$~
* IN THE HIGH COURT OF DELHI AT NEW DELHI
1 (SB)
+ ITA No. 180/2014
THE COMMISSIONER OF INCOME TAX-II ..... Appellant
Through: None.
versus
MITUSUBISHI CORPORATION INDIA P. LTD. ...Respondent
Through: None.
CORAM:
JUSTICE S. MURALIDHAR
JUSTICE PRATHIBA M. SINGH
ORDER
% 17.11.2017
In view of the difference of opinion between us on the questions framed in
the appeal, as expressed in our individual opinions placed on file, the matter
is placed before the Hon'ble Acting Chief Justice for appropriate orders.
S. MURALIDHAR, J.
PRATHIBA M. SINGH, J.
NOVEMBER 17, 2017
rd
$~
* IN THE HIGH COURT OF DELHI AT NEW DELH
+ ITA 180/2014
Reserved on: 11thSeptember, 2017
Date of decision: 17th November,2017
THE COMMISSIONER OF INCOME TAX-II ..... Appellant
Through: Mr. Raghvendra Singh, Mr.
Rahul Chaudhary and
Mr.Ashok Manchanda, Senior
Standing counsel.
versus
MITSUBISHI CORPORATION
INDIA PVT. LTD ...... Respondent
Through: Mr. M. S. Syali, Senior
Advocate with Mr. Mayank
Nagi, Mr. Tarun Singh and Mr.
Shubham Gupta, Advocates.
CORAM: JUSTICE S.MURALIDHAR
JUSTICE PRATHIBA M. SINGH
JUDGMENT
Prathiba M. Singh, J.:
1.The present appeal under Section 260A of the Income Tax Act, 1961
(hereinafter referred to as `the Act') challenges the order dated 23rd August,
2013 passed by the Income Tax Appellate Tribunal (`ITAT') in ITA
No.5147/Del/2010 for the Assessment Year (`AY') 2006-07.
2. This Court on 29th April, 2014, framed the following questions of law.
"(i) Whether the ITAT fell into error in holding
that Section 40(a)(i) of the Income Tax Act, 1961
ITA No.180/2014 Page 1 of 83
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 DRP on 30th
September, 2010 directed the AO to complete the assessment as per the draft
order.
5. The final assessment order dated 25th October, 2010 was passed by the
AO under Section 143(3)/144C of the Act and the addition of Rs.
97,89,54,176/- was confirmed under Section 40 (a) (i) of the Act and added
to the total income of the Assessee. An addition of Rs. 155,27,14,989/- was
ITA No.180/2014 Page 2 of 83
also made on account of difference of Arm's Length Price determination by
the TPO which is however, not the subject matter of the present Appeal.
6. Aggrieved by the final order of the AO, the Assessee filed an appeal
before the ITAT. The ITAT allowed the Assessee's appeal on 23rd August,
2013 insofar as it related to the deductions under Section 40 (a) (i) and sent
the matter back to the AO/TPO for determination of comparables and
consequently the Arm's length price for the international transactions with
the AEs. The said order insofar as it relates to the deduction under Section
40 (a) (i) is challenged by the Revenue in the present appeal.
7. The question that arises in the present case is whether MI was liable to
deduct TDS for the payments made by it in respect of transactions with
companies of the Mitsubishi Group including MC, MC Metal Services Asia,
Thailand (hereafter `MC Thailand'), Metal One Asia Pvt. Ltd., Singapore
(hereafter `MO Singapore'), and Metal One Corporation, Japan (hereafter
`Metal One'). The seven specific transactions that the Court is concerned
with in the present matter are -
S. No. Name of the Group Country Disallowance u/s
Company 40(a)(i) - Rs.
1 Mitsubishi Corporation Japan 5,01,55,844
2 MC Metal Services Asia Thailand 24,09,32,203
3 Metal One Asia P. Ltd. Singapore 10,06,99,115
4 Metal One Corporation Japan 57,91,87,712
5 Mc.Tubular Inc. USA 11,60,956
ITA No.180/2014 Page 3 of 83
6 Petro Diamond Japan 16,34,096
Corporation
7 Miteni Japan 51,84,250
Order of the Assessing Officer (`AO')
8. The final assessment order dated 25th October, 2010 passed by the AO,
captures in detail the business operations of MC. According to the AO, a
survey operation was conducted on the Liaison Office (`LO') of MC, which
resulted in MC finally conceding that it is liable to pay tax in India. The AO
records that MC has worldwide operations and operates through a network
of LOs and segmental 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.
ITA No.180/2014 Page 4 of 83
9. Insofar as Metal One is concerned, the AO analyzed the management plan
of Metal One as available on its website and came to the conclusion that the
functioning of Metal One is identical to that of MC. Metal One also has an
LO in India which functions in the same manner as its other LOs, which
undertake core activities. So according to the AO, the fact that Metal One
may be trading through an entity based in Singapore or Thailand, does not
make any difference, insofar as deduction of TDS is concerned. According
to the AO, the transactions are not exempt from the purview of Section 195
of the Act, as payment to a non-resident is included therein. If the non-
resident has a PE in India, then there is no doubt that TDS has to be
deducted. In the case of MC Thailand and MO Singapore, since they have a
business connection in India through the LO of Metal One, TDS was liable
to be deducted. The AO then discusses that the role of the Assessee is that
of a service provider between the customer in India and the vendor located
outside India. Hence, the Assessee's functions are in the nature of a service
provider, as per the AO.
10. Insofar as the Double Taxation Avoidance Agreement (hereafter
`DTAA') between India and Japan is concerned, the AO concluded that the
non-discrimination clause does not come to the assistance of the Assessee as
MI is, admittedly, a resident company. In any event, according to the AO,
since the recipient non-resident companies are chargeable to tax in India in
the case of MC it has a PE in India and in the case of Metal One it has a
close business connection - thus the Assessee was bound to deduct TDS
under Section 195 of the Act and by not doing so its expenses towards
purchase payments made to these entities were not liable to deduction under
ITA No.180/2014 Page 5 of 83
Section 40 (a) (i) of the Act. The AO relies upon the judgment of the
Supreme Court in Transmission Corporation of AP Ltd. v. CIT, (1999) 239
ITR 587 (SC) (hereafter `Transmission Corporation') to hold that `any
other sum chargeable under the provisions of this Act' as appearing in
Section 195 would not include cases where any sum payable to the non-
resident is a trading receipt which may or may not include `pure income'.
The observation of the Supreme Court that `the language of Section 195(1)
for deduction of income tax by the payee is clear and unambiguous and
casts an obligation to deduct appropriate tax at the rates in force' clearly
imposed an obligation 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 non-
residents as discussed above. As a result of this
default of the assessee, the payments made to non-
residents 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:
ITA No.180/2014 Page 6 of 83
1. The non-resident entities to whom payments
have been made by the assessee are chargeable to
tax in India in the light of their business model and
presence in India under the provisions of Income
Tax Act, 1961 and well as under the provisions of
relevant DTAA as they have a PEs as well as
business connection in India.
2. The purchases in the instant case are purchases
simplicitor as the nonresident entities are trading
houses whose work is to liaison with the seller and
purchaser and to make the deal happen. The
assessee is not an end user of the purchases but is
a mediator between the seller and the end user.
The argument that the purchases are not taxable in
India is therefore misplaced and out of context.
3. The 'non-discrimination' clause under the DTAA
cannot be invoked by resident assessee. In any
case there is no discrimination under the
prevailing provisions of law as discussed above.
4. An obligation is cast upon the assessee under
section 195 of the Income Tax Act, 1961 to comply
with the provisions of, the said section and to
withhold tax at source failing which other
provisions of Act including Sec. 40(a)(i) and Sec.
201 thereof apply to the facts of the assessee's
case."
Order of the Income Tax Appellate Tribunal
11. The ITAT describes MC's activities as that of a general trading company
known in Japanese language as `Sogo Shosha'. The ITAT recognized the
nature of services provided by the Assessee to MC. The ITAT after
considering the arguments made by both parties held that the transaction
ITA No.180/2014 Page 7 of 83
with Mc.Tubular Inc. USA was covered under the India-US DTAA as
discussed in Herbalife International Pvt. Ltd. V. ACIT 101 ITD 450 (Del)
(hereafter `Herbalife ITAT'). The ITAT thereafter sets out the relevant
provisions of the India-Japan DTAA that are in pari materia with the non-
discriminatory clause in the Indo-US DTAA and thus holds that the
Herbalife ITAT (supra) judgment of the Tribunal applies squarely to the
India-Japan DTAA. On the basis of Herbalife ITAT (supra) judgment, the
ITAT deleted the disallowance of purchases in respect of some companies,
namely, MC, Mc.Tubular Inc, U.S.A., Petro Diamond Corporation. Japan,
Miteni, Japan and Metal One.
12. The ITAT thereafter looked at the transactions in respect of MC
Thailand and MO Singapore. Relying upon the decision of the Tribunal in
ITA No.5377/Del/2011 (Metal One Corporation v. DCIT (hereafter `Metal
One DCIT')) for AY 2008-09, the ITAT holds that since Metal One has no
PE in India, payments to it are not taxable in India and hence 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.
ITA No.180/2014 Page 8 of 83
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 resident. In
view thereof, this Court held that a non-resident would have to be subjected
to the same conditions as a resident and held that `the lack of parity in
allowing all the payment as deduction' brings about discrimination. The
Court held that while payments to non-residents require deduction of TDS,
payment to residents were neither subject to deduction of TDS nor the
consequences of disallowance of the payment as deduction under Section 40
(a) (i). After noting this statutory position, the Court applied the principle
laid down in Union of India v. Azadi Bachao Andolan (2004) 10 SCC 1
(hereafter `Azadi Bachao Andolan'), wherein the Supreme Court, after
taking note of decisions given by various High Courts, held:
"...28. A survey of the aforesaid cases makes it clear
that the judicial consensus in India has been that
Section 90 is specifically intended to enable and
empower the Central Government to issue a
notification for implementation of the terms of a
Double Taxation Avoidance Agreement. When that
happens, the provisions of such an agreement, with
respect to cases to which where they apply, would
ITA No.180/2014 Page 9 of 83
operate even if inconsistent with the provisions of
the Income Tax Act. We approve of the reasoning in
the decisions which we have noticed. If it was not the
intention of the Legislature to make a departure
from the general principle of chargeability to tax
under Section 4 and the general principle of
ascertainment of total income under Section 5 of the
Act, then there was no purpose in making those
sections `subject to the provisions of the Act'. The
very object of grafting the said two sections with the
said clause is to enable the Central Government to
issue a notification under Section 90 towards
implementation of the terms of the DTACs which
would automatically override the provisions of the
Income tax Act in the matter of ascertainment of
chargeability to income tax and ascertainment of
total income, to the extent of inconsistency with the
terms of the DTAC..."
15. In view of this legal position, this Court held that the conditions of
deduction of TDS being discriminatory, the disallowance of the expenses
towards purchases made on the ground of non-deduction of TDS was not
sustainable.
Amendments to the Finance Act,
16. The Herbalife (supra) decision was rendered in the context of AY 2001-
02 and the present case relates to AY 2006-07. There 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:
ITA No.180/2014 Page 10 of 83
"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 company
or 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:
Provided that where in respect of any such sum, tax
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 tax has
been paid.
Explanation.--For the purposes of this sub-
clause,--
(A) "royalty" shall have the same meaning as
in Explanation 2 to clause (vi) of sub-section (1) of
section 9;
(B) "fees for technical services" shall have the same
meaning as in Explanation 2 to clause (vii) of sub-
section (1) of section 9;
(ia) any interest, commission or brokerage, rent,
royalty, fees for professional services or fees for
technical services payable to a resident, or amounts
payable to a contractor or sub-contractor, being
resident, for carrying out any work (including supply
ITA No.180/2014 Page 11 of 83
of labour for carrying out any work), 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 :
Provided that where in respect of any such sum, tax
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,
thirty per cent of such sum shall be allowed as a
deduction in computing the income of the previous year
in which such tax has been paid:
Provided further that where an assessee fails to deduct
the whole or any part of the tax in accordance with the
provisions of Chapter XVII-B on any such sum but is
not deemed to be an assessee in default under the first
proviso to sub-section (1) of section 201, then, for the
purpose of this sub-clause, it shall be deemed that the
assessee has deducted and paid the tax on such sum on
the date of furnishing of return of income by the
resident payee referred to in the said proviso.
Explanation.--For the purposes of this sub-
clause,--
(i) "commission or brokerage" shall have the same
meaning as in clause (i) of the Explanation to section
194H;
(ii) "fees for technical services" shall have the same
meaning as in Explanation 2 to clause (vii) of sub-
section (1) of section 9;
(iii) "professional services" shall have the same
meaning as in clause (a) of the Explanation 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;
ITA No.180/2014 Page 12 of 83
(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 non-
resident 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 paying to
a non-resident, not being a company, or to a foreign
company, any interest (not being interest referred to
in section 194LB or section 194LC) or section
194LD or any other sum chargeable under the
provisions of this Act (not being income chargeable
under the head "Salaries") shall, at the time of credit of
such income to the account of the payee or at the time
of payment thereof in cash or by the issue of a cheque
or draft or by any other mode, whichever is earlier,
deduct income-tax thereon at the rates in force:
Provided that in the case of interest payable by the
Government or a public sector bank within the
meaning of clause (23D) of section 10 or a public
financial institution within the meaning of that clause,
deduction of tax shall be made only at the time of
ITA No.180/2014 Page 13 of 83
payment thereof in cash or by the issue of a cheque or
draft or by any other mode:
Provided further that no such deduction shall be made
in respect of any dividends referred to in section 115-
O.
.....
Explanation 2.--For the removal of doubts, it is hereby
clarified that the obligation to comply with sub-section
(1) and to make deduction thereunder applies and shall
be 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."
The effect of these amendments would be discussed later.
Submissions of the Appellant-Revenue
18. Mr. Raghavendra Singh, learned Senior Standing Counsel appearing on
behalf of the Revenue, submits that the ITAT went drastically wrong in
applying the decision of Herbalife ITAT (supra). He submitted that the
amended statutory position has not been considered by the ITAT and thus
the ITAT erred in holding that the provisions continue to be discriminatory.
He relies on the following four tables to submit that the factual position
since the decision in Herbalife (supra) having changed, the discrimination
has been done away with:
ITA No.180/2014 Page 14 of 83
Position Prior to 1.4.1989:
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, 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
ITA No.180/2014 Page 15 of 83
residents and non-residents. In fact, the decision in Herbalife (supra)
supports the position that the imposition of withholding tax on non-residents
is appropriate in their case, as non-residents are beyond the jurisdiction of
the taxing country. Article 24 (3) of the India-Japan DTAA requires that
`disbursements paid by a resident of a contracting state to a resident of the
other contracting state shall, for the purposes of determining the taxable
profits of the first mentioned resident, be deductible under the same
conditions as if they had been paid to a resident of the first mentioned
contracting state.' The term `same conditions' would automatically bring
non-residents to the same position as residents and Chapter XVII-B
pertaining to TDS would squarely be applicable to non-residents.
20. Mr. Singh further submits that insofar as the entities situated in Thailand
and Singapore are concerned, the basis of disallowance is Section 195 of the
Act. He submits that deduction of tax is different from assessment of tax and
that Chapter XVII-B stands on a completely different footing. In an
assessment a full-fledged enquiry is made, but under Section 195 of the Act
the deduction is at source. Even a trading receipt will attract the provisions
of Section 195 of the Act. The question whether the income is taxable or
not, is a question which is to be answered at a later stage. Mr. Singh's stand
is that in order for an entity to be subjected to an assessment, the existence
of a PE is not essential. He submits that so long as the payee is present in
India and has some business connection, there is a presumption of taxability,
unless the Assessee proves otherwise. Explanation 2 to Section 195 (1) of
the Act, which was amended by Finance Act, 2012 with retrospective effect
from 1st April, 1962, does not contradict the DTAA.
ITA No.180/2014 Page 16 of 83
21. Mr. Singh relies upon Aggarwal Chamber of Commerce, Ltd v. Ganpat
Rai Hira Lal [1958] 33 ITR 245(SC) (hereafter `Ganpat Rai'), to submit
that even if a payee is located in a non-taxable territory, the deduction at
source ought to be made by the entity located in the taxable territory. The
question as to whether the amount is taxable in the hands of the payee,
which is a non-resident, is a question to be addressed at the time of his
assessment and not at the time of deduction at source. Mr. Singh also relies
upon Azadi Bachao Andolan (supra) to submit that if there is no 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
ITA No.180/2014 Page 17 of 83
scrutiny when it is assessed. That scrutiny cannot be done at this stage i.e.
when the tax is to be deducted by the payer. Mr. Chaudhary also relies upon
CIT v. Elbee Services Private Limited [2001] 247 ITR 109 (Bom)
(hereafter `Elbee Services') to submit that the orders under Section 195(2)
are not conclusive and that they do not preempt the department from passing
appropriate orders of assessment or even take a contrary view in the
assessment proceedings. He also submitted that the non-resident payee has
several options after the tax is deducted at source, under Sections 197 and
248 of the Act. The Treasury Department's Technical Explanation of the
Convention and Protocol between the United States of America and the
Republic of India for the avoidance of Double Taxation and the Prevention
of Fiscal Evasion with respect to Taxes on Income Signed at New Delhi on
September 12, 1989 (hereafter `US technical explanation') has been dealt
with in the decision of Herbalife (supra). The US technical explanation, in
fact, supports the case of the Revenue. Mr. Chaudhary specifically relied
upon the following extracts from the said explanation:
"Section 1446 of the Code imposes on any partnership
with income which is effectively connected with a U.S.
trade or business the obligation to withhold tax on
amounts allocable to a foreign partner. In the context
of the Convention, this obligation applies with respect
to an Indian resident partner's share of the partnership
income attributable to a U.S. permanent establishment.
There is no similar obligation with respect to the
distributive shares of U.S. resident partners. It is
understood, however, that this distinction is not a form
of discrimination within the meaning of paragraph 2 of
the Article. No distinction is made between U.S. and
Indian partnership, since the law requires that
partnerships of both domiciles withhold tax in respect
ITA No.180/2014 Page 18 of 83
of the partnership shares of non-U.S. partners. In
distinguishing between U.S. and Indian partners, the
requirement to withhold on the Indian but not the U.S.
partner's share is not discriminatory taxation, but, like
other withholding on non-resident aliens, is merely a
reasonable method for the collection of tax from
persons who are not continually present in the United
States, and as to whom it may otherwise be difficult for
the United States to enforce its tax jurisdiction. If tax
has been overwithheld, 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, learned Senior advocate appearing for the Respondent heavily
relies upon the various DTAAs to state that the said regime was more
ITA No.180/2014 Page 19 of 83
beneficial to the Assessee and it has, therefore, opted for being governed by
the same. According to Mr. Syali, the profits from the business of the payee
can be taxed in India only if the payee has a PE. He specifically relies upon
Article 7 of the India-Japan DTAA read with Article 5. His submission is
that insofar as MC Thailand and MO Singapore are concerned, they do not
have any PE in India and hence the income of the payee, corresponding to
these entities, is not chargeable to tax in India. According to Mr. Syali,
Section 195, therefore, does not apply and consequently, Section 40 (a) (i)
also does not apply.
25. Mr. Syali submits that reliance on Transmission Corporation (supra) is
misplaced. In fact, he submits that as per the tests laid down in the said case,
the first question to be determined is - whether the payment made to the
non-resident is chargeable to tax under the Act. Until and unless the issue of
chargeability is decided, the liability to deduct tax does not exist. He further
relies upon the judgment of the Supreme Court in GE India Technology
Cen. (P.) Ltd. v. CIT (hereafter `GE India Technology'), which confirmed
this position.
26. According to Mr. Syali, the onus to establish that there is a PE of the
Assessee is on the Revenue. He submits that Section 197 of the Act does not
rule out the application of Section 195, inasmuch as the mere fact that the
payee can obtain a certificate at a lower rate subsequently, does not by itself
imply that the tax was deductible in the first place. He submits that in so far
as the transactions governed by the Indo-US DTAA and Indo- Japan DTAA
ITA No.180/2014 Page 20 of 83
are concerned, the Assessee is protected by the non-discrimination clauses in
the said agreements.
27. In case of the other transactions viz., with the entities in Thailand and
Singapore, the question, according to Mr. Syali, is whether the non-
deduction of TDS straightway attracts the disallowance. He submits that the
reliance on the decision in Ganpat Rai (supra) is misplaced as even the said
decision does not uphold that chargeability is an irrelevant consideration at
the time of deduction of the TDS. According to Mr. Syali, the decision in
Ganpat Rai (supra) was whether the determination of income is essential
while deducting 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
ITA No.180/2014 Page 21 of 83
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 the effect that the
transaction is at arm's length. Mr. Syali further relies upon Rajeev
Sureshbhai Gajwamo v. ACIT 129 ITD 145 (Ahmd) (S.B.) (hereafter
`Rajeev Sureshbhai').
29. Mr. Syali, thus, submits that though the wordings in the various DTAA
are different, the impact of all the said DTAAs is the same. According to
him, non-discrimination forms the foundation of all the DTAAs despite the
clauses being different. Mr. Syali places heavy reliance on paragraph 48 of
the Herbalife (supra) where he had made submissions as an intervener that
the amount paid towards purchases are not covered by Section 40 (a) (ia)
and thus the legal position as enunciated in Herbalife (supra) has not
changed insofar as the facts of this case are concerned. Further, according to
Mr. Syali, the term `other sum chargeable' as appearing in Section 40 (a) (i)
is not contained in Section 40 (a) (ia) and this by itself establishes
discrimination.
30. The final plank of Mr. Syali's submissions is that the issues that arise in
this case stand concluded by the decision in Herbalife (supra). He
concludes by submitting the following four propositions
(i) that the US technical explanation was discussed by the ITAT, Pune in
Automated Securities v. ACIT 118 TTJ 618 (hereafter `Automated
Securites') and the ITAT, Ahmedabad in Rajeev Sureshbhai (supra),
wherein Automated Securities (supra) was over ruled by ITAT, Ahmedabad
in Rajeev Sureshbhai (supra);
ITA No.180/2014 Page 22 of 83
(ii) the provisions requiring deduction of TDS are not determinative on the
issue of discrimination and that arguments about section 195 become
irrelevant except on the issue of chargeability;
(iii) the principles of Article 14 cannot be applied in the determination of
issue of non-discrimination in the context of the various DTAAs;
(iv) Section 90 (2) does not refer to a situation of conflict between the
DTAA and the Act but merely provides that the provisions of DTAA would
prevail so long as they are more beneficial to the Assessee;
Rejoinder by the Appellant-Revenue
31. According to Mr. Singh, Section 195 is independent and stands on its
own legs. Until and unless the Assessee can establish that any provision in
the DTAA is more beneficial to the Assessee, chargeability cuts across all
the transactions. Explanation 2 to Section 195 lessens the rigors to be
established by the Revenue. He relies upon the article 23 (1) 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.
ITA No.180/2014 Page 23 of 83
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) (ia) and Section 40 (a) (ib),
in place of the earlier Section 40 (a) (i) as also the addition of Explanation 2
to Section 195, to the Act. These provisions read with Sections 4, 5 and 9 of
the Act leave no manner of doubt that tax is deductible at source, whether
payments are made to residents or non-residents if the sum is chargeable to
tax under any of the provisions of the Act. In fact as per the newly added
Explanation, chargeability is no longer dependent upon the existence of a
PE, a business connection or a place of business or any other presence in any
manner whatsoever. The chargeability only depends on the nature of the
transaction. Even if some portion is taxable, tax is to be deducted. This
being the position, the submission of the Revenue that chargeability cuts
across the provisions of the Act is correct. The question whether the income
of the payee is finally to be considered as taxable income or not is an issue
to be decided when the payee is assessed to tax and not at the stage of
deduction of TDS. Thus, the obligation to deduct tax under Section 195 is
inescapable insofar as the payer is concerned.
ITA No.180/2014 Page 24 of 83
34. Deduction of tax at source is recognized as an acceptable mode of
collection of tax even under the various DTAA provisions. It is a tool that
can be employed to ensure that no income escapes tax, especially from such
entities from whom it may be otherwise difficult to enforce tax payments.
This rationale and logic finds acceptance in almost all the international
jurisdictions as is evident from the U.S. Technical explanation (supra) relied
upon by the Revenue as also the decision of Azadi Bachao Andolan
(supra).
35. The deduction of tax at source is also an obligation which applies to all
payments made inasmuch as payments, whether to a resident or a non-
resident, would be included in the total income from whatever source
derived. Section 4 (2) which is the charging section also stipulates that
income tax shall be deducted at the source, in respect of income chargeable
under Section 4 (1). Section 4 and Section 5 of the Act are extracted below:
"Section 4 - (1) Where any Central Act enacts that
income-tax shall be charged for any assessment year at
any rate or rates, income-tax at that rate or those rates
shall be charged for that year in accordance with, and
subject to the provisions (including provisions for the
levy of additional income-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.
ITA No.180/2014 Page 25 of 83
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
set up in India.
(2) Subject to the provisions of this Act, the total
income of any previous year of a person who is a non-
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.
Explanation 1 - Income accruing or arising outside
India shall not be deemed to be received in India
within the meaning of this section by reason only of the
fact that it is taken into account in a balance sheet
prepared in India.
Explanation 2 - For the removal of doubts, it is hereby
declared that income which has been included in the
total income of a person on the basis that it has
accrued or arisen or is deemed to have accrued or
arisen to him shall not again be so included on the
ITA No.180/2014 Page 26 of 83
basis that it is received or deemed to be received by
him in India."
36. Since the obligation to deduct tax at source applies equally towards
payments made to residents and non-residents, especially the insertion of
Explanation 2 to Section 195, the discrimination ceases to exist.
37. In Transmission Corporation (supra) it was held in no unclear terms
has held that the scheme of the Act requires the payer to discharge the
obligation of tax deduction at source. The relevant extract reads as under:
"...10. The scheme of Sub-sections (1), (2) and (3) of
Section 195 and Section 197 leaves no doubt that the
expression "any other sum chargeable under the
provisions of this Act" would mean 'sum' on which
Income Tax is leviable. In other words, the said sum is
chargeable to tax and could be assessed to tax under
the Act. Consideration would be - whether payment of
sum to non-resident is chargeable to tax under the
provisions of the act or not? That sum may be income
or income hidden or otherwise embedded therein. If so,
tax is required to be deducted on the said sum. What
would be the income is to be computed on the basis of
various provisions of the Act including provisions for
computation of the business income, if the payment is
trade receipt. However, what is to be deducted is
Income Tax payable thereon at the rates in force.
Under the Act, total income for the previous year
would become chargeable to tax under Section 4. Sub-
section (2) of Section 4 inter alia, provides that in
respect 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
ITA No.180/2014 Page 27 of 83
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 non-
resident 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 of rights of
patents, goodwill or drawings for plant and machinery
and such other transactions, it may contain large sum
as taxable income under the provisions of the Act.
Whatever may be the position, if the income is from
profits and gains of business, it would be computed
under the Act as provided at the time of regular
assessment. The purpose of Sub-section (1) of Section
195 is to see that the sum which is chargeable under
Section 4 of the Act for levy and collection of Income
Tax, the payee should deduct Income Tax thereon at
the rates in force, if the amount is to be paid to a
nonresident. The said provision is for tentative
deduction of Income Tax thereon subject to regular
assessment and by the deduction of Income Tax, rights
of the parties are not, in any manner, adversely
affected. Further, the rights of payee or recipient are
fully safeguarded under Sections 195(2), 195(3) and
197. Only thing which is required to be done by them is
to file an application for determination by the
Assessing Officer that such sum would not be
ITA No.180/2014 Page 28 of 83
chargeable to tax in the case of recipient, or for
determination of appropriate proportion of such sum
so chargeable, or for grant of certificate authorising
recipient to receive the amount without deduction of
tax, or deduction of Income Tax at any lower rates or
no deduction. On such determination, tax at
appropriate rate could be deducted at the source. If no
such application is filed Income Tax on such sum is to
be deducted and it is the statutory obligation of the
person responsible for paying such 'sum' to deduct tax
thereon before making payment. He has to discharge
the obligation of tax deduction at source..."
38. The judgment in Transmission Corporation (supra) came to be
considered in GE India Technology (supra) by the Supreme Court where it
was held
"If the contention of the Department that the moment
there is remittance the obligation to deduct TAS arises
is to be accepted then we are obliterating the words
"chargeable under the provisions of the Act" in section
195(1). The said expression in section 195(1) shows
that the remittance has got to be of a trading receipt,
the whole or part of which is liable to tax in India. The
payer is bound to deduct TAS only if the tax is
assessable in India. If tax is not as assessable, there is
no question of TAS being deducted."
39. This position was also reiterated 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.
ITA No.180/2014 Page 29 of 83
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 completely exempt from the tax
· The deduction under Section 195 is a tentative deduction subject to
regular assessment and payees are not affected adversely;
41. From the above it is clear that even if the payment is for purchase of
goods it does not exempt the payer from making deduction of tax at source.
Moreover, as per the facts of this case it is not a case of only purchase of
goods or a trading receipt. A reading of the AO's order clearly gives the
impression that the Assessee's income is for rendering of services as an
intermediary between the customer and the vendor. Under the Act, in the
case of a non-resident, the question whether a sum is chargeable to tax
ITA No.180/2014 Page 30 of 83
requires determination of whether it has either a PE or a business connection
in India. Owing to the nature of the activities of MC in India, as contained in
the DRP's report as also the AO's order, it cannot be straightway said that
the payees in this case did not have a business connection in India. The
factors noted by the DRP and the AO are that
· All the payees are connected and linked to MC;
· They are the arms of MC in different countries;
· MC's turnover includes the turnover of all its group companies
including payees herein;
· MC Japan attributed the activities of all these group companies
to its LO in India;
· To the extent the turnovers of the group companies are relatable
to India, the existence of a PE insofar as MC is concerned
stands admitted and even tax is being paid by MC;
· Some payees like Metal One also have LOs in India;
· The payees are merely different divisions of MC;
· The Assessee MI is, in fact, securing orders in India for the MC
group, and all the group companies appear to be under a
common control;
· MI is not the user of the products purchased but is rendering
services in the nature of intermediary between the seller and the
end user;
· All the payees either have a PE or a business connection in
India.
ITA No.180/2014 Page 31 of 83
42. These findings, which are part of the record in the report of the DRP as
also the AO's order, have not been disturbed by the ITAT. The ITAT has
merely proceeded on the basis that Metal One does not have a PE in India
and hence the sums are not taxable in India. This is clearly an erroneous
finding by the ITAT. The ITAT has also held that TDS was not to be
deducted without considering the chargeability of the sums to tax. 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 that "business connection" shall include any
ITA No.180/2014 Page 32 of 83
business activity carried out through a person who,
acting on behalf of the non-resident,--
(a) has and habitually exercises in India, an authority
to conclude contracts on behalf of the non-resident,
unless his activities are limited to the purchase of
goods or merchandise for the non-resident; or
(b) has no such authority, but habitually maintains in
India a stock of goods or merchandise from which he
regularly delivers goods or merchandise on behalf of
the non-resident; or
(c) habitually secures orders in India, mainly or wholly
for the non-resident or for that non-resident and other
non-residents controlling, controlled by, or subject to
the same common control, as that non-resident:
Provided that such business connection shall not
include any business activity carried out through a
broker, general commission agent or any other agent
having an independent status, if such broker, general
commission agent or any other agent having an
independent status is acting in the ordinary course of
his business :
Provided further that where such broker, general
commission agent or any other agent works mainly or
wholly on behalf of a non-resident (hereafter in this
proviso referred to as the principal non-resident) or on
behalf of such non-resident and other non-residents
which are controlled by the principal non-resident or
have a controlling interest in the principal non-
resident or are subject to the same common control as
the principal non-resident, he shall not be deemed to
be a broker, general commission agent or an agent of
an independent status."
ITA No.180/2014 Page 33 of 83
44. A reading of the Explanation reveals that `business connection' of the
payee could be established in several ways and the underlying facts
requiring that determination cannot be made in the payer's challenge.
45. Thus, under the applicable provisions in the AY in question, there
existed a clear obligation to deduct tax at source, and both the AO and the
DRP were right in holding that as per Section 195 of the Act, the Assessee
was under an obligation to comply with the said provision. In so far as the
judgment in GE India Technology (supra) is concerned, the transaction in
the said case related to purchase of shrink wrap software wherein, the
Supreme Court held that it is only if the sum is chargeable to tax in India,
that the obligation to deduct 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
ITA No.180/2014 Page 34 of 83
charging provisions i.e. Sections 4, 5 and 9 of the Act, the analysis
hereinafter makes it evident that all the payees in the present case either
have a PE or a close business connection in India and thus, the obligation to
deduct tax at source exists. Moreover, even the nature of the transaction, as
recorded in the AO's order, suggests that it could be composite in nature i.e.,
purchase of goods as also providing of services as an intermediary. In such a
case, the ratio in Transmission Corporation (supra) squarely applies.
Analysis of Section 40 (a) and the provisions of DTAAs
46. The decision of this Court in Herbalife (supra) was clearly rendered
under the provisions as they stood in the AY 2001-02. The obligation to
deduct the tax at source in the said case was found to exist only for
payments made to non-residents and not to residents. Thus, this Court held
that the said provisions being discriminatory, the deductions ought to be
allowed for expenses made towards the payments of purchases. The Court
also took note of the amendments brought in w.e.f. 1stApril, 2004 by
Finance Act, 2004 in paragraph 48, which reads as under:
"...48. Section 40 (a) (i) of the Act, as it was during the
AY in question i.e. 2001-02, did not provide for
deduction in the TDS where the payment was made in
India. The requirement of deduction of TDS on
payments made in India to residents was inserted, for
the first time by way of Section 40 (a) (ia) of the Act
with effect from 1st April 2005. Then again as pointed
out by Mr. M.S. Syali, learned Senior Advocate for the
Intervener, Section 40 (a) (ia) refers only to payments
of interest, commission or brokerage, fees for
professional services or fees for technical services
payable to a resident, or amounts payable to a ITA No.
7/2007 Page 27 of 35 contractor or sub-contractor
ITA No.180/2014 Page 35 of 83
etc. It does not include an amount paid towards
purchases. Correspondingly, there is no requirement of
TDS having to be deducted while making such
payment...."
47. This observation of the Court did not take into consideration (and rightly
so) the insertion of Explanation 2 to Section 195, as the amendments in
Section 40 (a) did not apply to the AY in question in Herbalife (supra). The
submission of the Assessee that the discrimination, qua payments made to
residents and non-residents, continues until 1st April, 2015 when Section 40
(a) (ia) was amended, ignores the retrospective nature of the amendment
made to Section 195 by insertion of Explanation 2. The said explanation, 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',
ITA No.180/2014 Page 36 of 83
that the amount is not deductible while computing the income under Section
40, whereas, in the case of non-residents, if tax is not deducted at source qua
`any sum chargeable' then the deduction under Section 40 (a) (i) is not
available. In fact this goes to show that the provisions are more favourable
in the case of non-residents as compared to residents. Though, the obligation
to deduct TDS exists qua both residents and non-residents, the deduction
under Section 40 (a) (ia) is given only qua certain payments. The mention of
the various amounts in Section 40 (a) (ia) does not determine that it is only
qua these amounts that TDS is deductible. The obligation to deduct tax
under Section 195 exists independently of Section 40, qua all payments
made both to residents and to non-residents so long as they are `chargeable
to tax'. The provisions of discrimination have to result in a disadvantage to
the non-resident which in this case is not found to exist. The non-resident is
not subject to any disadvantage vis-à-vis the resident and in fact, a resident
payee, in respect of whom tax is not deducted at source, may face a higher
risk of being subjected to a more rigorous assessment at a later stage. Thus,
the deduction of tax at source being a recognized mode of collection of tax
qua a non-resident, and the same having been fully incorporated in the
statutory scheme, the obligation to comply is mandatory. Any other
interpretation would render the various amendments which have been
brought into the Act wholly nugatory, especially the insertion of Explanation
2 to Section 195 of the Act.
Factual Analysis
49. Applying the above principles to the seven transactions in question, it is
to be noted that arguments of counsels were primarily restricted to the first
ITA No.180/2014 Page 37 of 83
four transactions enumerated in the table in paragraph 7 above. In any event,
the analysis qua the first four transactions would also in effect provide the
basis and reasoning for the remaining three transactions, as would be evident
below.
Transaction with Mitsubishi Corporation, Japan
50. In relation to this transaction, the resultant disallowance was of
Rs.5,01,55,844/-.The fact that MC has a PE in India is not even disputed.
Thus, for all intents and purposes, MC is to be treated as a resident company
for which obligation to deduct tax existed upon MI. The AO has rightly held
that, after analyzing the nature of activities of MC in India and relying upon
the report of DRP, MC has accepted chargeability of its income 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 non-
discrimination 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
ITA No.180/2014 Page 38 of 83
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
not triggered qua it at this stage.
51. The Assessee before us being MI, it had an obligation to deduct tax
under Section 195 and the non-deduction attracts the consequences as
contemplated under Section 40 (a) (i) and not Section 40 (a) (ia). The payer
i.e. MI cannot determine that the payment to MC is not the `sum chargeable'
under this Act. Thus, having not deducted TDS for the payments made to
MC, the AO has rightly disallowed the deduction under 40 (a) (i). At this
juncture, it is relevant to note that the ITAT, unfortunately, appears to
confuse the two issues and has wrongly applied Section 40 (a) (ia) of the Act
to the present case. The ITAT was clearly wrong in assuming that the AO
examined the provisions of Section 40 (a) (ia) when clearly what the AO had
applied was Section 40 (a) (i) of the Act.
52. The India-Japan DTAA, as per Article 24 (3) clearly provides as under:
"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 first mentioned
Contracting State."
53. Under Section 195 of the Act, payments to residents and non-residents
are subject to the same conditions and thus, the position that existed when
ITA No.180/2014 Page 39 of 83
this Court rendered the judgment in Herbalife (supra), no longer applies.
The discrimination has been clearly done away with. The decision in
Herbalife (supra) in paragraph 48 notes that in the AY 2001-02, TDS was
not to be deducted where the payment was made in India which was inserted
for the first time w.e.f. 1st April, 2005. Thus, the argument of discrimination
no longer survives in the context of the India-Japan DTAA. The error in the
Assessee's submissions is that the services mentioned in Section 40 (a) (ia)
are not an exhaustive list of the services for which tax is deductible at
source. Whereas Section 195 uses the term `any other sum chargeable under
the provisions of this Act', Section 40 (a) (ia) prior to 1st April, 2015
mentions some services for which tax is deductible and if not deducted, the
said payments shall be included in computing the income of the Assessee. It
is application 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,
ITA No.180/2014 Page 40 of 83
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 claimed as expense even if tax is not deducted at source though
the obligation to deduct does exist. In any event, w.e.f. 1st April, 2015, even
qua residents the expression used in Section 40 (a) (ia) is `any sum payable'
and the listing of various services has been done away with. The intention
appears to be clear that on all payments to residents and non-residents, tax
ought to be deductible so long as the sum is `chargeable under the
provisions of this Act'.
55. The argument of non-discrimination has to be considered from the point
of view of whether there exists a more favourable provision in the DTAA
for the non-resident. Clearly, there is none. Thus, Section 90 of the Act or
the observations in Azadi Bachao Andolan (supra) do not come to the aid
of the Assessee. The DTAA does not have any provision which requires
non-deduction of tax at source. Article 24 (3) does not come to the aid of the
Assessee as tax is deductible at source irrespective of whether the payment
is made to a resident or a non-resident and thus they are being subjected to
the `same conditions'.
Transaction with Metal One Corporation, Japan
56. Metal One, Japan has an LO in India which operates within the MC
group. It undertakes various core activities as has been found by the AO. It
is relevant at this juncture to note the specific observations in the report of
the DRP that the Metals division operated by Metal One follows a very
ITA No.180/2014 Page 41 of 83
similar chain of activity as that of MC for trading in goods. The DRP
specifically notices that the turnover of all the group companies, including
Metal One, is attributable to the activities of MC in India. It is considered to
be turnover related to India. Thus, Metal One, clearly, has a business
connection in India and under Section 9, all income arising from any
business connection in India is income deemed to accrue or arise in India.
Thus, at the stage of deduction of tax at source, it is not possible to hold that
the payment is not a sum chargeable under the provisions of this Act. Thus,
the Assessee had an obligation to deduct tax at source and the AO has
rightly added the amount of payment made to Metal One, to the income of
the Assessee, in the absence of such deduction.
Transactions with MC Metal Services Asia, Thailand and Metal One Asia P.
Ltd., Singapore
57. The relevant extracts of the non-discrimination clauses in the Indo-Thai
DTAA 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
ITA No.180/2014 Page 42 of 83
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 DTAA. No submission has been made before this Court that
there are any provisions in either of these DTAAs which contradict the Act
or are more burdensome to the Assessee. Thus, the argument of
discrimination does not apply in the case of the transactions of the Assessee
with either MC Thailand or MO Singapore.
59. The payments being made to these companies are subject to the
obligation under Section 195 which falls in Chapter XVII-B of the Act
relating to collection and recovery of tax deduction at source. The deduction
as per Explanation 2 to Section 195 has to be made irrespective of whether
these entities have a residence or place of business or a business connection
in India, or any other presence in any manner whatsoever. These companies
are group companies of MC and their incomes are attributed to the activities
of the LO of MC in India as per paragraph 5.5 of the directions of DRP
which specifically notes as follows:
"In this connection it is noted that all the group
companies of the assessee are stated to be working on
same business models. They are like the arms of MC -
Japan in different countries. Their accounts are
consolidated with MC-Japan. Their turnover after
ITA No.180/2014 Page 43 of 83
netting becomes part of the turnover of the assessee.
The supply from these companies follows the same
pattern. While considering the taxability of MC-Japan,
it is noticed that entire turnover of the MC-Japan
including those of its group companies were taken into
account and were attributed to the activities of the
Liaison Office in India. All these companies need not
establish their offices in India as MC-Japan being their
flagship company undertakes necessary activities for
them. As stated, the turnover of these companies were
also agreed to be the part of turnover relatable to India
on which permanent establishment was conceded by
MC-Japan and tax was paid thereon. It is also noted
that these companies form part of various divisions' viz
metal division, chemical division etc and were
accordingly consolidated in the global accounts of
MC-Japan. Therefore, contention of the assessee that
other AEs did not have their individual and separate
presence in India is not very convincing."
60. This observation of the DRP led to the AO holding that Metal One,
which was established as a new company in January, 2003, functions on
identical lines as that of MC. Metal One, under which both 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 McTubular Inc., USA, Petro Diamond
Corporation, Japan and Miteni, Japan are concerned, neither side has made
ITA No.180/2014 Page 44 of 83
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 entities do
not have a PE in India, they are not chargeable to tax in India, which clearly
is an incorrect finding inasmuch as even the existence of business
connection is sufficient for being chargeable to tax in India. None of these
entities lack a business connection with India and the observations made by
the DRP and the AO clearly points to an unequivocal existence of a business
connection, at least while viewed from the payer's perspective. The question
as to whether all these companies would have to pay tax on these
transactions is a question that needs to be determined when their respective
assessments are made either through MC or the LO of Metal One in India.
That is not the subject matter of the present case. From the payer's
perspective, so long as the transactions are chargeable to tax, tax has to be
deducted at source. The findings herein are not conclusive qua any of the
companies with whom the Assessse has had transactions. Thus, the tax
payable by those companies would be the subject matter of their respective
assessment proceedings, which this Court is not concerned with in this case.
ITA No.180/2014 Page 45 of 83
63. The ITAT's order is clearly not sustainable in law for the reasons
aforesaid, and the same is thus, set aside. Thus, Question 1 is answered in
the affirmative i.e. in favour of the Revenue and against the Assessee.
64. Question 2, however, is modified to read as under:
Whether the ITAT was in error in reversing the
findings of the DRP with respect to the existence of
PEs as well as a business connection in India?
65. The AO had clearly come to the conclusion that the non-resident entities
had a PE as well as a business connection in India. This Court holds that MC
admittedly has a PE. The other entities also do have a business connection in
India. The question is thus, answered in the affirmative i.e. in favour of the
Revenue and against the Assessee.
66. The appeal is accordingly allowed. There will be no order as to costs.
PRATHIBA M. SINGH, J
Per Dr. S. Muralidhar, J.:
1. Having gone through the judgment of my learned colleague Prathiba M.
Singh, J., I am unable to agree with the conclusions reached by her on the
two questions of law framed by this Court in the present case by order dated
29th April, 2014. The said questions read as under:
"(i) Whether the ITAT fell into error in holding that Section 40(a) (i)
of the Income Tax Act, 1961 cannot be applied in view of the
ITA No.180/2014 Page 46 of 83
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 India
and Japan (the Indo-Japan DTAA) and between India and the USA (the
Indo-US DTAA) both contain identically worded non-discrimination clauses
that would govern the payments made to non-resident entities incorporated
in those respective countries. In other words, the payments made by MI to
MC, Metal One Japan, Petro Diamond and Miteni are governed by the Indo-
Japan DTAA and the payment by MI to Mc Tubular is governed by the
Indo-US DTAA. In these cases, as regards the tax treatment of these
payments and claiming deductions thereof while computing its taxable
ITA No.180/2014 Page 47 of 83
income, MI has opted for the more beneficial DTAA provisions. Question
(i) framed by the Court therefore pertains to the above payments.
4. However, the DTAAs between India and Thailand and India and
Singapore do not contain similar non-discrimination provisions. As regards
the payments made to the entities in those countries, viz., MC Metal
Thailand and Metal One Asia, MI claims deduction on the ground that the
said payments were not chargeable to tax as the profits of those entities
could not be brought to tax in India in the absence of a permanent
establishment (PE) of such entities in India. The Revenue's case is that the
two entities do have PEs in India. It contends that in any event Explanation 2
to Section 195 of the Income Tax Act 1961 (`Act') (as introduced by the
Finance Act 2012 (FA 2012) obviates the need to first establish the
existence of a PE before deducting TDS while making such payment. This is
the basis of Question (ii) framed by the Court which question is relevant
only for the payments by MI to the Thailand and Singapore entities.
Analysis of the relevant provisions of the Act
5. The Indo-Japan DTAA, like the Indo-US DTAA, has a non-
discrimination clause in the form of Article 24 (3). It mandates inter alia
that, for the purposes of taxation, the treatment afforded to payments made
by Indian Assessees to non-resident companies incorporated in Japan, is to
receive a treatment no different from payments to resident Indian entities.
6. Section 195 of the Act, which is in Chapter XXVII, requires TDS to be
deducted while making payment to a non-resident entity of a sum
ITA No.180/2014 Page 48 of 83
"chargeable" to tax under the Act. Explanation 2 inserted in Section 195 by
the FA 2012 with retrospective effect from 1st April 1962 clarifies that the
obligation to TDS applies irrespective of whether the non-resident entity has
a permanent establishment (PE), place of business or business connection or
any other presence in India.
7. The consequence for the failure to deduct TDS as mandated by Section
195 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
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
ITA No.180/2014 Page 49 of 83
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 company or 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 during the previous year, or in the
subsequent year before the expiry of the time prescribed under
sub-section (1) of Section 200.......
Provided that where in respect of any such sum, tax has been
deducted in any subsequent year or, has been deducted in the
previous year but paid in any subsequent year after the expiry
of the time prescribed under sub-section (1) of section 200,
such sum shall be allowed as a deduction in computing the
income of the previous year in which such tax has been paid
Explanation....
(ia) any interest, commission or brokerage, fees for professional
services or fees for technical services payable to a resident, or
amounts payable to a contractor or sub-contractor, being
resident, for carrying out any work (including supply of labour
for carrying out any work), on which tax is deductible at source
under Chapter XVIIB and such tax has not been deducted or,
after deduction, has not been paid,-
(A) in a case where the tax was deductible and was so deducted
during the last month of the previous year, on or before the due
date specified in sub-section (1) of section 139; or
(B) in any other case, on or before the last day of the previous
year
ITA No.180/2014 Page 50 of 83
Provided that where in respect of any such sum, tax has been
deducted in any subsequent year, or has been deducted
(A) during the last month of the previous year but paid after the said
due date; or
(B) during any other month of the previous year but paid after the end
of the said previous year, such sum shall be allowed as a deduction in
computing the income of the previous year in which such tax has been
paid
Explanation...."
9. A careful comparison of the two sub-clauses i.e. (i) and (ia) of clause (a)
of Section 40 of the Act, as they stood during AY 2006-07, would reveal
that the expression "or other sum chargeable under the Act" occurring in
sub-clause (i) is missing in sub-clause (ia). 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.
ITA No.180/2014 Page 51 of 83
Analysis of the relevant provisions of the DTAA
10. As already noted, under Article 24 (3) of the Indo-Japan DTAA the tax
treatment 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-discrimination provision reads thus:
"24 (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 first mentioned Contracting State."
11. What does the above provision actually say? It says that barring certain
kinds of payments covered under Articles 9, 11 (8) or 12 (7) of the Indo-
Japan DTAA, payment to non-resident entities of sums towards interest,
royalties and `other disbursements' shall be deductible for the purpose of
computation of taxable profits under the `same conditions' as if they had
been made to a resident entity.
12. In the present case, the payment made by MI to the aforementioned
Japanese and US entities is for purchases made from the latter. It is not a
payment covered under any of the exceptions i.e. Articles 9, 11 (8) or 12 (7)
of the Indo-Japan DTAA (or the corresponding provisions under the Indo
US DTAA). The payment for purchases is, therefore, covered by the
expression `other disbursements' occurring in Article 24(3) of the Indo-
Japan DTAA and Article 26 (3) of the Indo US DTAA.
ITA No.180/2014 Page 52 of 83
The orders of the AO, DRP and ITAT
13. We have to now examine the orders passed by the various authorities in
the present case. The AO in his draft assessment order dated 31st December
2009 went essentially by the fact that MC Japan had itself submitted to
jurisdiction of the tax authorities in India and had paid tax on its income
earned in India. Therefore according to the AO, Section 195 of the Act
applied to the payments made to MC Japan and it was mandatory for MI to
have deducted TDS from such payments. The failure to do so attracted the
consequence under Section 40 (a) (i) of the Act. Since all its group entities
followed the same business model, they should also be held to have a PE in
India and it was incumbent on MI to deduct TDS from the payments to them
as well.
14. As regards the reliance placed by MI on the DTAA, the AO held:
(i) MI being a resident could not invoke the DTAA.
(ii)In any event in view of the decision of the Supreme Court in
Transmission Corporation of AP Ltd. v. CIT 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.
ITA No.180/2014 Page 53 of 83
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 Securities Clearance Inc. 118 TTJ 619 (Pune
ITAT) which had declined to follow the decision in Herbalife ITAT. It was
further held: "......Therefore, genuine requirement and reasonableness of
putting a system in place to examine payment to non-residents in special
manner cannot be held to be a ground for nondiscrimination." In his final
assessment order the AO reiterated his draft order in its entirety and also
extracted portions of the DRP's order.
17. The Assessee's further appeal was allowed by the ITAT by relying on its
decision in Herbalife ITAT. As regards the payments made to the entities in
Japan and the USA, the ITAT held that the said decision which interpreted
Article 26 (3) of the Indo US DTAA squarely applied to the instant case.
The ITAT in the impugned order noted that as a result of the decision of the
Special Bench of the ITAT in Rajeev Sureshbhai Gajwamo v. ACIT 129
ITA No.180/2014 Page 54 of 83
ITD 145 (Ahmd) (SB), the decision of its Pune Bench in Automated
Securities Clearance Inc. was no longer good law.
18. As regards the payments to the entities in Singapore and Thailand the
ITAT noted that the AO had drawn an inference that these entities had a PE
in India only because it had earlier been held that Metal One Corporation
Japan had a PE in India. However, that decision of the AO had been set
aside by the ITAT in its decision dated 11th May 2012 in ITA No.
5377/Del/2009. In the case of none of the entities, other than Metal One
Corporation had the Department passed any orders holding that they had a
PE in India. The ITAT held:
"Thus the income of these entities are not taxed in India. Under these
circumstances, we have to necessarily hold that the payments made to
these entities for purchases from these entities are not taxable in India
as these entities have not (been) held as having a PE in India and
hence the provisions of S.195 are not attracted and consequently the
disallowances made u/s 40 (a) (ia) [(sic 40 (a) (i)] are bad in law."
19. It requires to be noticed that against the above decision dated 11th May
2012 of the ITAT in the case of Metal One Corporation, the Revenue's
appeal being ITA 113 of 2013 has been admitted by this Court and is
pending consideration.
Revenue's submissions
20. In the present appeal the Revenue's submissions as regards question (i)
have centred around the fact that after insertion of sub-clause (ia) in Section
40 (a) with effect from 1st April 2005, the discrimination pointed out by this
Court in Commissioner of Income Tax v. Herbalife International Pvt. Ltd.
ITA No.180/2014 Page 55 of 83
[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 195. A detailed enquiry must
take place in the former and not in the latter. In the latter, a detailed enquiry
is possible if Sections 163, 161 and 166 are attracted. The AO, it is
contended, had conducted the appropriate enquiry for applying Section 195.
Reliance is placed on the decision in Aggarwal Chamber of Commerce v.
Ganpat Rai [1958] 33 ITR 245 (SC).
22. Secondly, it is contended by learned counsel for the Revenue that after
the insertion of Explanation 2 to Section 195 (1), the determination of the
existence of a PE is not required. It is stated that while for chargeability the
business connection/PE is a sine qua non, it is not for deductibility. The
focus ought to be on "sum chargeable under the provisions of this Act" and
ITA No.180/2014 Page 56 of 83
not on whether the recipient is a taxable unit under the Act. To the extent
determination of "sum chargeable under the provisions of this Act" requires
determination of the existence of PE (like in the case of business profits
instead of royalty of FTS), Explanation 2 displaces such a determination for
tax deduction. Section 90 (2) cannot apply to Explanation 2 because the two
tests laid down in Union of India v. Azadi Bachao Andolan [2016] 263 ITR
706 (SC) are not fulfilled. The two tests are (i) that beneficial provision in
the Act will not be denied to a resident of a contracting country merely
because the corresponding provision in the tax treaty is less beneficial; (ii) in
case of conflict between the terms of the DTAA and the IT Act, the DTAA
alone would prevail. It is submitted that the DTAA contains no conflicting
provision that deduction of tax at source can only be made if PE is
determined. On the other hand, Article 23(1) of the DTAA states that the
laws in force in either of the Contracting States shall continue to govern the
taxation of income in the respective Contracting State except where express
provisions to the contrary are made in this Convention.
Assessee's submissions
23. The learned counsel for the Assessee points out that as far as question (i)
is concerned, all the submissions of the Revenue have been comprehensively
answered against it in the decision of this Court in Herbalife HC. As regards
question (ii) which pertains to the applicability of Section 195 of the Act, the
decision in Transmission Corporation (supra) is sought to be distinguished
on facts. Reliance on the other hand is placed on the later decision of the
Supreme Court in GE India Technology Centre Pvt. Ltd. v CIT [2010] 327
ITR 456 (SC) (hereafter GE India).
ITA No.180/2014 Page 57 of 83
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 to tax which is a condition precedent
for deducting TDS. It does not shift the onus from the Revenue of having to
establish that the payee has a PE in India. With the ITAT having held that
the said onus had not been discharged, there can be no consequence under
Section 40 (a) (i) of the Act for failure to deduct TDS.
Question (i)
26. The Court first takes up question (i) which is more or less the question
that arose for determination in its decision in Herbalife HC. The Revenue
contended that the AY in question in the said decision was AY 2001-02
ITA No.180/2014 Page 58 of 83
whereas in the present case it is AY 2006-07. According to the Revenue, one
important distinction is the insertion of sub-clause (ia) in Section 40 (a) of
the Act with effect from 1st April 2005. However, as will be seen hereafter,
this change was taken note of in Herbalife HC itself.
27. The material facts relevant to question (i) are as follows:
(a) The payments made by the Assessee MI to the non-resident entities were
for purchases only. It was not a composite payment for purchases and
services. This is clear from para 4.22 (2) of the final assessment order dated
25th October 2010 of the AO which notes:
"4.22 (2) The purchases in the instant case are purchases simpliciter
as the Non-resident entities are trading houses whose work is to
liaison with the seller and purchaser and to make the deal happen. The
assessee is not an end user of the purchases but is a mediator between
the seller and the end user. The argument that the purchases are not
taxable in India is therefore misplaced and out of context."
(b) The finding of the AO that the sum paid for purchases was taxable in
India was as a result of the earlier finding that the non-resident entities to
which the payments were made had PEs in India. However, the AO
proceeded on the basis that the payment was only for purchases and nothing
else.
(c) As far as the assessee is concerned it is asserted throughout and in
particular in para 2.6 of its written submissions that: "There is no dispute
that the payment made to non-resident, in the present case, is neither
'Royalty' nor 'Fee for technical services'. It is a case of payment made for
purchases from the non-resident."
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(d) Even the Revenue does not dispute that the payments were made by MI
to the non-resident entities for purchases. There is nothing to the contrary
stated 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 decision of this Court in Herbalife
30. The above conclusions are fully supported by the decision of this Court
in Herbalife HC which upheld the decision of the ITAT in Herbalife ITAT
which has been followed by the ITAT in the impugned order.
ITA No.180/2014 Page 60 of 83
31. The expression `other disbursements' occurring in the identically
worded Article 26 (3) of the Indo-US DTAA was interpreted by the Division
Bench of this Court in Herbalife HC. There the sum which was not allowed
by the AO to be deductible was that paid by the Indian assessee (Herbalife
India HIAI) to Herbalife USA as `administrative fees' which the Revenue
was characterizing as Fee for Technical Services (FTS). The ITAT had in
Herbalife ITAT agreed with the Assessee there that the deduction could not
be disallowed in terms of Article 26 (3) of the Indo-US DTAA. Agreeing
with the ITAT, and dismissing the Revenue's appeal, this Court in Herbalife
HC held:
"38. The question that next arises is whether the payment by the
Assessee to HIAI qualifies as 'other disbursements' for the purpose of
Article 26 (3) DTAA?
39. To recapitulate, the case of the Revenue is that the expression
`other disbursements' should take colour from the context and would
apply only to income which is of passive character just like interest
and royalties. The Revenue invokes the doctrines of `noscitur-a-
sociis' and `ejusdem generis'. It is submitted that FTS does not
qualify as `other disbursements' since it is not a passive character like
royalties and interest.
40. The Court is unable to agree with the above submissions of the
Revenue. In the context in which the expression `other disbursement'
occurs in Article 26 (3), it connotes something other than `interest and
royalties`. If the intention was that `other disbursements` should also
be in the nature of interest and royalties then the word 'other' should
have been followed by `such` or `such like`. There is no warrant,
therefore, to proceed on the basis that the expression `other
disbursements' should take the colour of `interest and royalties`.
41. The expression `other disbursements` occurring in Article 26 (3)
of the DTAA is wide enough to encompass the administrative fee paid
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by the Assessee to HIAI which the Revenue has chosen to
characterize as FTS within the meaning of Explanation 2 to Section 9
(1) (vii) of the Act."
32. In Herbalife HC the Court was dealing 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 Assessee, then in
terms of Section 40 (a) (i) of the Act, it will not be allowed as a
deduction under Section 37 (1) of the Act for computing the
Assessee's income chargeable under the head 'profits and gains of
business'.
47. Article 26(3) of the DTAA calls for an enquiry into whether the
above condition imposed as far as the payment made to HIAI, i.e.,
payment made to a non-resident, is any different as far as allowability
of such payment as a deduction when it is made to a resident.
48. Section 40 (a) (i) of the Act, as it was during the AY in question
i.e. 2001-02, did not provide for deduction in the TDS where the
ITA No.180/2014 Page 62 of 83
payment was made in India. The requirement of deduction of TDS on
payments made in India to residents was inserted, for the first time by
way of Section 40 (a) (ia) of the Act with effect from 1st April 2005.
Then again as pointed out by Mr. M.S. Syali, learned Senior Advocate
for the Intervener, Section 40 (a) (ia) refers only to payments of
"interest, commission or brokerage, fees for professional services or
fees for technical services" payable to a resident, or amounts payable
to a contractor or sub-contractor etc. It does not include an amount
paid towards purchases. Correspondingly, there is no
requirement of TDS having to be deducted while making such
payment.
49. However, the element of discrimination arises not only because of
the above requirement of having to deduct TDS. The OECD Expert
Group which brought out a document titled "Application and
Interpretation of Article 24(Non-Discrimination), Public discussion
Draft, May 2007 did envisage deduction of tax while making
payments to non-residents. It is viewed only as additional compliance
of verification requirement which would not attract the non-
discrimination rule. The OECD Expert Group noted that the non-
discrimination obligation under tax conventions is restricted in scope
when compared with equal treatment or nondiscrimination clauses in
an investment agreement." Specifically, in relation to withholding
taxes, the Expert Group in the note by its chairman titled Non-
Discrimination in Bilateral Tax Conventions noted as follows:
"6. The more limited non-discrimination obligations in tax
conventions reflect the practical problems of cross-border
taxation. For example, countries frequently collect taxes from
non-residents through a system of withholding 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
ITA No.180/2014 Page 63 of 83
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 deducted at
the time of making such payment, it will not be allowed as deduction
while computing the taxable profits of the payer. No such
consequence was envisaged in terms of Section 40 (a) (i) of the Act as
it stood as far as payment to a resident was concerned. This, therefore,
attracts the non-discrimination rule under Article 26 (3) of the
DTAA."
33. In Herbalife HC, this Court interpreted the expression "same
conditions" occurring in Article 26 (3) of the Indo-US DTAA which
incidentally is also found in Article 24(3) of the Indo-Japan DTAA. In
Herbalife HC, this Court noted the submissions of the parties and gave its
reasoning as under:
"51. The arguments of counsel on both sides focussed on the
expression `same conditions', in Article 26(3) of the DTAA. To
recapitulate, a comparison was drawn by learned counsel for the
Revenue with Article 26 (1) which speaks of preventing
discrimination on the basis of nationality and which provision
employs the phrase `same circumstances'. Article 26 (2), which talks
of prevention of discrimination vis-a-vis computing tax liability of
PEs, employs the expression `same activities'. The expression used in
Article 26 (3) is `same conditions'. Learned counsel for the Revenue
sought to justify the difference in the treatment of payments made to
non-residents by referring to Article 14 of the Constitution of India
and contended that the line of enquiry envisaged examining whether
ITA No.180/2014 Page 64 of 83
(a) the classification was based on an intelligible differentia and (b)
whether the classification had a rational nexus with the object of the
statute.
52. Section 40 (a) (i), in providing for disallowance of a payment
made to a non-resident if TDS is not deducted, is no doubt meant to
be a deterrent in order to compel the resident payer to deduct TDS
while making the payment. However, that does not answer the
requirement of Article 26 (3) of the DTAA that the payment to both
residents and non-residents should be under the `same conditions` not
only as regards deduction of TDS but even as regards the allowability
of such payment as deduction. It has to be seen that in those `same
conditions' whether the consequences are different for the failure to
deduct TDS.
53. It is argued by the Revenue that since in the present case no
condition of deduction of TDS was attracted, in terms of Section 40
(a) (i) of the Act as it then stood, to payments 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 non-
discrimination 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 to the economies of developing countries
which need foreign investment. The Court felt that this was a matter
ITA No.180/2014 Page 65 of 83
best left to the discretion of the executive as it is dependent upon
several economic and political considerations.
55. Consequently, while deploying the `nexus, test to examine the
justification of a classification under a treaty like the DTAA, the line
of enquiry cannot possibly be whether the classification has nexus to
the object of the `statute' for the purposes of Article 14 of the
Constitution of India, but whether the classification brought about by
Section 40 (a) (i) of the Act defeats the object of the DTAA.
56. The argument of the Revenue also overlooks the fact that the
condition under which deductibility is disallowed in respect of
payments to non-residents, is plainly different from that when made to
a resident. Under Section 40 (a) (i), as it then stood, the allowability
of the deduction of the payment to a non-resident mandatorily
required deduction of TDS at the time of payment. On the other hand,
payments to residents were neither subject to the condition of
deduction of TDS nor, naturally, to the further consequence of
disallowance of the payment as deduction. The expression `under
the same conditions' in Article 26 (3) of the DTAA clarifies the
nature of the receipt and conditions of its deductibility. It is
relatable not merely to the compliance requirement of deduction
of TDS. The lack of parity in the allowing of the payment as
deduction is what brings about the discrimination. The tested party
is another resident Indian who transacts with a resident making
payment and does not deduct TDS and therefore in whose case there
would be no disallowance of the payment as deduction because TDS
was not deducted. Therefore, the consequence of non-deduction of
TDS when the payment is to a non-resident has an adverse
consequence to the payer. Since it is mandatory in terms of
Section 40 (a) (i) for the payer to deduct TDS from the payment to
the non-resident, the latter receives the payment net of TDS. The
object of Article 26 (3) DTAA was to ensure non-discrimination in
the condition of deductibility of the payment in the hands of the
payer where the payee is either a resident or a non-resident. That
object would get defeated as a result of the discrimination
brought about qua non-resident by requiring the TDS to be
ITA No.180/2014 Page 66 of 83
deducted while making 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 of sub-clause (ia) by the
FA 2014 with effect from 1st April, 2015.
36. Therefore, the assertion by the Revenue in para 4 of its written
submissions that "discrimination as held by CIT v. Herbal Life [2016] 384
ITR 276 (Delhi) has been done away with" is true only after 1st April, 2015
and not during the relevant AY 2006-07. The contention about the situs of
payment has been raised for the first time in this Court in the written
ITA No.180/2014 Page 67 of 83
submissions. It was not the case of the Revenue earlier that the payments
were made outside India and not in India. It was only argued that the
discrimination pointed out in Herbalife HC no longer exists whereas, as
demonstrated earlier, it did even during AY 2006-07.
37. The inevitable conclusion is, therefore, that the decision of this Court in
Herbalife HC squarely applies and answers question (i) against the
Revenue. Since Section 40 (a) (i) of the Act as it stood in AY 2006-07
continued to discriminate in the above manner and was inconsistent with
Article 24 (3) of the Indo Japan DTAA or Article 26 (3) of the Indo US
DTAA, the Assessee was entitled to rely on the above DTAA provisions to
claim deduction of the sums paid to entities in Japan and USA.
38. For the above reasons, question (i) is answered in the negative i.e. in
favour of the Assessee and against the Revenue.
Question (ii)
39. This question as noted even by the Revenue is relevant for the payments
made by the Assessee for purchases made to non-resident entities
incorporated in Thailand and Singapore.
40. As noticed earlier, the AO drew an inference that the above entities also
had a PE in India since their business model was no different from that of
Metal One Corporation Japan which was held to have a PE in India. The
subsequent development was that the said decision of the AO in the case of
ITA No.180/2014 Page 68 of 83
Metal One Corporation was set aside by the ITAT. That decision is of
course the subject matter of a separate appeal pending in this Court.
41. The factual finding of the ITAT is that other than Metal One
Corporation, the Department has not passed any orders holding that any of
the other entities including the two in Thailand and Singapore had a PE in
India. This factual finding has not been shown by the Revenue to be
perverse. The Revenue has not argued before this Court that either the entity
in Thailand or the one in Singapore have even an LO in India. If their 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.
ITA No.180/2014 Page 69 of 83
43. There is merit in the contention of the Assessee that the above
Explanation emphasises the obligation of the `payer' whether resident or
non-resident and does not obviate the pre-condition of the sum having to be
chargeable to tax, which is written into sub-section (1) of Section 195 and
which requirement has not undergone any change. This is also
acknowledged in the Memorandum explaining the insertion of Explanation 2
by the Finance Bill, 2012 (reported in 342 ITR (St) 234 @ p.265), the
relevant extract of which reads thus:
"... Section 195 of the Income-tax Act requires any person to deduct
tax at source before making payments to a non-resident if the income
of such non-resident is chargeable to tax in India. "Person", here will
take its meaning from section 2 and would include all persons,
whether resident or non-resident. Therefore, a non-resident person is
also required to deduct tax at source before making payments to
another non-resident, if the payment represents income of the payee
non-resident chargeable to tax in India. There are no other conditions
specified in the Act and if the income of the payee non-resident is
chargeable to tax, then tax has to be deducted at source, whether
the payment is made by a resident or a non-resident..." (emphasis
supplied)
44. In the context of the present case, before proceeding to deduct TDS from
the payments to the Thailand and Singapore entities for purchases made
from them, MI would have to ascertain if the said sums were in fact
chargeable to tax in India. Considering that they were non-resident entities
the transactions with whom were governed by the respective DTAA, this
question is even more relevant.
45. In this context, it requires to be noticed that Section 195 does not begin
with a non-obstante clause. It is subject to the other provisions of the Act
ITA No.180/2014 Page 70 of 83
and in particular Section 90 (2) of the Act in terms of which if there is a
provision of the Act that is more beneficial to the Assessee than the DTAA
provision, then the Act will apply. Conversely, the provision of the DTAA
would apply, if it is more favourable to the Assessee than the provision of
the Act. The decision of the Supreme Court in Azadi Bachao Andolan
(supra) clarifies the position. In any event for determining the chargeability
of a sum to tax, the provisions of the DTAA where applicable, would have
to be taken into account.
The decision in the Transmission Corporation case
46.1 The decision of the Supreme Court in Transmission 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.
ITA No.180/2014 Page 71 of 83
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
observed that:
"9. The scheme of sub-sections (1), (2) and (3) of Section 195 and
Section 197 leaves no doubt that the expression 'any other sum
chargeable under the provisions of this Act' would mean 'sum' on
which income-tax is leviable. In other words, the said sum is
chargeable to tax and could be assessed to tax under the Act.
Consideration would be - whether payment of sum to non-
resident is chargeable to tax under the provisions of the Act or
not? That sum may be income or income hidden or otherwise
embedded therein. If so, tax is required to be deducted on the said
sum. What would be the income is to be computed on the basis of
various provisions of the Act including provisions for computation of
the business income, if the payment is a trade receipt. However, what
is to be deducted is income tax payable thereon at the rates in force.
Under the Act, total income for the previous year would become
chargeable to tax under Section 4. Sub-section (2) of Section 4, inter
alia, provides that in respect of income chargeable under sub-section 9
(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."
(emphasis supplied)
46.4 It should be noticed that the above decision was in the context of
payments made for a composite contract which admittedly included payment
for the erection and commissioning of a plant in India which gave rise to
taxable income of the payee (non-resident) in India. Secondly, the question
whether the payment would be governed by the provisions of a DTAA did
not arise and in any event was not considered by the Supreme Court when it
ITA No.180/2014 Page 72 of 83
gave the above decision. Thirdly, the Supreme Court did emphasise that for
deducting TDS in terms of Section 195 (1) of the Act a pre-condition was
that the sum paid had to be chargeable to tax.
The decision in GE India
47.1 The issue regarding deductibility of TDS for payments made to non-
resident entities was revisited by the Supreme Court in GE India (supra). A
detailed analysis was undertaken by the Supreme Court of Section 195 (1) of
the Act. The Supreme Court in the said decision used the expression
`deduction of Tax at Source (TAS).' The following observations in that
regard are relevant:
"7. Under Section 195 (1), the tax has to be 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 non-
residents 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 non-
resident, 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 voluntarily, such payments cannot be regarded
as income under the Income-tax Act. It may be noted that Section 195
contemplates not merely amounts, the whole of which are pure
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income payments, it also covers composite payments which has an
element of income embedded or incorporated in them. Thus, where an
amount is payable to a non-resident, the payer is under an obligation
to deduct TAS in respect of such composite payments. The obligation
to deduct TAS is, however, limited to 'the appropriate proportion of
income chargeable under the Act forming part of the gross sum of
money payable to the non-resident. This obligation being limited to
the appropriate proportion of income flows from the words used in
Section 195(1), namely, "chargeable under the provisions of the Act".
It is for this reason that vide Circular No. 728 dated 30-10-1995
that the CBDT has clarified that the tax deductor can take into
consideration the effect of DTAA in respect of payment of
royalties and technical fees while deducting TAS. It may also be
noted that Section 195(1) is in identical terms with Section 18(3B) of
the 1922 Act.....The application of Section 195 (2) presupposes that
the person responsible for making the payment to the non-resident is
in no doubt that tax is payable in respect of some part of the amount
to be remitted to a non-resident but is not sure as to what should be
the portion so taxable or is not sure as to the amount of tax to be
deducted. In such a situation, he is required to make an application to
the ITO (TDS) for determining the amount. It is only when these
conditions are satisfied and an application is made to the ITO (TDS)
that the question of making an order under Section 195 (2) will arise.
.....While deciding the scope of Section 195(2) it is important to
note that the tax which is required to be deducted at source is
deductible only out of the chargeable sum. This is the underlying
principle of Section 195. ...."
8. If the contention of the Department that the moment there is
remittance the obligation to deduct TAS arises is to be accepted
then we are obliterating the words "chargeable under the
provisions of the Act" in section 195(1). The said expression in
section 195(1) shows that the remittance has got to be of a trading
receipt, the whole or part of which is liable to tax in India. The payer
is bound to deduct TAS only if the tax is assessable in India. If tax is
not as assessable, there is no question of TAS being deducted.
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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, if, the.
contention of the Department was accepted it would must obliteration
of the expression "sum chargeable under the provisions of the Act"
from section 195(1).....Hence, the provisions relating to TDS applies
only to those sums which are chargeable to tax under the Income-tax
Act. If the contention of the Department that any person making
payment to a non-resident is necessarily required to deduct TAS then
the consequence would be that the Department would be entitled to
appropriate the moneys deposited by the payer even if the sum paid is
not chargeable to tax because there is no provision in the Income- tax
Act by which a payer can obtain refund. Section 237 read with section
199 implies that only the recipient of the sum, i.e., the payee could
seek a refund. It must therefore follow, if the Department is right, that
the law requires tax to be deducted on all payments. The payer,
therefore, has to deduct and pay tax, even if the so-called deduction
comes out of his own pocket and he has no remedy whatsoever, even
where the sum paid by him is not a sum chargeable under the Act.
The interpretation of the Department, therefore, not only requires the
words "chargeable under the provisions of the Act" to be omitted, it
also leads to an absurd consequence. The interpretation placed by the
Department would result in a situation where even when the income
has no territorial nexus with India or is not chargeable in India, the
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Government would nonetheless collect tax. ......As stated
hereinabove, Section 195(1) uses the expression "sum chargeable
under the provisions of the Act." We need to give weightage to those
words. Further, section 195 uses the word 'payer' and not the word
"assessee". The payer is not an assessee. The payer becomes an
assessee-in-default only when he fails to fulfil the statutory obligation
under Section 195(1). If the payment does not contain the element of
income the payer cannot be made liable. He cannot be declared to be
an assessee-in-default. The abovementioned contention of the
Department is based on an apprehension which is ill founded. The
payer is also an assessee under the ordinary provisions of the Income-
tax Act. When the payer remits an amount to a non-resident out of
India he claims deduction or allowances under the Income-tax Act for
the said sum as an "expenditure". Under section 40(a) inserted vide
Finance Act, 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 other
sum to a non-resident is not liable to deduct tax if such sum is not
chargeable to tax under the Act.
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(ii) Circular No. 728 dated 30th October 1995 issued by the CBDT clarifies
that the payer who is expected to deduct TDS can take into consideration the
effect of DTAA on such payment.
(iii) If the contention of the Revenue that the moment there is remittance, the
obligation to deduct TDS arises is accepted, then it would result in
obliterating the words "chargeable under the provisions of the Act" in
Section 195 (1) of the Act.
(iv) The link between Section 195 (1), which is in Chapter XVII B and
Section 40 (a) (i) of the Act was acknowledged. It was noted that where the
payer is an Assessee he will claim the payment made to the non-resident as a
deduction. If on inquiry the AO finds that the sum paid in respect of which
TDS was not deducted is one chargeable to tax under the Act, he can
disallow such deduction. It is not as if the payer has to invariably first deduct
the TDS irrespective of the amount being chargeable to tax and then leave it
to the payee to claim refund.
47.3. It also requires to be noticed that in its decision in GE India (supra),
the Supreme Court dwelt at length on the earlier decision in Transmission
Corporation(supra). After discussing the facts of Transmission
Corporation (supra), the Supreme Court, in para 10 of the decision in GE
India (supra), observed as under:
"10......In our view, Section 195(2) is based on the "principle of
proportionality". The said sub-Section gets attracted only in cases
where the payment made is a composite payment in which a certain
proportion of payment has an element of "income" chargeable to tax
in India. It is in this context that the Supreme Court stated, "If no such
application is filed, income-tax on such sum is to be deducted and it is
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the statutory obligation of the person responsible for paying
such `sum' to deduct tax thereon before making payment. He has to
discharge the obligation to TDS". If one reads the observation of the
Supreme Court, the words "such sum" clearly indicate that the
observation refers to a case of composite payment where the
payer has a doubt regarding the inclusion of an amount in such
payment which is exigible to tax in India. In our view, the above
observations of this Court in Transmission Corporation case (supra)
which is put in italics has been completely, with respect,
misunderstood by the Karnataka High Court to mean 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 of the DTAA
have to be accounted for, it is plain that Explanation 2 to Section 195 (1)
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will not compel deduction of TDS where the payer is reasonably certain that
the sum paid for purchases is not chargeable to tax.
49. Before concluding this discussion, a reference may be made to the
decision in Aggarwal Chamber of Commerce v. Ganpat Rai (supra), relied
upon by learned counsel for the Revenue. There the Supreme Court was not
called upon to decide any issue in the context of a DTAA. The issue
considered was whether for the purposes of deduction of TDS,
determination of the world income of the payee was essential and whether
the payer was required to consider the impact of losses on taxability of the
sum paid and in respect of which TDS was to be deducted. Both issues were
answered in the negative. In the present case, the questions arise in an
entirely different context. The computation of income and the chargeability
of a sum to tax are two different concepts.
50. As far as question (ii) is concerned, it is plain that the Revenue had not
discharged its onus of showing that the Thailand and Singapore entities had
a PE in India. The AO had simply relied on the AO's own earlier decision
holding that Metal One Corporation Japan had a PE in India and on that
basis held that the Thailand and Singapore entities also had a PE in India.
This conclusion had no factual basis since neither entity had even an LO in
India. In any event the ITAT itself subsequently set aside that decision of the
AO in the case of Metal One Corporation, Japan and held that even the latter
did not have a PE in India. In the circumstances, the conclusion of the ITAT
in this regard cannot be faulted. Question (ii) is accordingly answered in the
negative, i.e. in favour of the Assessee and against the Revenue.
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Points of divergence
51. The reasons for the divergence of views are, therefore, obvious. As far as
question (i) is concerned, one fundamental reason is the premise on which
the opinion of my learned colleague proceeds viz., in para 41 of her opinion
that "Moreover, as per the facts of this case it is not a case of only purchase
of goods or a trading receipt.....the Assessee's income is for rendering
services as an intermediary between the customer and the vendor." Further
in para 47 she observes: "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."
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 non-
resident 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 have to be considered. I, therefore, do not subscribe
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to the view of my colleague as expressed in para 48 of her opinion that "the
obligation under Section 195 operates and exists independently of Section
40."
53. The second major reason for the divergence of opinion stems from my
conclusion that even after insertion of sub-clause (ia) in Section 40 (a) of the
Act, with effect from 1st April 2005, the discrimination in the consequence
for non-deduction of TDS for payments made for purchases from non-
residents and those made to residents for purchases, is apparent. In my
considered view the decision of this Court in Herbalife HC also holds
likewise after noticing the insertion of sub-clause (ia) in Section 40 (a)
although that case pertained to AY 2001-02 whereas the present case
pertains to AY 2006-07. Therefore, I conclude that Section 40 (a) (i) of the
Act will not apply to deny the Assessee the deduction. I am also of the view
that Herbalife HC is conclusive as to the interpretation of the expressions
`other disbursements' and `same conditions' in Article 26 (3) of the Indo US
DTAA (which is identical to Article 24 93) of the Indo Japan DTAA.
54. As far as question (ii) is concerned, I have taken note of the stand of
both the Assessee and the Revenue that the issue arises in the limited context
of the payments made to the non-resident entities of Thailand and
Singapore, the DTAAs with whom do not contain a non-discrimination
clause similar to the ones in the Indo-Japan and Indo US DTAAs. Factually,
it has been held by the ITAT that neither entity has even an LO in India. The
finding of the AO that that both entities had a PE was based only on his
decision in the case of Metal One Corporation Japan, which decision has
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been set aside by the ITAT. I also, therefore, do not agree that question (ii)
requires to be modified to include the question whether the said entities have
a `business connection' in India.
55. Finally, as regards Explanation 2 to Section 195 (1) of the Act, inserted
by the FA 2012 with retrospective effect from 1st April 1962, I have
concluded that the said Explanation, obligates the `payer', whether a
resident or a non-resident, to deduct TDS. It does not dispense with the
fulfilment of the pre-condition that the sum in respect of which TDS is to be
deducted has to be shown to be chargeable to tax. In this regard I rely on the
decision in GE India (supra) as well as the Explanatory Memorandum to
the said amendment inserted by FA 2012.
56. I also have taken note of the CBDT Circular dated 30th October 1995
which clarifies that the payer who is expected to deduct TDS can take into
consideration the effect, if any, of the DTAA on such payment. I, therefore
do not agree with the opinion of my colleague as expressed in para 33 that
"the obligation to deduct tax under Section 195 is inescapable insofar as the
payer is concerned." These are the broad points of divergence. The details
are in our respective opinions.
Conclusion
57. The two questions framed should, in my considered opinion, be
answered in the negative, that is in favour of the Assessee and against the
Revenue.
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58. Consequently the present appeal of the Revenue is dismissed.
S. MURALIDHAR, J.
NOVEMBER 17, 2017
dk/rd
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