AI Drafter 
TaxTMI 
TaxTMI 
2017 (11) TMI 1427
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....into error in holding that Section 40(a)(i) of the Income Tax Act, 1961 cannot be applied in view of the provisions of the Double Tax Avoidance Agreement between the Indian and Japan and India and the US? (ii) Whether the ITAT fell in error in reversing the findings of the DRP with respect to the existence of the PEs in India?" 3. The Assessee, Mitsubishi Corporation India Private Limited (hereafter 'MI') was incorporated in India on 22nd May, 1996. It is engaged in the development of international trade and is also procuring raw materials and marketing finished products in India, through various Indian joint ventures of Mitsubishi Corporation, Japan (hereafter 'MC'). The return of income for AY 2006-07 was filed by the Assessee on 29th November, 2006 declaring a total income of Rs. 6,39,59,620/- and the same was assessed under the provisions of Section 143 (3) read with Section 144C of the Act. 4. The Assessing Officer ('AO') passed a draft assessment order under Section 144C of the Act on 31st December, 2009 and made, amongst others, an addition of Rs. 97,89,54,176/-. The Assessee filed its objections before the Dispute Resolution Panel ('DRP') on 2nd February, 2010. The....
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....al units called divisions. According to the AO, there is an overlap between the functions of MI and the LOs of MC. The AO discussed the complete structure of MC and also notes that the various groups created in India and the divisions created thereunder including the Business Initiative Group, Energy Group, Chemical and Business Group, Metal Business Group, Living Essential Business Group, Machinery Group, are shared between the LOs and MI. The AO analyzed in detail the manner in which MC conducted its activities in various countries. The AO finally relies upon the letter dated 10th March, 2006 given by MC to the department, which stated that MC admitted that it would have no objection to pay tax in India by applying the gross profit rate of 2.75% for computing the profitability in respect of the Indian transactions of MC. This letter, as per the AO, meant that MC admitted to the existence of its Permanent Establishment ('PE') in India. The AO, thus, concludes that since MC is taxable in India and this position is not contested by it, the provisions relating to TDS i.e. Section 195 of the Act, consequently, apply to MC. 9. Insofar as Metal One is concerned, the AO analyzed the m....
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....ation upon the Assessee to deduct tax. The AO also relied upon the judgment of the Karnataka High Court in Commissioner of Income Tax, International Taxation and the Income Tax Officer TDS-I v. Samsung Electronics Co. Ltd., India Software Operations [2010] 320 ITR 209 (Kar) (hereafter 'Samsung Electronics') to support this view. The AO then concluded as under: "4.21 In light of the unambiguous legal position as emanates from the discussion made above under the observations of Hon'ble Apex Court and Hon'ble Karnataka High Court, the assessee was clearly under obligation to comply with the provisions of Sec.195 of the I. T. Act and to deduct tax at source on the payments made to nonresidents as discussed above. As a result of this default of the assessee, the payments made to nonresidents as above, are clearly disallowable u/s 40(a)(i) of the Income Tax Act, 1961 and I hold accordingly. 4.22 To sum up the above discussion, the payments made to non-residents are disallowable on the following grounds: 1. The non-resident entities to whom payment shave been made by the assessee are chargeable to tax in India in the light of their business model and presence in India und....
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....ce the provisions of Section 195 of the Act are not attracted. Consequently, according to the ITAT, the disallowance under Section 40 (a) (ia) is bad in law. 13. Thus, the ITAT set aside the order of the AO and deleted the additions so made by him. However, in respect of the addition made by the AO in respect of the Arm's length pricing, the ITAT remanded the matter to the AO for fresh adjudication on the issue of the determination of comparables and to conduct a fresh TP study and file additional evidences/comparables before the AO/TPO for consideration. Decision in Herbalife International India Pvt. Ltd. 14. The decision in Herbalife ITAT (supra) was appealed to this Court and in its decision dated 13th May 2016 in CIT v. Herbalife International Pvt. Ltd. [2016] 384 ITR 276 (hereafter 'Herbalife'), this Court analyzed the provisions relating to non-discrimination, namely Article 26 (3) of the DTAA between India and U.S.A. After analyzing the extant provisions of the Act as applicable, read with the provisions of the DTAA, it was held that in the AY in question i.e. 2001-02, Section 40 (a) (i) did not provide for deduction of TDS where the payment was made in India to a r....
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....ere have since been amendments to the Act. The Finance Act, 2004, that came into operation with effect from 1st April, 2005, substituted/added sub-clauses (i), (ia) and (ib) to Section 40 (a) of the Act. Section 195 of the Act was also amended by the Finance Act, 2012, by adding Explanation 2 w.r.e.f. 1st April, 1962. The amended provisions as applicable to the AY in issue, read as under: "Section 40 - Notwithstanding anything to the contrary in sections 30 to 38, the following amounts shall not be deducted in computing the income chargeable under the head "Profits and gains of business or profession",- (a) in the case of any assessee - (i) any interest (not being interest on a loan issued for public subscription before the 1st day of April, 1938), royalty, fees for technical services or other sum chargeable under this Act, which is payable,- (A) outside India; or (B) in India to a non-resident, not being a companyor to a foreign company, on which tax is deductible at source under Chapter XVII-B and such tax has not been deducted or, after deduction, has not been paid on or before the due date specified in sub-section (1) of section 139:....
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....lanation to section 194J; (iv) "work" shall have the same meaning as in Explanation III to section 194C; (v) "rent" shall have the same meaning as in clause (i) to the Explanation to section 194-I; (vi) "royalty" shall have the same meaning as in Explanation 2 to clause (vi) of sub-section (1) of section 9; (ib) any consideration paid or payable to a nonresident for a specified service on which equalisation levy is deductible under the provisions of Chapter VIII of the Finance Act, 2016, and such levy has not been deducted or after deduction, has not been paid on or before the due date specified in sub-section (1) of section 139 : Provided that where in respect of any such consideration, the equalisation levy has been deducted in any subsequent year or has been deducted during the previous year but paid after the due date specified in sub-section (1) of section 139, such sum shall be allowed as a deduction in computing the income of the previous year in which such levy has been paid...." 17. Section 195 (1) along with its newly added explanation as applicable to the AY in question reads as under: "Section 195(1) Any person responsible for payi....
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....n as amended by Finance Act, 1988 (Applicable in CIT v. Herbalife, [2016] 384 ITR 276 (Del) which dealt with AY 2001-02): Any payer to any resident payee Any payer to a non-resident payee Payable Outside India 40(a)(i) 40(a)(i) Payable in India N.A. N.A. Position as amended by Finance Act, 2003: Any payer to any resident payee Any payer to a non-resident payee Payable Outside India 40(a)(i)(A) 40(a)(i)(A) Payable in India N.A. 40(a)(i)(B) Position as amended by Finance Act, 2004 (Applicable to the present case for AY 2006-07): Any payer to any resident payee Any payer to a non-resident payee Payable Outside India 40(a)(i)(A) & 40(a)(ia) 40(a)(i)(A) Payable in India 40(a)(ia) 40(a)(i)(B) 19. Mr. Singh submits that the provisions of Chapter XVII-B are also not discriminatory as residents and non-residents have been placed on the same footing insofar as compliance of the requirements under Chapter XVII-B is concerned. Mr. Singh further submits that the provisions of the DTAA relating to non-discrimination do not mandate absolute parity between residents and non-residents. In ....
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.... conflict between the DTAA and the provisions of the Act, then Section 90 of the Act is not triggered. Since the Indo-Thai and India-Singapore DTAAs do not have any conflicting provisions, the only law occupying the field is Section 195. According to Mr. Singh, Section 90 (2) of the Act does not, in any manner, come in the way of giving effect to Section 195. This is not a case where there is a conflict or a case where the Assessee is claiming any provision which is beneficial to it, as compared to the DTAA. 22. Mr. Rahul Chaudhary, learned Senior Standing Counsel also supports the case of the Revenue and submitted that the determination is essentially provisional in nature. He relied upon Areva T & D SA v. Assistant Director of Income Tax [2012] 349 ITR 127 (Del) (hereafter 'Areva SA') to submit that the deduction of tax under Section 195 of the Act is not in itself final and the payee can always seek a certificate for deduction at the lower rate under Section 197 of the Act or for refund on the ground that the income is not taxable in India etc. The deduction of tax at source being a measure to safeguard the interest of the Revenue, the payee would be subjected to scrutiny whe....
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....r with held, the partner can, as in other cases of over-withholding, file for a refund. Paragraph 3 prohibits discrimination in the allowance of deductions. When an enterprise of a contracting State pays interest, royalties or other disbursements to a resident of the other contracting State, the first-mentioned contracting State must allow a deduction for those payments in computing the 'taxable profits of the enterprise under the same conditions as if the payment had been made to a resident of the first-mentioned Contracting State...." 23. As per the above technical explanation, it is clear that the payee can file for refund and this method of deduction of tax is recognized within the Indo US DTAA regime. According to Mr. Chaudhary, in the present case, trading receipts are liable to withholding tax since all the Associated Enterprises ('AE') are working together to generate business in like manner and the entire business is traceable to one source namely MC. He supports the submissions of Mr. Singh, that a person, who is a resident of India as in the case of MI, cannot invoke the non-discrimination clause under any DTAA. Respondent-Assessee's Submissions 24. Mr. Syali....
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....cting the tax at source. This judgment was not in the context of any DTAA. According to him, the question that arose was whether the payer needs to consider as to what constituted the taxable income of the payee at the time of deduction of the TDS, and this question was rightly answered by the Court in the negative. He submits that the computation of income is different from its chargeability. 28. Mr. Syali fairly submits that the amount paid by the payer to the payee constitutes income, but for the purpose of determining whether TDS is to be deducted, the chargeability of the said amount to tax has to be established. He relies upon Prithvi Information Solutions v. ACIT [2014] 34 ITR (Trib) 429 (ITAT Hyd) (hereafter 'Prithvi Information Solutions') to submit that according to the ITAT, the judgment in GE India Technology (supra) still holds good. He urges this Court to uphold the view taken by the ITAT in Prithvi Information Solutions (supra). Mr. Syali states that MC Thailand and MO Singapore have no LO in India and the AO rightly records that if there is no LO then the onus is higher on the Revenue for proving existence of a PE. He relies upon the observations of the ITAT to t....
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....) of Indo Japan DTAA to state that the laws of the Contracting State shall continue to govern the taxation of income. The question, whether the payee has a PE of its own, has to be established in the assessment proceedings of the payee and not at this stage. The ITAT observes clearly that after 1st April, 2004, there is equality between residents and non-residents. He again reiterates and derives support from Article 24 (3) of the India-Japan DTAA which clearly provides that tax is deductable on the same conditions as is deductible qua residents and thus Section 40 (i) (a) applies equally both for the residents and non-residents. Analysis and Reasoning 32. Before proceeding with the facts, it is necessary to analyze the change in the statutory position post the amendments that have taken place by the Finance Act, 2004 w.e.f. 1st April, 2005 and the Finance Act, 2012 with retrospective effect w.e.f. 1st April, 1962. Scheme of the Income Tax Act, 1961, after amendments 33. The scheme of the Act has undergone a substantial change subsequent to the decision in Herbalife (supra). The change arises due to the substitution and insertion of Section 40 (a) (i), Section 40 (a) (i....
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....ome-tax) of, this Act in respect of the total income of the previous year of every person : Provided that where by virtue of any provision of this Act income-tax is to be charged in respect of the income of a period other than the previous year, income-tax shall be charged accordingly. (2) In respect of income chargeable under sub-section (1), income-tax shall be deducted at the source or paid in advance, where it is so deductible or payable under any provision of this Act. Section 5 - (1) Subject to the provisions of this Act, the total income of any previous year of a person who is a resident includes all income from whatever source derived which- (a) is received or is deemed to be received in India in such year by or on behalf of such person ; or (b) accrues or arises or is deemed to accrue or arise to him in India during such year ; or (c) accrues or arises to him outside India during such year : Provided that, in the case of a person not ordinarily resident in India within the meaning of sub-section (6) of section 6, the income which accrues or arises to him outside India shall not be so included unless it is derived from a business controlled in or a profession....
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....spect of income chargeable under Sub-section (1), Income Tax shall be deducted at source where it is so deductible under any provision of the Act. If the sum that is to be paid to the non-resident is chargeable to tax, tax is required to be deducted. The sum which is to be paid may be income out of different heads of income provided under Section 14 of the Act, that is to say, income from salaries, income from house property, profits and gains of business or profession, capital gains and income from other sources. The scheme of Tax deduction at source applies not only to the amount paid which wholly bears "income" character such as salaries, dividends, interest of securities etc., but also to gross sums, the whole of which may not be income or profits of the recipient, such as payments to contractors and sub-contractors and the payment of insurance commission. It has been contended that the sum which may be required to be paid to the nonresident may only be a trading receipt, and, may contain a fraction of sum as taxable income. It is true that in some cases, a trading receipt may contain a fraction of sum as taxable income, but in other cases such as interest, commission, transfer....
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....erated in Vodafone International Holdings BV v. Union of India & Anr. (2012) 6 SCC 613 (hereafter 'Vodafone') wherein it was held - "Section 195 casts an obligation on the payer to deduct tax at source ("TAS", for short) from payments made to non-residents which payments are chargeable to tax. Such payment(s) must have an element of income embedded in it which is chargeable to tax in India." 40. From a conjoint reading of the Transmission Corporation (supra), GE India Technology (supra)and Vodafone (supra) it can be said that- * A sum is chargeable to tax if it can be assessed to tax under the Act and tax is leviable thereon; * The question whether the sum can be assessed to tax is to be determined under Sections 4, 5 or 9; * The heads of income are to be determined as per Section 14; * A trading receipt could be chargeable to tax either as income tax from the business or income from other sources depending on the facts; * In the case of a trading receipt even if a fraction of the sum forms part of the taxable income, it could still be included in the computation of income at the time of regular assessment; * A trading receipt cannot be said to be comp....
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..... This approach of the ITAT is contrary to the decisions in Transmission Corporation (supra) and GE India Technology (supra). 43. In this case, the Assessee is an Indian Company. The question whether there is discrimination qua the non-resident payees is an issue to be decided if and when the said non-resident payees raise issues relating to discrimination. A resident company per se ought not to be allowed to invoke the provisions of the DTAA, inasmuch as the resident payer would be unable to either conclusively decide at the time of deduction that the sum is not chargeable to tax or even bring all the facts relating to all the payee's businesses in India before the Court in its assessment proceedings. A resident company is fully bound by the provisions of the Act, and for the said purpose the existence of a PE of the payee is not essential. What is required to be seen is as to whether the sum is chargeable under the provisions of the Act and for the said purpose even a 'business connection' is sufficient as per Explanation 2 to Section 9 of the Act. The said Explanation reads - "Section 9 - ................ Explanation 2 - For the removal of doubts, it is hereby declared ....
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....ct tax arises. The Supreme Court further held that Transmission Corporation (supra) dealt with a case relating to a composite contract that included sums for payments of purchases as also installation and commissioning, part of which was clearly taxable in India. The Supreme Court rejected the contention of the Revenue that the moment there is a remittance, an obligation to deduct the TDS arises. This view of the Supreme Court in GE India Technology (supra) does not support the case of the Assessee inasmuch as, GE India Technology (supra) related to an AY which is prior to the insertion of Explanation 2 to Section 195 of the Act. Addition of the said explanation, in the present case, changes the nature of the payment inasmuch as it takes away the need to establish existence of a PE or a business connection in India. Thus, the legislative scheme has undergone a change post the decision in GE India Technology (supra). Even otherwise, going by the ratio decidendi in GE India Technology (supra), that chargeability to tax has to be read in conformity with the charging provisions i.e. Sections 4, 5 and 9 of the Act, the analysis hereinafter makes it evident that all the payees in the pre....
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.... in categorical terms, provides that the obligation to make tax deduction at source extends and shall be deemed to have always extended to all persons, resident or non-resident, in India. Moreover, in the present case, it is not a case of mere purchase of goods but the Petitioner is also rendering other services as recorded in the AO's order, thus the transactions are composite in nature. 48. The obligation under Section 195 operates and exists independently of Section 40. The question as to whether any amount is deductible in computing the income is a question that arises at a subsequent stage. The stage of deduction of tax at source arises at the inception itself and Section 195 of the Act applies at that stage. Section 40 provides for the consequence of not deducting the tax at source. Taking Mr. Syali's arguments at its highest, it would mean that in the case of residents, it is only if the amount payable is either 'interest, commission or brokerage, rent, royalty, fees for professional services or fees for technical services payable to a resident', that the amount is not deductible while computing the income under Section 40, whereas, in the case of non-residents, if ta....
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....ome to tax in India. Thus, Section 195 applies qua MC. Insofar as the Assessee's arguments with respect to MC are concerned, the argument that nondiscrimination clauses of the DTAAs continue to apply, is incorrect inasmuch as has been held above, there is no discrimination in view of the applicable statutory position. The obligation to deduct the tax applies when the payee is a resident or a non-resident so long as it is chargeable to tax. At the stage of deduction it cannot be said that the sum paid to MC is not chargeable to tax. It is settled that the deduction at source is not conclusive by itself. MC may well, as a part of its own assessment proceedings, be able to obtain deductions and benefits as permissible in law, however, for deduction of TDS, at the stage of inception, it cannot be categorically held that the payments are not liable to deduction. As held earlier, Section 195 and Section 40 operate in different spaces - the former at the stage of payment by the payer to the payee, and the latter at the stage of assessment of the payer. Insofar as the payer is concerned, there may be interlinking of the two however, insofar as the payee is concerned i.e. MC, Section 40 is ....
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....ation of a deductive logic in an indirect manner resulting in reading services mentioned in Section 40 (a) (ia) as being the only services for which tax is deductible at source qua residents. Such a reading is not supported by the plain language of Section 195 of the Act and the clarification as issued by insertion of Explanation 2 to it. 54. It could easily be concluded that insofar as the sums paid for purchases to residents are concerned, though the tax is deductible as source, if the payer does not deduct tax then the deduction under Section 40 (a) (ia) could still be available, since purchases are not mentioned in the provision. The logic is not hard to believe inasmuch as, if the payer does not deduct tax qua the purchase payments made to a payee who is a resident, then the collection of tax, if chargeable, can happen through the payee's assessment itself as the payee is subject to the jurisdiction of the authorities concerned. However, such a luxury does not exist qua a non-resident payee who is outside the shores and from whom the collection of tax would be difficult to say the least. Thus, purchase payments made by a resident payer to a resident payee, could still be cl....
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....AA and the India-Singapore DTAA are extracted herein below: "Article 24 (1) of the Indo-Thai DTAA: The nationals of a Contracting State shall not be subjected in the other Contracting State to any taxation or any requirement connected therewith which is other or more burdensome than the taxation and connected requirements to which nationals of that other State in the same circumstances are or may be subjected. Article 26 (1) of the India-Singapore DTAA: The nationals of a Contracting State shall not be subjected in the other Contracting State to any taxation or any requirement connected therewith which is other or more burdensome than the taxation and connected requirements to which nationals of that other State in the same circumstances and under the same conditions are or may be subjected." 58. A perusal of the DTAAs shows that the law of the Contracting State should govern taxation of income and the provisions for non-residents should not be more burdensome than those applicable to residents. Thus, the clauses under both these DTAAs primarily require the Assessee to show that there is either a contrary provision in the DTAA or a less burdensome provision in the DT....
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.... MC Thailand and MO Singapore function, has an LO in India. Since the main company i.e., Metal One, is chargeable to tax in India, the fact that the transactions are routed through entities based in Thailand and Singapore does not obviate the obligation to deduct tax at source. Since both these entities have a business connection in India through the LO of Metal One, at this stage, it cannot be said that the said payments are not chargeable to tax. Other Transactions 61. Insofar as the transactions with Mc Tubular Inc., USA, Petro Diamond Corporation, Japan and Miteni, Japan are concerned, neither side has made any submissions qua these companies as the transactions are of low value. In any event, all these three companies are part of MC group and are governed by the Indo-US DTAA and India-Japan DTAA provisions. 62. The payments to these companies ought to have made after deduction of tax at source. The ITAT, apart from applying the wrong provision i.e. Section 40 (a) (ia), has failed to notice the various changes in the provisions of the Act as were applicable in the judgment in Herbalife (supra) and the present case. Thus, the ITAT proceeds on the basis that if these ent....
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....t, 1961 cannot be applied in view of the provisions of the Double Tax Avoidance Agreement between the Indian and Japan and India and the US? (ii) Whether the ITAT fell in error in reversing the findings of the DRP with respect to the existence of the PEs in India?" Scope of the two questions 2. In the present case, the questions arise in the context of Mitsubishi Corporation India Pvt. Ltd ('MI'), the Respondent Assessee, during the Assessment Year (AY) 2006-07, failing to deduct tax at source (TDS) while making payments to a number of non-resident entities incorporated in Japan including Mitsubishi Corporation, Japan ('MC') and other group companies of MC, Metal One Corporation, Japan ('Metal One Japan'), Petro Diamond Corporation, Japan ('Petro Diamond') and Miteni, Japan ('Miteni'). It also concerns payments made to certain other non-resident entities including viz., MC Metal Services Asia, Thailand ('MC Metal Thailand'), Metal One Asia Pvt. Ltd., Singapore ('Metal One Asia'), and Mc Tubular Inc. USA ('Mc Tubular'). 3. The Double Taxation Avoidance Agreements ('DTAAs') between Indiaand Japan (the Indo-Japan DTAA) and between India and the USA (the Indo-US DTAA) both ....
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....on or any other presence in India. 7. The consequence for the failure to deduct TDS as mandated by Section195 of the Act, is spelt out in Section 40 of the Act. The consequence is the denial of the said sum as a deduction from the income of the Assessee. Where the failure is to deduct TDS from any sum paid outside India or to non-residents, Section 40 (a) (i) of the Act applies. Where the failure is to deduct TDS from certain sums paid to residents, then Section 40 (a) (ia) of the Act applies. In the present case, we are concerned with AY 2006-07 and so the above provisions as they stood during AY 2006-07 are relevant. The distinction between sub-clauses (i) and (ia) of Section 40 (a) 8. The consequence for the failure to deduct TDS in terms of Sections 40 (a) (i) and 40 (a) (ia) of the Act, as they stood during the AY 2006-07, differed in a significant way. To understand this, both provisions (as they stood during AY 2006-07) require to be set out in full. They read as under: "40. Notwithstanding anything to the contrary in sections 30 to 38, the following amounts shall not be deducted in computing the income chargeable under the head "Profits and gains of business or ....
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....). This means that while in the case of failure to deduct TDS from payments of any sum to non-resident entities (including payments for purchases), such sum would not be allowed as a deduction while computing the taxable income of the payer (Assessee), only certain payments to resident entities as spelt out in sub-clause (ia) would be disallowed as deductions if no TDS is deducted while making payment. Taking the example of payments for purchases, if no TDS was deducted while making payments to non-residents for purchases, then the sum paid would not be deductible while computing the taxable income of the payer. However, sums paid to residents for purchases would not suffer the same consequence of non-deductibility. This difference has since 1st April 2015 been done away with by further amending sub-clause (ia). However during the relevant AY 2006-07, this difference did exist. Analysis of the relevant provisions of the DTAA 10. As already noted, under Article 24 (3) of the Indo-Japan DTAA the taxtreatment given to payments made to non-residents which are entities incorporated in Japan has to be no different from that given to payments made to resident entities. This non-disc....
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.... 1999 239 ITR 587 (SC) as followed by the Karnataka High Court in CIT (International Transaction) v. Samsung Electronics Co. Ltd. (2010) 320 ITR 209 (Kar) the chargeability to tax of the 'other receipt', for the purposes of Section 195 of the Act, was clearly established. Therefore the failure by MI to deduct TDS from the payments to the Japan and US entities would attract non-allowability of the deduction under Section 40 (a) (i) of the Act. 15. The AO also dwelt on the aspect of transfer pricing of the international transactions involving the Assessee and its Associated Enterprises. However, this is not relevant for the present appeal since that aspect of the matter was remanded to the TPO by the ITAT for a fresh determination. 16. The Dispute Resolution Panel (DRP) by its order dated 30th September 2010 rejected the Assessee's objections to the AO's draft assessment order. The DRP virtually endorsed the AO's draft order. It also rejected the contention of the Assessee based on the decision of the ITAT in Herbalife International (India) P. Ltd. v. ACIT [2006] 101 ITD 450 (Delhi) ('Herbalife ITAT') by referring to another decision of the Pune Bench of the ITAT in Automated S....
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....0 (a) with effect from 1st April 2005, the discrimination pointed out by this Court in Commissioner of Income Tax v. Herbalife International Pvt. Ltd. [2016] 384 ITR 276 (Delhi) ('Herbalife HC') has now been done away with. It is contended that the different treatment under Section 40(a) (i) of the Act is not dependent on the fact that disbursements has been paid by an Indian enterprise to a Japanese resident, but is dependent on the fact that any payer has made a payment outside India. It is contended that Section 40(a) (i) does not use the criteria of residence of the recipient but the situs of the payment. 21. As regards question (ii), which is correctly noted as applying only in the context of the payments made to the Thailand and Singapore entities, the submission of the Revenue has focussed largely on Section 195 of the Act and the insertion therein of Explanation 2 by the FA 2012 with retrospective effect from 1st April 1962. It is submitted that there is a material difference in determining the existence of a PE for levying charge of income tax on the non-resident, and in determining the existence of a PE for ascertaining the compliance by a resident payer under Section ....
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....the later decision of the Supreme Court in GE India Technology Centre Pvt. Ltd. v CIT [2010] 327 ITR 456 (SC) (hereafter GE India). 24. As regards question (ii), it is pointed out that the AO held that Metal One Corporation, Japan had a liaison office (LO) in India which exceeded the mandate of RBI and hence its LO constituted a PE in India. This dictum was applied to MC Metal One, Thailand and Metal One Asia, Singapore on the sole allegation (without any facts) that they function on the same lines as Metal One Corporation, Japan. The AO overlooked the fact that though Metal One Corp., Japan was functioning in India through its LO, the entities of Thailand and Singapore did not even have an LO in India. There was therefore, no factual basis for the conclusion that payments to those entities had to be subject to deduction of TDS. 25. It is further submitted on behalf of the Assessee that Explanation 2 to Section 195 only lays down compliance on part of the 'payer'. It stipulates an obligation to deduct TDS even if the payer is a non-resident, provided the income is chargeable to tax in India. The said Explanation has nothing to do with the chargeability of the amount t....
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....ated either in the memorandum of appeal or even its written submissions. 28. The payment for purchases comes within the purview of the expression 'other disbursements' in Article 24 (3) of the Indo Japan DTAA and Article 26 (3) of the Indo US DTAA. It also comes within the purview of the expression 'other sum chargeable' in Section 40 (a) (i) of the Act. Further, the payment does not come within the purview of any of the exceptions spelt out in Article 24 (3) of the Indo Japan DTAA or Article 26 (3) of the Indo US DTAA. 29. The purport of Article 24 (3) of the Indo Japan DTAA and Article 26 (3) of the Indo US DTAA is that MI cannot be denied deduction of the sum paid to the non-resident entities in Japan and USA for purchases, if it would not be denied deduction of such sum if paid by it to a resident entity for purchases. However, in terms of Section 40 (a) (i) of the Act as it stood in AY 2006-07, MI would be denied such deduction of the sum paid to the entities in Japan and USA if it did not deduct TDS. The payments made by it to resident entities during the same period for purchases would not be denied deduction even if no TDS was deducted from such payment. The decisi....
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....aling with the AY 2001-02, it noted the changes that had been brought about by insertion of Section 40(a)(i) with effect from 1st April, 2005 as regards the requirements of deduction of tax at source ('TDS') for the payments made in India as well. However, discrimination did not arise as a result of non-deduction of TDS alone but regarding non-allowability of deduction for computation of income on account of failure to deduct TDS. This is evident from paragraphs 46 to 50 of this Court's decision in Herbalife HC, which read as under: "46. Section 40 is in the nature of a non-obstante provision and therefore, it overrides the other provisions as contained in Sections 30 to 38 of the Act. This means that the expenditure which is allowable under Sections 30 to 38 of the Act in computing business income would be subject to deductibility condition in Section 40 of the Act. The payment of FTS to HIAI would be allowable in terms of Section 37 (1) of the Act but before such payment can be allowed the condition imposed in Section 40 (a) (i) of the Act regarding deduction of TDS has to be complied with. In other words if no TDS is deducted from the payment of FTS made to HIAI by the Assess....
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....thholding at source. Withholding is most frequently imposed on passive income, such as dividends, interest, rents, and royalties. Because the recipient may have no connection with the country of source other than the investment generating the income, withholding at the time of payment is likely to be the only realistic opportunity for the source country to collect its tax. Withholding is often not required on payments to residents. However, the application of withholding tax systems is appropriate. Residents have substantial economic connections with their country of residence; so that country is likely to have ample opportunity to collect its tax later, when a tax return is filed. Non-residents may be beyond the collection jurisdiction of the taxing country." (emphasis supplied) 50. While the above explanation provides the rationale for insisting on deduction of TDS from payments made to non-resident, the point here is not so much about the requirement of deduction of TDS per se but the consequence of the failure to make such deduction. As far as payment to a non-resident is concerned, Section 40 (a) (i) of the Act as it stood at the relevant time mandated that if no TDS is ded....
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....nts made to a resident, but only to payments made to non-residents, the two payments could not be said to be under the 'same condition'. The further submission is that if they are not made under the same condition', the nondiscrimination rule under Article 26 (3) of the DTAA is not attracted. 54. In the first place it requires to be noticed that DTAA is as a result of the negotiations between the countries as to the extent to which special concessional tax provisions can be made notwithstanding that there might be a loss of revenue. In Union of India v. Azadi Bachao Andolan (supra) the Supreme Court noted that treaty negotiations are largely - a bargaining process with each side seeking concessions from the other, the final agreement will often represent a number of compromises, and it may be uncertain as to whether a full and sufficient quid pro quo is obtained by both sides. The Court acknowledged that developing countries allow 'treaty shopping' to encourage capital and technology inflows which developed countries are keen to provide to them. It was further noted that the corresponding loss of tax revenues could be insignificant compared to the other non-tax benefits ....
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....aking payment of FTS in terms of Section 40 (a) (i) of the Act." (emphasis supplied) 34. The Court in Herbalife HC thereafter noted Section 90(2) of the Act as well as the decision of the Supreme Court in Azadi Bachao Andolan and negated the Revenue's plea that "unless there are provisions similar to Section 40 (a) (i) of the Act in the DTAA, a comparison cannot be made as to which is the more beneficial provision." 35. It is significant that even while the Court was hearing the submissions in Herbalife HC, it permitted the present Assessee to intervene and make submissions. These submissions were noted in paragraphs 28 to 30 of the said judgment. Therefore, even in Herbalife HC this Court was conscious of the changes brought about by introduction of Section 40 (a) (ia) in the Act with effect from 1st April, 2005. However, even after this change, the element of discrimination continued in AY 2006-07. The distinction between sub-clauses (i) and (ia) as regards the consequence of disallowance of the sum paid to a non-resident towards purchases as a deduction on account of the failure to deduct TDS, continued. That distinction was ultimately done away with only by the amendment ....
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....heir profits are, therefore, not chargeable to tax in India, the question of applying Section 195 of the Act to deduct TDS from the payments made to them for purchases cannot arise. These reasons are therefore sufficient to answer question (ii) also in the negative i.e. in favour of the Assessee and against the Revenue. Nevertheless, since extensive arguments were advanced by the Revenue on the scope of Section 195 (1) of the Act, and in particular Explanation 2 thereof, it is discussed hereafter. 42. The insertion of Explanation 2 to Section 195 of the Act does not affect the pre-condition for its applicability viz., that the sum from which TDS is deducted is 'chargeable' to tax. Explanation 2 to Section 195 emphasises the obligation to comply with sub-section (1) thereof. It is now deemed to "have always applied and extends and shall be deemed to have always extended to all persons, resident or non-resident whether or not the non-resident person has (i) a residence or place of business or business connection in India or (ii) any other presence in any manner whatsoever in India. 43. There is merit in the contention of the Assessee that the above Explanation emphasises the ob....
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....ansmission Corporation (supra) and that of the Karnataka High Court in CIT (International Transaction) v. Samsung Electronics Co. Ltd. (supra) were relied upon by the AO in the present case to hold that it was mandatory for MI to have deducted TDS while making payment to the non-resident entities. The said decision of the Supreme Court requires to be discussed first. 46.2 The facts in Transmission Corporation (supra) were that a resident entity made payments to a non- resident pursuant to a 'composite contract' comprising supply of plant, machinery and equipment in India, as well as its installation and commissioning in India. It was not in dispute that the erection and commissioning of the plant and machinery in India gave rise to income taxable in India. It was, therefore, clear to the payer that the payments to the non-resident included an element of income which was exigible to tax in India. 46.3 The contention of the Assessee in that case was that TDS was deductible only to 'pure income' payments and not to 'composite payments' which had an element of income embedded or incorporated in them. It was in that context that the Supreme Court held against the Assessee and obse....
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.... deducted at source from interest (other than interest on securities) or any other sum (not being salaries) chargeable under the Income-tax Act in the case of nonresidents only and not in the case of residents. Failure to deduct the tax under this section may disentitle the payer to any allowance apart from prosecution under section 276B. Thus, Section 195 imposes a statutory obligation on any person responsible for paying to a nonresident, any interest (not being interest on securities) or any other sum (not being dividend) chargeable under the provisions of the Income-tax Act, to deduct Income-tax; at the rates in force unless he is able to pay income-tax thereon as an agent.......The most important expression in Section 195(1) consists of the words "chargeable under the provisions of the Act". A person paying interest or any other sum to a non-resident is not liable to deduct tax if such sum is not chargeable to tax under the Income-tax Act. For instance, where there is no obligation on the part of the payer and no right to receive the sum by the recipient and that the payment does not arise out of any contract or obligation between the payer and the recipient but is made volunt....
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....ble in India. If tax is not as assessable, there is no question of TAS being deducted. 9. One more aspect needs to be highlighted. Section 195 falls in Chapter XVII which deals with collection and recovery. Chapter XVII-B deals with deduction at source by the payer. On analysis of various provisions of Chapter XVII one finds use of different expressions, however, the expression "sum chargeable under the provisions of the Act" is used only in Section 195. ....Therefore, section 195 has to be read in conformity with the charging provisions, i.e., sections 4, 5 and 9. This reasoning flows from the words "sum chargeable under the provisions of the Act" in section 195(1). The fact that the revenue has not obtained any information per se cannot be a ground to construe section 195 widely so as to require deduction of TAS even in a case where an amount paid is not chargeable to tax in India at all. We cannot read section 195, as suggested by the Department, namely, that the moment there is remittance the obligation to deduct TAS arises. If we were to accept such a contention it would mean that on mere payment income would be said to arise or accrue in India. Therefore, as stated earlier....
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...., 1988 with effect from 1-4-1989, payment in respect of royalty, fees for technical services or other sums chargeable under the Income-tax Act would not get the benefit of deduction if the assessee fails to deduct TAS in respect of payments outside India which are chargeable under the Income-tax Act. This provision ensures effective compliance of section 195 of the Income-tax Act relating to tax deduction at source in respect of payments outside India in respect of royalties, fees or other sums chargeable under the Income-tax Act. In a given case where the payer is an assessee he will definitely claim deduction under the Income-tax Act for such remittance and on inquiry if the Assessing Officer finds that the sums remitted outside India comes within the definition of royalty or fees for technical service or other sums chargeable under the Income-tax Act then it would be open to the Assessing Officer to disallow such claim for deduction....." (emphasis supplied) 47.2 It is therefore plain from the decision in GE India (supra) that: (i) Under Section 195 (1) of the Act, a person paying interest or any othersum to a non-resident is not liable to deduct tax if such sum is not cha....
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....that it is not open for the payer to contend that if the amount paid by him to the non-resident is not at all "chargeable to tax in India", then no TAS is required to be deducted from such payment. This interpretation of the High Court completely loses sight of the plain words of Section 195 (1) which in clear terms lays down that tax at source is deductible only from "sums chargeable" under the provisions of the I.T. Act, i.e., chargeable under Sections 4, 5 and 9 of the I.T. Act." 47.4. It is plain that in GE India (supra), the Supreme Court distinguished the decision in Transmission Corporation (supra) as being one given in the context of composite payments in which taxable income was thought to be embedded. It disapproved of the approach of the Karnataka High Court in its decision in CIT (International Transaction) v. Samsung Electronics Co. Ltd. (supra). Incidentally, it is the latter two decisions that have been heavily relied upon by the AO in the present case. 48. After the above clarification of the legal position that for deduction of TDS under Section 195 (1) of the Act from payments made by MI to the non-resident entities of Thailand and Singapore, the provisions ....
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....the Petitioner is also rendering other services as recorded in the AO's order, thus the transactions are composite in nature." 52. The issue here is about the Assessee not being allowed a deduction under section 40 (a) (i) of the Act in respect of the sums paid by it for the purchases made by it to non-resident entities for purchases made from the latter. For this issue, whether the Assessee is itself rendering any other service is not relevant. The question is whether the sum paid to the nonresident is chargeable to tax as income of the non-resident payee. Secondly, it is nobody's case, and certainly not the Revenue's, that the payment by MI is for composite transactions. The final assessment order of the AO, as noted hereinbefore, itself makes it clear that the payments to the Japanese and US entities (and for that matter to the Thailand and Singapore entities) was for purchases. They were not for 'composite transactions'. In other words the payment was not for any other services rendered by such non-resident entities, as was perhaps the case in Transmission Corporation (supra). In determining whether TDS is to be deducted from such payments, the provisions of the DTAA hav....