of H....
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....efer 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 relation to taxation of permanent establishment (pargarph2 of the Article) whereas the present case deals with paragraph 3 of the Article therefore those decisions are not all relevant to the case and not applicable. 101. Learned Departmental Representative then addressed his arguments on merits and contended that the decision of the coordinate bench in the case ....
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....enue'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. Paragraph 74 of the Commentary (page 108 of Revenue's PB) clearly mentions that application of thin capitalization rules provided in domestic rules are not covered by paragraph 4 of the Article. This indicates that domestic rules do not automatically results into discrimination if the purpose is well established. 16. Similarly, paragraph 75 of the Commentary refers to additional inf....
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....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 the Act. In this regard reference is made to Circular No. 528 dated 16th December, 1988 explaining the scope and effect of section 40(a)(i) of the Act (page 159 to 161 of the Paper Book). This circular explicitly states that " in order to ensure effective compliance of the provisions of section 195 of the Act relating to deduction of tax at source in respect of payments made outside India. The law as well as ci....
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....iminatory 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 non-resident vis-àvis resident because in case of non-resident tax is required to be deducted and if not paid disallowance will be made. This contention is farfetched and has no basis because in that case business decisions are considered to have been dictated for the reason of tendency of a taxpayer for not obeying the law. There is no justification for no-deduction and after deduction non-payment of tax when these functions are performed in a fiduciary capacity and acting as a part of government tax collection mach....
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....ow 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 Representative that there is only one case of non-resident recipient in which the existence of PE is established and of the recipient having filed its return of income in India, and even in that case recipient is admitted to have taken into account the impugned receipt of Rs. 91,80,507 in its computation of business income. It was also put to the learned Departmental Representative that when the recipient non-resident has alread....
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....ry 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 (supra), so far as impermissible non-discrimination with regard to deductibility conditions in respect of payments to non-residents, learned Departmental Representative once again relied upon the stand of the Assessing Officer and his detailed note reproduced earlier in this order. Learned Departmental Representative reiterated that post insertion of Section 40(a)(ia), there is no discrimination in disallowing payments made to no....
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....earned 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 to adjudicate on this aspect of the matter. What has been accepted by the AO himself in the preceding assessment year cannot be disputed now. In any case, even on merits, the discrimination is glaring inasmuch as when payments are made from a resident assessee, which essentially has an income embedded in it, there is no tax deduction at source requirement, whereas when payment is made to a non-resident Japanese assessee, whether ....
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.... 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 40(a)(ia) in view of application of second proviso to Section 40(a)(ia) which has been held to be retrospective in effect by a coordinate bench decision in the case of Rajeev Kumar Agarwal Vs (supra). He submits that for this reason also the impugned disallowance is discriminatory in nature and it should be read down in the light of the Article 24(2) of the Indo Japan tax treaty. In his short rejoinder on this proposition put to the....
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....ng 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 the other Contracting State vis-a-vis enterprises of the host State carrying out the same activity; (c) payments made to the residents of the other Contracting State vis-a-vis payments made to the residents of the host State- so far as deductibility in computation of business profits is concerned; and (d) enterprises of the host State in which capital is, partly or fully directly or indirectly, held by one of more residents of the other Contracting S....
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.... 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 us, though, as a matter of fact, non-discrimination protection is being invoked in respect of the payments made to a tax resident of treaty partner country, i.e. Japan in this case. What is being sought by the assessee in the present case is deduction neutrality so far as payments made to the resident taxpayers in India vis-à-vis payments made to non-residents fiscally domiciled in Japan are concerned. The treaty protection is thus being sough....
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.... 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 personal allowances, reliefs and reductions for taxation purposes on account of civil status or family responsibilities which it grants to its own residents. 3. Except where the provisions of article 9, paragraph 8 of article 11, or paragraph 7 of article 12, apply, 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 firstmentioned Contracting State. 4. Enterprises of a Contracting State, the capital of which is wholly or partly owned or controlled, directly or indirectly, by one or more residents of the other Contracting State, shall not be subjected in the firs....
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....e payment is concerned. If appropriate tax withholding by the person making the 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. It is not a question of applying the casus omissus, which could have been relevant in the case of supplying something in the process of interpretation of statute, but it is giving life and practical effect to a treaty provision, which has overriding effect on the provisions of domestic tax legislation, specifically providing for ensuring non-discrimination against the tax residents of the treaty partner jurisdiction. The mechanism is provided in the tax treaty and Income Tax Act itself and is not a result of any creative exercise in the process of interpretation of statutes. Casus omissus is not ordinary permissible in the 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....
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.... McIntyre, in their oft referred book 'International Tax Primer' (Second Edition @ p. 128), "in general, discrimination means distinguishing between persons adversely on the grounds that are unreasonable, irrelevant, or arbitrary". 'Conversely', according to distinguished authors, 'nondiscrimination means equal (functionally equivalent) or neutral treatment'. Prof. Kees Van Raad, in his book 'Non-discrimination in International Tax Laws', notes that while the original meaning of the expression 'discrimination', which refers to 'distinction' and 'differentiation', is neutral, in modern parlance the neutral meaning of the word 'discrimination' has virtually disappeared. He then proceeds to make following important observations: "....In the course of time, two elements have been added. At present, the term is restricted to instances where discriminated person is treated with less, rather than more, favour. In addition, the term nowadays implies that, in view of the nature of treatment 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 thu....
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....withholding on non-resident aliens, is merely a reasonable method for the collection of tax from persons who are not continually present in the US, and as to whom it otherwise may be difficult for the US to enforce its tax jurisdiction. .........." 37. The Technical Explanation issued by the USA, which is treaty partner State in the present case, is of very significant persuasive value. When the treaty partner State takes the stand that a differential treatment, which meets the test of reasonableness, cannot be construed as discrimination under art. 26(2), and with a view to ensure reciprocity in treatment, the same stand should ideally be followed by the other treaty partner State. 38. It is also interesting to note that art. 26(5) of the Indo-US tax treaty, inter alia, states that nothing in the non-discrimination article, "shall be construed as preventing either Contracting State from imposing the taxes described in art. 14 (permanent 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 ....
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....As held by the Hon'ble Supreme Court, in the case of State of West Bengal vs. Anwar Ali Sarkar AIR 1952 SC 75 and reiterated thereafter in several judgments, in order to pass the test of permissible classification, two conditions must be fulfilled, namely (i) the classification must be founded on an intelligible differentia which distinguishes persons or things that are grouped together from others left out of the group, and (ii) the differentia must have a rational relation to the object ought to be achieved by the legislation in question. Unless, therefore, a case is made out that the basis for differentiation has no rational relation to the object sought to be achieved by the legislative provision, it cannot be said that there is indeed discrimination. 41. Rakesh Kadakia and Nilesh Mody, in their book "The Law and Practice of Tax Treaties-an Indian Perspective", observe that the non-discrimination provisions in a 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....
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.... its policy through treaties entered into by it and even such treaties contain provision for deciding fiscal domicile in one State or the other and thus prevail over other provisions of the IT Act. It would be unnecessary to refer to the terms addressed in the OECD or in any of the decisions of the foreign jurisdictions. This can also be illustrated by examining the contents of para No. (2) of art. 26 of the treaty with United Kingdom of Great Britain and Northern Ireland, which permits the levy of higher rate of tax on the profits of the PE of that country in India. This para is reproduced below: "2. The taxation on a PE which an enterprise of a Contracting State has in the other Contracting State shall not be less favourably levied in that other State than the taxation levied on enterprises of that other State carrying on the same activities in the same circumstances or under 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....
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....ther need to discuss the case of Gracemac Corporation (supra). Otherwise also, the ruling rendered by the Authority for Advance Rulings is with reference to the facts of that case and is not applicable to any other case as a precedent. Similarly, it is also not necessary to go into the ruling in the case of Dassault Systems K.K., In re (2010) 229 CTR (AAR) 105 : (2010) 34 DTR (AAR) 218. 8.5 At this stage, we may also examine the decision of Mumbai Tribunal in the case of Metchem Canada Inc. (supra). The crux of the decision is that restriction placed on deduction of head office expenses under s. 44C will not be applicable in the case of a Canadian company in view of art. 24 contained in the treaty between India and Canada. The decision has been arrived at for the reason that art. 24 of the treaty will have precedence over art. 7, which contains deductions 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 un....
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....views of the special bench. When this is the view taken by the special bench with regard to the non-discrimination provisions in the Indo US tax treaty, in which the emphasis on valid differentiation due to reasonableness is perpetuated in the treaty itself- as also in the US Technical Explanation, it is stretching the things too far to suggest that such reasonableness criterion should also be read into non-discrimination provisions of all the tax treaties. Learned Departmental Representative's plea, therefore, does not merit acceptance. Accordingly, in our considered view, a different treatment to the foreign enterprise per se is enough to invoke the non-discrimination clause in the Indo Japan DTAA. Clearly, therefore, it will be contrary to the scheme of the tax treaties in question that if appropriate tax withholding by the person making the 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 opine....
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....uly 2012, and which provides that "any person, including the principal officer of a company, who fails to deduct the whole or any part of the tax in accordance with the provisions of this Chapter on the sum paid to a resident or on the sum credited to the account of a resident shall not be deemed to be an assessee in default in respect of such tax if such resident-(i)has furnished his return of income under section 139; (ii) has taken into account such sum for computing income in such return of income; and(iii) has paid the tax due on the income declared by him in such return of income, and the person furnishes a certificate to this effect from an accountant in such form as may be prescribed." The unambiguous underlying principle seems to be that in the situations in which the assessee's tax withholding lapse have not resulted 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....
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....se, in the wisdom of the special bench, the 2010 amendment to Section 40(a)(ia) by inserting first proviso thereto, which is what the special bench was dealing with, was an " intended consequence" of the provision of Section 40(a)(ia). 6. However, the stand so taken by the special bench was disapproved by Hon'ble Delhi High Court in the case of CIT Vs Rajinder Kumar (362 ITR 241). While doing so, Their Lordships observed that, "The object of introduction of Section 40(a)(ia) is to ensure that TDS provisions are scrupulously implemented without default in order to augment recoveries.......Failure to deduct TDS or deposit TDS results in loss of revenue and may deprive the Government of the tax due and payable" (Emphasis by underlining supplied by us)". Having noted the underlying objectives, Their Lordships also 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 Se....
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....on, and in the light of the above analysis of the scheme of the law, we are of the considered view that section 40(a)(ia) cannot be seen as intended to be a penal provision to punish the lapses of non-deduction of tax at source from payments for expenditure- particularly when the recipients have taken into account income embedded in these payments, paid due taxes thereon and filed income tax returns in accordance with the law. As a corollary to this proposition, in our considered view, declining deduction in respect of expenditure relating to the payments of this nature cannot be treated as an "intended consequence" of Section 40(a)(ia). If it is not an intended consequence i.e. if it is an unintended consequence, even going by Bharti Shipyard decision (supra), "removing unintended consequences to make 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 lo....
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.... unintended consequences is to be treated as retrospective in nature even though it may not state so specifically, the insertion of second proviso must be given retrospective effect from the point of time when the related legal provision was introduced. In view of these discussions, as also for the detailed reasons set out earlier, we cannot subscribe to the view that it could have been an "intended consequence" to punish the assessees for non-deduction of tax at source by declining the deduction in respect of related payments, even when the corresponding income is duly brought to tax. That will be going much beyond the obvious intention of the section. Accordingly, we hold that the insertion of second proviso to Section 40(a)(ia) is declaratory and curative in nature and it has retrospective effect 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 ha....
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....f payments made, without appropriate deduction of tax at source, to the non-residents are concerned, is not relaxed in the cases in which the non-resident recipient has taken such receipts into account in computation of income, paid taxes on the income so computed and filed, under section 139(1), related income tax return. Article 24(3) of the India Japan DTAA requires similar relaxation in respect of the rigour of disallowance for payments made to the Japanese entities. Accordingly, the relaxation under second proviso to Section 40(a)(ia) is to be read into Section 40(a)(i) as well and it is required to be treated as retrospective in effect in the same manner as second proviso to Section 40(a)(i) has been treated. Such an interpretation will lead to the deduction parity as envisaged 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 ....
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.... punishing a lapse are two different things and have distinctly different, and sometimes mutually exclusive, connotations. The scheme of Section 40(a)(ia), as the coordinate bench concluded, 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 was not seen as 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 as 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. When it is held to be the scheme of the law when it comes 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....
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....eting ground, we do not think that would have been the appropriate course of action. At a time when there is a clarion call by the Government of India, at the highest level, to simplify the process of implementing the laws, and ensure certainty friendly measures to the foreign enterprise doing business in India, we would perhaps fail in our duty if we do not, though within whatever be our inherent limitations, rise to the occasion and discharge our judicial functions in a comprehensive, rather than superficial, manner, and contribute to the dispute reaching finality sooner rather than later. There is no point in our simply remitting the matter to the assessment stage when it is clear that there is no meeting ground on the perceptions even on the 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....
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....ppellant-Revenue. No contrary decision of a High Court has been shown to us. The Punjab and Haryana High Court in Commissioner of Income Tax, Faridabad Vs. M/s. Lakhani Marketing Incl., ITA No.970/2008, decided on 02.04.2014, made reference to two earlier decisions of the same Court in CIT Vs. Hero Cycles Limited, [2010] 323 ITR 518 and CIT Vs. Winsome Textile Industries Limited, [2009] 319 ITR 204 to hold that Section 14A cannot be invoked when no exempt income was earned. The second decision is of the Gujarat High Court in Commissioner of Income Tax-I Vs. Corrtech Energy (P.) Ltd. [2014] 223 Taxmann 130 (Guj.). The third decision is of the Allahabad High Court in Income Tax Appeal No. 88 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 i....