$~
* IN THE HIGH COURT OF DELHI AT NEW DELHI
+ ITA 7/2007
Reserved on: March 30, 2016
Decision on: May 13, 2016
COMMISSIONER OF INCOME TAX ..... Appellant
Through: Mr. Ashok K. Manchanda, Senior
Standing counsel with Mr. Raghvendra Singh,
Ms. Vibhooti Malhotra, Junior standing counsel
and Mr. Aamir Aziz, Advocate.
versus
HERBALIFE INTERNATIONAL INDIA
PVT. LTD. .....Respondent
Through: Mr. Ajay Vohra, Senior Advocate
with Mr. Mukesh Butani, Mr. Vishal Kalra and
Ms. Khyati Dadhwal, Advocates.
Mr. M. S. Syali, Senior Advocate with
Mr. Mayank Nagi, Ms. Husnal Syali and
Mr. Tarun Singh, Advocates for Interveners.
CORAM:
JUSTICE S. MURALIDHAR
JUSTICE VIBHU BAKHRU
JUDGMENT
% 13.05.2016
Dr. S. Muralidhar, J.:
1. This appeal by the Revenue is directed against the impugned order
dated 28th February 2006 passed by the Income Tax Appellate Tribunal
(ITAT`) in ITA No. 1771/Del/2005 for the Assessment Year (AY`)
2001-02.
Background facts
2. The background facts are that the Assessee, which is the Indian
ITA No. 7/2007 Page 1 of 35
subsidiary of Herbalife International Inc. (HII`), USA, carries on
business of trading and marketing of herbal products for use in weight
management, to improve nutrition and enhance personal care. The
Assessee was incorporated as a company in India with 100% foreign
equity participation, pursuant to an approval granted by the Department
of Industrial Policy and Promotion, Secretariat for Industrial Assistant,
Ministry of Industry, Government of India. The approval was obtained by
HII. In terms of the approval, the Assessee was to manufacture herbal
products on contract basis in India and should not import these items.
3. It is stated that HII developed significant expertise over the years. It
provided data processing services, record keeping, distributor/supervisor
information and order and shipment processing etc. HII also provided
financial and marketing services. Apart from the direct services, HII also
rendered some indirect administrative services. Thus, services are
rendered to several subsidiaries worldwide and the costs incurred in this
regard are centralized costs, which is allocated to the overseas
subsidiaries on a scientific basis.
4. The Assessee entered into an Administrative Services Agreement
(ASA`) dated 10th November 1999 with M/s. Herbalife International of
America Inc. (HIAI) in terms of which HIAI agreed to provide data
processing services, accounting, financial and planning services,
marketing services, long term financial planning for the Assessee,
analysis of prospects etc., for the purpose of obtaining approval for the
products from government and regulatory bodies and if necessary to
assist in protecting the trademark, trade name logo of the products. The
Assessee was to pay an administrative fee to HIAI in terms of the ASA.
5. For the purpose of manufacturing the products in India on a contract
ITA No. 7/2007 Page 2 of 35
basis, the Assessee entered into Licence and Technical Assistance
Agreement (LTAA`) dated 10th November 1999 with HII, the owner of
the incorporeal right relating to the process of manufacture of the various
products. As the owner of the technical know-how regarding
manufacture, HII permitted the Assessee, as a licensee, to manufacture
the products.
6. For the AY in question, in the returns filed by it, the Assessee claimed
an expenditure of Rs. 5.83 crores as administrative fee paid to HIAI as
consideration for the various services provided to the Assessee under the
ASA. The breakup of the said sum on the basis of the period it relates to
is as follows:
1st January 2000 to 31st December 2000 10,00,000 US$
1st January 2001 to 31st March 2001 2,50,000 US$
12,50,000 US$
12,50,000 US$ is equivalent to Rs. 5.83 crores.
7. It is stated that HIAI followed the calendar year and the annual charges
payable for the calendar year 2000 was 10,00,000 US$. The case of the
Revenue was that since the administrative fee claimed as deduction by the
Assessee for the period 1st January 2000 to 31st March 2000 related to the
previous year relevant to AY 2000-01, it could not be claimed as a
deduction in AY 2001-02. On the other hand the plea of the Assessee was
that the payment by the Assessee to HIAI required the prior permission of
the Reserve Bank of India (RBI`) under the Foreign Exchange
Regulation Act, 1973 (FERA`). Though the Assessee had applied for
grant of such permission on 24th March 2000, the RBI granted permission
only on 30th June 2000. The RBI directed the Assessee to remit only
10,00,000 US$ as reimbursement of head office expenses. The RBI
ITA No. 7/2007 Page 3 of 35
further directed that income tax should be paid on the remittances in
terms of the Income Tax Act, 1961 (Act`). The case of the Assessee was
that the expenditure in question cannot be deemed to have accrued to the
Assessee in accordance with law without the RBI approval. The Assessee
accordingly treated the expenditure as having accrued only during the
previous year relevant to AY 2001-02.
8. The further submission was that by 31st March 2000 when the
accounting year for AY 2000-01 ended, the Assessee had not received the
details regarding the share of common expenses payable by it to HIAI.
The Assessee pointed out that since the ASA commenced only from 11 th
September 2000 (M/s. HIAI had waived ASA fee from 11th September
2000 to 31st December 2000) there was no past precedent which enabled
the Assessee to make a provision for administrative fee on an estimate
basis. The Assessee stated that an interim invoice was received on 30th
June 2000 for US$ 333,333. The second interim invoice for the same sum
was raised on 30th September 2000 and the final invoice on the same
amount on 31st December 2000. The last invoice duly supported with cost
allocation sheets was received on 31st January 2001 and the total amount
payable to HIAI towards administrative fee worked out to US$ 1,015,240.
In terms of the approval granted by the RBI only an amount of US$ 1
million was remitted. The balance US$ 15,240 was waived by HIAI.
According to the Assessee, this formed a prudent basis for determining
accrual of such expenses for the first quarter of 2001 (1st January to 31st
March 2001) in the Assessee`s books.
9. For the period 1st January 2001 to 31st March 2001, the Assessee
pointed out that the bills up to 31st December 2000 were received from
HIAI and on the basis of the above proceeds, it had estimated the same at
ITA No. 7/2007 Page 4 of 35
1/4th of the sum payable for a period of 12 months. The second plea was
that with the Foreign Exchange Management Act, 1999 (FEMA`)
becoming effective from 1st June 2000, the payment could be made on
current account transactions. In terms of Section 5 of FEMA foreign
exchange could be drawn from an authorized dealer without RBI's prior
permission. On account of both factors it was contended that the sum
payable by the Assessee to HIAI could be ascertained, and had accrued
and arisen to the Assessee and was, therefore, allowable as deduction
during the AY in question.
Assessment order
10. The AO, in the assessment order dated 10th March 2004, held that
since the services were rendered in the previous year 1999-2000, the
liability had to be accounted for in the accounts for the year ending on
31st March 2000. The AO held that the approval from the RBI was only
for the purposes for remittance. The said administrative expenses were,
therefore, disallowed. As regards the fees in relation to the present year
2000-01, the AO observed that under Section 9 (1) (vii) of the Act, the
income by way of fees for technical services (FTS`) payable by a person
who is a resident in India would be deemed to accrue or arise in India
because the services have been utilized in India. Therefore, under Section
195 of the Act, the Assessee was liable to deduct tax at source (TDS`) on
the said amount. The case of the Assessee was that this was only a cost
sharing arrangement and was not in the nature of a fee being remitted
overseas and therefore, it was not liable to deduct tax at source. However,
the AO disagreed and disallowed this expenditure invoking Section 40 (a)
(i) of the Act.
11. As regards the fees relating to the period from 1 st January 2001 to 31st
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March 2001 the AO observed that the amount was not to be paid by the
Assessee as it was a dead liability not to be discharged at any future date.
The Assessee had not provided any liability on this account in the
subsequent years as well. The AO has, therefore, not allowed the said
expenses.
12. The AO has also disallowed the claim of Rs. 53,63,731 on account of
lease hold improvements made by the Assessee during the AY in question
although the amount had been capitalized in its books. The AO observed
that the details filed by the Assessee showed that the expenditure was on
account of fixing of new aluminium sliding windows, new interior work
including aluminium partition, cupboards, counters, storage, tables,
chairs, electrical fittings etc. This was treated as capital expenditure by
the AO as the expenditure was not in the nature of current repairs and
depreciation was allowed on the same
13. The third issue related to the loss in the sum of Rs. 73,17,184 on
account of foreign exchange (FE`) fluctuation. The Assessee had booked
a net loss of Rs. 5,97,184 on account of year and re-statement of
liabilities. The AO observed that the loss on account of exchange rate
would arise only at the time of remission and therefore, disallowed the
said loss.
Order of the CIT (A))
14. Aggrieved by the aforementioned assessment order, the Assessee filed
an appeal before the Commissioner of Income Tax (Appeals) [CIT (A)`].
By an order dated 25th February 2005, the CIT (A) disposed of the
Assessee`s appeal by holding that the administrative expense was in the
nature of FTS rendered and was taxable in India in the hands of HIAI and
therefore, Section 40 (a) (i) stood attracted. CIT (A) did not discuss the
ITA No. 7/2007 Page 6 of 35
allowability of the expenses for the quarters ending on 31st March 2000
and 31st March 2001.
Order of the ITAT
15. The Assessee then went in appeal before the ITAT. By the impugned
order dated 28th February 2006 the ITAT allowed the appeal of the
Assessee and held that a sum of Rs. 5.83 crores being administrative fee
paid by the Assessee to HIAI was allowable as deduction. It was held that
Section 40 (a) (i) of the Act could not be invoked by the AO to disallow
the claim for deduction as the payment in question was not taxable at the
hands of the payee, i.e., HIAI as business income. It was held that HIAI
did not have a permanent establishment (PE) in India. Further, even if it
was taxable, it had to be examined whether it was fees for included
services (FIS) under Article 12 (4) of the Double Taxation Avoidance
Agreement (DTAA`) entered into between USA and India. Further in
light of Article 26 (3) of the DTAA, Section 40 (a) (i) of the Act was
discriminatory and could not be invoked to disallow the claim of the
Assessee for deduction even if the sum in question was chargeable to tax
in India.
16. As regards the fee attributable to the period from 1 st January 2000 to
31st March 2000, the ITAT observed that the payment could not be made
by the Assessee without seeking prior approval of the RBI which came
about only on 30th June 2000. The liability accrued to the Assessee during
the AY in question and was allowable as deduction during the year. Even
as regards the fees payable for the period from 1st January 2001 to 31st
March 2001, the ITAT observed that though the approval from the RBI
was not required and though the Assessee had not received any bill for
the this period from HIAI, it was still allowable as deduction since the
ITA No. 7/2007 Page 7 of 35
Assessee had estimated it on a reasonable basis i.e. on the basis of the bill
received for the period from 1st January 2000 to 31st December 2000.
Reference was made by the ITAT in the impugned order to the decision
of the Supreme Court in Bharat Earthmovers v. Commissioner of
Income Tax (2000) 245 ITR 428. The ITAT allowed the entire sum of
Rs. 5.83 crores as deduction.
17. The ITAT also allowed expenditure of Rs. 53,63,731 towards
improvements carried out in respect of the premises taken on lease,
relying on the earlier order passed by the ITAT in the case of same
Assessee for the AYs 1999-2000 and 2000-01 in ITA Nos. 3098 and
2664/Del/04. Relying on the decision of the Special Bench of the ITAT in
ONGC Limited v. Deputy Commissioner of Income Tax (2002) 83 ITD
151 [ITAT(Del)], the ITAT allowed a sum of Rs. 5,97,184 towards loss
on account of FE fluctuation.
Questions of law
18. At the time of admission of the appeal, on 21st October 2009 the
following questions of law were framed by the Court:
(a) Whether the ITAT was correct in law in allowing the sum of
Rs. 5.83 crores being administrative fee paid by the Assessee to
M/s. Herbalife International of America Inc.?
(b) Whether the ITAT was correct in holding that the sum of Rs.
5.83 crores was not taxable in the hands of payee in India either as
fees for technical services or as business income?
(c) Whether the ITAT was correct in holding that the provisions of
Section 40 (a) (i) of the Act is discriminatory and therefore not
applicable in the present case as per provisions of Article 26 (3) of
the Indo-US DTAA.
(d) Whether ITAT was justified in law in allowing the payment
relating to the period for 1st January 2000 to 31st March 2000 to the
ITA No. 7/2007 Page 8 of 35
Assessee as deduction despite the fact that it was for a prior period
expense and liability to pay the same was not accrued during the
year?
(e) Whether the ITAT was correct in law in holding that the
liability to pay the amount relating to the period from 1st January
2000 to 31st March 2000 accrued during the year as RBI had
accorded its approval during the year?
(f) Whether the ITAT was correct in law in allowing the
expenditure on account of administrative fee relating to the period
from 1st January 2001 to 31st March 2001 to the Assessee as
deduction despite the fact that the foreign company had not raised
the bill for the same?
19. On 15th October 2015 the questions were reframed as under:
(a) Whether the ITAT was correct in law in allowing the sum of
Rs. 5.83 crores being the administrative fee paid by the Assessee to
M/s. Herbalife International America Inc.?
(b) Whether the ITAT was correct in holding that Section 40 (a) (i)
of the Act is discriminatory and therefore, not applicable in the
present case as per provisions of Article 26 (3) of the Indo-US
DTAA?
(c) Whether the ITAT was justified in law in allowing the payment
relating to the period for 1st January 2000 to 31st March 2000 to the
Assessee as deduction despite the fact that it was a prior period
expense and liability to pay the same did not accrue during the
year?
(d) Whether the ITAT was correct in law in allowing the
expenditure on account of administrative fee relating to the period
from 1st January 2001 to 31st March 2001 to the Assessee as
deduction despite the fact that the foreign company had not raised
the bill for the same?
Submissions on behalf of the Revenue
20. At the outset it is pointed out by Mr. Ashok Manchanda, learned
Senior standing counsel appearing for the Revenue, that the during the
pendency of the above proceedings the Assessee invoked the Mutual
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Agreement Procedure (MAP`) of the DTAA. The MAP culminated with
the finding of the Bangalore Bench of the ITAT by its order date 23rd
December 2009 in ITA Nos. 842 to 844 (Bang.)/2007 [M/s. Herbalife
International India Private Limited v. The Income Tax Officer ] that
25% of the income on account of administrative fees is taxable in India.
The Bangalore Bench of the ITAT had also directed that TDS under
Section 195 of the Act ought to be deducted at 25% of the administrative
expenses amount.
21. The first submission made by Ms. Vibhooti Malhotra, learned counsel
also appearing on behalf of the Revenue in the present appeal, is that
without determining the character of the payment it is not possible to
resort to the provisions of non-discrimination contained in Article 26 (3)
of the DTAA. It is submitted that non-discrimination in deduction rule in
terms of Article 26(3) of the DTA applies only when the payments in
question are in the nature of either interest, royalty and FTS or other
disbursements. Further, on the question of allowability of the payment as
deduction, such payment have to be tested on the 'same condition' as if
the payment in question has to be made to a resident, and where the
exceptions mentioned in Article 26 (3) are not applicable. It is submitted
that in the absence of a determination of the character of administrative
fees, the first step of enquiry for applying the non-discrimination rule
fails.
22. It is further submitted that if the exceptions mentioned in Article 26
(3) of the DTAA can be broadly classified as situations where excessive
payments have been made due to the special relationship between the
parties [Articles 9(1), 11(7) and 12(8)]. Article 9 (1) is applied in the
context of domestic transfer pricing regulations. Article 11 (7) envisaged
ITA No. 7/2007 Page 10 of 35
excessive interest having been paid on account of a special relationship
between payer and payee. Article 12 (8) envisaged excessive royalty or
FIS being paid on account of such special relationship. It is submitted that
the ITAT failed to record any specific finding in relation to the above
exceptions. Further, in the course of the assessment proceeding, no
objection was raised regarding the question of applicability of Article 26
(3) of the DTAA and, therefore, there was no determination whether the
payment made by the Assessee to its US parent was excessive or not.
23. It is further submitted that the next step in application of the non-
discrimination rule was to examine under the 'same conditions' deduction
would have been allowed if the same payment had been made to a
resident. It is pointed out that Article 26 (1) prohibits discrimination on
the basis of nationality and uses the expression same circumstances`.
Article 26 (2) prohibits discrimination vis-a-vis computing tax liability of
PEs and uses the expression same activities`. It is submitted that while
the expressions similar circumstances` and same activities` have been
discussed in the OECD Commentaries there is little indication on what is
implied by the expression same conditions` found in Article 24 (4) of the
OECD Model which is more or less similar to Article 26 (3) of the
DTAA.
24. It is contended that Section 40 (a) (i) of the Act does not discriminate
between a resident doing business with a non-resident and resident doing
business with a resident under similar conditions`. Accordingly, is
submitted that Section 40 (a) (i) cannot be covered by Article 26 (3) of
the DTAA. It is submitted that requirement of withholding taxes while
making payments to non-residents does not offend the principle of non-
discrimination. It is submitted that the onus is on the payer to deduct
ITA No. 7/2007 Page 11 of 35
TDS. However, to ensure compliance on the part of the payer, Section
201 was introduced in the Act which provides that in event of failure to
deduct, the person making payment will be treated as assessee in default
and the tax shall be recovered from it. Section 40 (a) (i) was also a
deterrent provision which promotes compliance on the part of resident
payers. Section 40 (a) (i) provided that the in the event the resident payers
do not deduct tax on payments to non-residents, they will not be entitled
to deduction for the said expenditure. The distinction in Section 40 (a) (i)
is situs of payment which was not a prohibited differentia under the
DTAA.
25. It is further submitted that Section 40 (a) (i) of the Act did not create
any classification between resident payments and non-resident payments.
It deals with disallowance of expenditure where TDS has not been
deducted. Secondly, assuming that Section 40 (a) (i) creates a distinction
between resident payments and non-resident payments, it was built on
intelligible differentia having a rational nexus with the object of Section
40 (a) (i) of the Act. The basis is that while there are several sources for
collection and recovery of tax from resident, the same opportunities may
not be available in the case of a non-resident. Consequently, the Act
envisages TDS only on non-resident payments to collect tax at the very
source of income. Reference is made to the decision of Pune Bench of the
ITAT in Automated Securities Clearance Inc. v. Income Tax Officer
(2008) 118 TTJ 619 [ITAT(Pune)]. It is submitted that the impugned
order of the ITAT has been passed on the basis of a very superficial and
prima facie reading of provisions of Article 26 (3) of the DTAA.
26. It is contended that Section 40 of the Act is not a deductibility
provision and hence outside the purview of Article 23 of the DTAA. In
ITA No. 7/2007 Page 12 of 35
terms thereof the plea of non-discrimination can be raised only by the
non-resident and not by a resident making the payment. It is further
pointed out that the treaty benefit can be availed only where the specific
provision overrides the modus provided in the Act. Since no such
provision existed in the treaty, Section 40 (a) (i) needed to be given full
effect to, unbridled by the treaty.
Submissions on behalf of the Assessee
27. On behalf of the Assessee it is submitted as under:
(a) Section 40 (a) (i) of the Act cannot be invoked in view of
Article 26 (3) of the DTAA which mandates that the conditions for
allowance or disallowance of expenses in case of payment made to
residents and non-residents have to be the same.
(b) Prior to its amendment by the Finance (No. 2) Act, 2004
Section 40 (a) (i) of the Act provided for disallowance of payments
made to non-residents where tax is not deducted at source, whereas
a similar payment to resident did not result in such disallowance.
After its amendment in 2004, certain payments to residents without
deduction of TDS was disallowed under Section 40 (a) (i) of the
Act.
(c) A Circular 5 of 2005 dated 15th July 2005 issued by the Central
Board of Direct Taxes (CBDT`) explained that the purpose of
introduction of clause (1a) to Section 40 of the Act was to
augment compliance of TDS provisions for residents. It is pointed
out that there were no deterrent measures for failure to deduct TDS
on payments to residents. Such measures existed only in respect of
payment to non-residents. Thus, there existed a differential
treatment which amounted to discrimination as envisaged under
ITA No. 7/2007 Page 13 of 35
Article 26 (3) of the DTAA.
(d) A resident left with a choice of dealing with a resident or a non-
resident would opt to deal with a resident rather than a non-resident
owing to Section 40 (a) (i) of the Act and to this extent the non-
resident is discriminated against.
(e) Reference is made to Article 24 of the OECD Model
Convention which is pari materia with Article 26 (3) of the
DTAA. The OECD Commentary on Article 24 explains that the
above article was designed to end a particular form of
discrimination resulting from the fact that the deduction of interest,
royalties and other disbursements allowed without restriction when
the recipient is resident, is restricted or even prohibited when he is
a non-resident. Reference is also made to Article 24 (4) of the UN
Model Convention which is also identical terms as Article 26 (3) of
the DTAA.
(f) Relying on the decisions in Union of India v. Azadi Bachao
Andolan (2003) 263 ITR 706 (SC), Ishikawajima Harima Heavy
Industries Ltd. v. DIT (2007)288 ITR 408 (SC), DIT v. Morgan
Stanley & Co. (2007) 292 ITR 416 (SC), Asia Satellite Tel. Co.
Ltd. v. DIT (2011) 332 ITR 340 (Del) and CIT v. EKL Appliances
Ltd. (2012) 345 ITR 241 (Del) it is submitted that international
commentaries can be relied upon on the interpreting the provisions
of DTAA. Reference is also made to the book The International
Tax Primer` authored by Brain J. Arnold and Michael J. Mcintyre
as well as Double Taxation Conventions and International Tax
Laws' manual by Phillip Baker.
ITA No. 7/2007 Page 14 of 35
(g) There is a categorical finding of the AO which has been
confirmed by the CIT (A) that the payment made to HIAI was in
the nature of FTS as defined in Explanation 2 to Section 9 (1) (vii)
of the Act. In that view of the matter, the contention of the
Revenue that ITAT could not have proceeded to apply the non-
discrimination provision in Article 26 (3) of the DTAA without
recording a finding as to the nature of the payment made was
untenable. The ITAT had correctly proceeded on the basis that the
payment was in the nature of FTS liable to tax in India consistent
with the stands of the Revenue before the AO as well as before the
CIT (A).
(h) Section 40 of the Act is in the nature of a non-obstante
provision, which overrides other provisions including Sections 30
to 38 of the Act. The expenditure allowable under Sections 30 to
38 of the Act in computing business income is subject to the
deductibility condition in Section 40 of the Act.
(i) Section 40 (a) (i) of the Act imposes a condition precedent, i.e.,
deduction of TDS as regards taxability of payment to a non-
resident including payment of FTS. However, the resident is not
governed by the 'same condition' and to that extent Article 26 (3) of
the DTAA stood attracted. Article 26 (3) of the DTAA was not
concerned with discrimination in terms of nationality but with
treatment of enterprises of a Contracting State under the domestic
tax laws of other state`.
(j) The expression under the same conditions` refers to the
conditions for deductibility in relation to payments made under the
domestic law and does not refer to discrimination on account of
ITA No. 7/2007 Page 15 of 35
compliance requirements. This essentially meant that conditions
for allowance or disallowance of expenses in case of payments
made to residents and non-residents had to be same. Under Section
90 of the Act, where the DTAA is more beneficial to the Assessee
taxpayer, it would prevail over the Act.
(k) The disallowance of expenses pertaining to the quarter ended
31st March 2000 as a 'prior-period' item was erroneous considering
that the first debit note/invoice was raised by HIAI on 30th June
2000 and there was no possibility of an estimation of the liability in
the absence of any past precedents or basis. Reliance is placed on
the decisions in Bharat Earth Movers v. CIT (supra) and
Saurashtra Cement & Chemical Industries Limited v. CIT (1995)
213 ITR 523 (Guj).
(l) The remittance for the period from 1st April 2000 onwards, did
not require the prior approval of the RBI. As regards the period up
to 31st March 2000, the RBI approval was received on 30th June
2000 for remittance of amount up to US$ 1 million. The said
expenditure cannot be said to have accrued under law without
approval having being so accorded by the RBI.
(m) Reliance is placed on the decisions in Nonsuch Tea Estate
Ltd. v. CIT (1975) 98 ITR 189 (SC), Dorr-Oliver (India) Ltd. v.
CIT (1998) 234 ITR 723 (Bom), and Pfizer Corporation v. CIT
(2003) 259 ITR 391 (Bom).
(n) As regards the disallowance of the expenses pertaining to the
period 1st January 2001 to 31st March 2001, a reasonable estimate
was made on the basis of the invoices raised by HIAI for the period
ITA No. 7/2007 Page 16 of 35
1st January 2000 to 31st December 2000. This formed a prudent
basis for accrual of such expenses for the first quarter of the year
2001 in the books of the period ended 31st March 2001. After the
enactment of FEMA, the payment in question by the Assessee to
HIAI would fall in the category of current account transaction.
Therefore, such payments did not call for any permission from the
RBI. As per the mercantile system of accounting, the Assessee
claimed the expenditure accrued for the relevant financial year.
The mere non-payment of the said expenses by the Assessee to
HIAI during the AY in question will postpone the accrual of the
liability. Therefore, the disallowance made by the AO was not in
accordance with law.
Submissions of the intervener
28. The impugned order of the ITAT refers to the decision of the ITAT in
the case of Mitsubishi Corporation India Limited where similar
questions are involved. Mr. M.S. Syali, learned Senior counsel for
Mitsubishi Corporation India Limited was, therefore, permitted to address
the Court. It is pointed out that the non-discrimination envisaged by
Article 26 (3) of the DTAA is a sub-set of the discrimination based on
nationality and need not be construed independently. The words other
disbursement` in Article 26 (3) of DTAA takes colour from context. They
cannot be restricted to income of a passive character. The doctrines of
noscitur-a-sociis and ejusdem generis would not apply.
29. A reference is made to several passages of the decision of the
Supreme Court in Union of India v. Azadi Bachao Andolan (supra). It is
pointed out that the treaty embodies a well thought out modus of bringing
about equality in treatment of a resident and the non-resident in
ITA No. 7/2007 Page 17 of 35
determining profits, and, giving deduction of the specified items. It is
submitted that the inconvenience of collecting tax from the payee who is
not resident, but within reach, as compared to deduction at source by the
payer at the time of payment is not a factor that can negate the intent of
Article 26 (3) of the DTAA.
30. It is further submitted that the scope of Section 40 (a) (i) was
expanded by insertion of Section 40 (a) (ia). The latter provision was to
ensure that there was parity in the disallowance. However, if the nature of
payment (as in the present case) does not fall under Section 40 (a) (ia) of
the Act then the discrimination shall ensue. It is further submitted that the
expression under same conditions` qualifies deductibility and not its
being subject to deduction of tax at source. It is further submitted that
since Article 9 contemplates an AE, once the status is that of an AE the
entire Article 26 (3) is ruled out.
Exceptions to Article 26 (3) DTAA do not apply
31. The questions that have been framed by this Court revolve around the
interpretation of Article 26 (3) of the DTAA and Section 40 (a) (i) of the
Act.
32. Article 26 (3) of the DTAA reads as under:
Except where the provisions of paragraph 1 of Article 9
(Associated Enterprises), paragraph 7 of Article 11 (Interest),
or paragraph 8 of Article 12 (Royalties and Fees for included
Services) apply, interest, royalties, and other disbursements
paid by a resident of a Contracting State to a resident of the
other Contracting State 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 State.
33. There are specific kinds of payments mentioned in Article 26 (3) of
ITA No. 7/2007 Page 18 of 35
the DTAA. These require treatment in the same manner vis-a-vis a
resident and a non-resident. They include interest, royalty and other
disbursements. Article 26 (3) therefore states that for the purpose of
determining the taxable profits of a resident of a contracting State (in the
present case the Assessee who is a resident and HIAI of the other
contracting State, i.e., USA). The payment of the above amounts shall be
deductible under the same conditions` that apply to such payment being
made to a resident of the contracting State (India). Article 26 (3) borrows
the text and language of Article 24 of the OECD Model Convention.
34. There are three exceptions as far as Article 26 (3) is concerned. These
are when the following provisions apply namely Article 9 (1) relating to
AE, Article 11 (7) (interest) or Article 12 (8) (royalties and fees for
Included Services). At the outset it requires to be noticed that fees for
included services (FIS) is different from FTS. It is not even the Revenue`s
case that the payment made by the Assessee to HIAI which is sought to
be allowed as a deduction, is in the nature of FIS. It is also not the case of
the Revenue that Article 9 (1) or Article 11 (7) applies in the instant case.
35. Article 9 (1) provides for adjustment and reason the transfer price
mechanism. This provision is not invoked in the present case in the
context of the present deduction. Likewise, it is not the Revenue`s case
that Article 11 (7) or 12 (8) of the DTAA is attracted. Throughout, the
case of the Revenue has been that the payment is in the nature of FTS.
There is a specific finding of the AO as well as CIT (A) to this effect. It
is not therefore open to the Revenue to now contend that the ITAT
erroneously and hastily applied Article 26 (3) without first returning a
finding on the nature and character of the payment made by the Assessee
to HIAI.
ITA No. 7/2007 Page 19 of 35
36. Consequently, the Court proceeds on the basis that the exceptions
mentioned in the Article 26 (3) do not apply in the facts and
circumstances of the case.
37. At this juncture, it has to be noticed that Bangalore Bench of the
ITAT did render its opinion on 23rd December 2009 reported at 2009
taxmann.com 1024 (Bangalore Tribunal) that TDS under Section 195 of
the Act ought to be deducted at 25% of the administrative expenses
amount and that by no means settles the issue of the nature and character
of the payment as far as the present appeals are concerned. For the AY in
question, the AO and the CIT (A) have proceeded on the basis that the
payment was in the nature of the FTS as defined in Explanation 2 to
Section 9 (1) (vii) of the Act and this is confirmed by the CIT (A).
'Other disbursements'
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 of which the expression other disbursement`
ITA No. 7/2007 Page 20 of 35
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 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.
42. At one stage of the proceedings, the Assessee sought to contend that
the payment was FIS covered under Article 12 (4) of the DTAA. The
ITAT did not address this issue. It addressed the question whether, even
assuming it was FIS, Section 40 (a) (i) of the Act cannot be applied and
consequently, no disallowance can be made. Before this Court no
question has been framed at the instance of the Assessee that the payment
is covered by Article 12 (4) of the DTAA. Consequently, this question is
not examined by the Court.
Section 40 (a) (i) of the Act
43. Once it is held that the FTS is covered within the expression other
disbursements`, the question that next arises is whether for the purpose of
determining the taxable profits of the Assessee, the payment made by it to
HIAI is deductable under the same conditions` as would apply if it had
been paid to resident in India.
44. In order to determine what is non-deductible, Section 40 (a) of the Act
as it stood at the relevant time reads as under:
ITA No. 7/2007 Page 21 of 35
Section 40 Amounts not deductible
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 outside India, on which tax
has not been paid or deducted under Chapter XVII-B:
Provided that where in respect of any such sum, tax has
been paid or deducted under Chapter XVII-B in any
subsequent year, such sum shall be allowed as a deduction in
computing the income of the previous year in which such tax
has been paid or deducted.
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;
(ii) any sum paid on account of any rate or tax levied on the
profits or gains of any business or profession or assessed at a
proportion of, or otherwise on the basis of, any such profits
or gains;
(iia) any sum paid on account of wealth-tax.
Explanation.--For the purposes of this sub-clause,
"wealth-tax" means wealth-tax chargeable under the
Wealth-tax Act, 1957 (27 of 1957), or any tax of a
similar character chargeable under any law in force in
any country outside India or any tax chargeable under
such law with reference to the value of the assets of,
or the capital employed in, a business or profession
carried on by the assessee, whether or not the debts of
the business or profession are allowed as a deduction
ITA No. 7/2007 Page 22 of 35
in computing the amount with reference to which such
tax is charged, but does not include any tax chargeable
with reference to the value of any particular asset of
the business or profession;
(iii) any payment which is chargeable under the head
"Salaries", if it is payable outside India and if the tax has not
been paid thereon nor deducted therefrom under Chapter
XVII-B;
(iv) any payment to a provident or other fund established
for the benefit of employees of the assessee, unless the
assessee has made effective arrangements to secure that tax
shall be deducted at source from any payments made from
the fund which are chargeable to tax under the head
"Salaries";
45. Section 40 (a) was later amended by the Finance (No. 2) Act, 2004
and the amended section reads as under:
Section 40 Amounts not deductible
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 during the previous year, or in the subsequent
year before the expiry of the time prescribed under sub-
section (1) of section 200:
ITA No. 7/2007 Page 23 of 35
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.--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, 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 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.--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;
ITA No. 7/2007 Page 24 of 35
(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 ;
(ib) any sum paid on account of securities transaction tax
under Chapter VII of the Finance (No. 2) Act, 2004;
(ii) any sum paid on account of any rate or tax levied on the
profits or gains of any business or profession or assessed at a
proportion of, or otherwise on the basis of, any such profits
or gains;
(iia) any sum paid on account of wealth-tax.
Explanation.--For the purposes of this sub-clause, "wealth-
tax" means wealth-tax chargeable under the Wealth-tax Act,
1957 (27 of 1957), or any tax of a similar character
chargeable under any law in force in any country outside
India or any tax chargeable under such law with reference to
the value of the assets of, or the capital employed in, a
business or profession carried on by the assessee, whether or
not the debts of the business or profession are allowed as a
deduction in computing the amount with reference to which
such tax is charged, but does not include any tax chargeable
with reference to the value of any particular asset of the
business or profession;
(iii) any payment which is chargeable under the head
"Salaries", if it is payable--
(A) outside India; or
(B) to a non-resident,
and if the tax has not been paid thereon nor deducted
therefrom under Chapter XVII-B;
(iv) any payment to a provident or other fund established for
the benefit of employees of the assessee, unless the assessee
has made effective arrangements to secure that tax shall be
deducted at source from any payments made from the fund
which are chargeable to tax under the head "Salaries";
(v) any tax actually paid by an employer referred to in
ITA No. 7/2007 Page 25 of 35
clause (10CC) of section 10;"
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 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 26 of 35
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 non-
discrimination 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 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)
ITA No. 7/2007 Page 27 of 35
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.
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 and 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 (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
ITA No. 7/2007 Page 28 of 35
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
ITA No. 7/2007 Page 29 of 35
need foreign investment. The Court felt that this was a matter 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
ITA No. 7/2007 Page 30 of 35
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 deducted while making payment of FTS in terms of
Section 40 (a) (i) of the Act.
57. A plain reading of Section 90 (2) of the Act, makes it clear that the
provisions of the DTAA would prevail over the Act unless the Act is
more beneficial to the Assessee. Therefore, except to the extent a
provision of the Act is more beneficial to the Assessee, the DTAA will
override the Act. This is irrespective of whether the Act contains a
provision that corresponds to the treaty provision. In Union of India v.
Azadi Bachao Andolan (supra) the Supreme Court took note of the
Circular No. 333 dated 2nd April 1982 issued by the CBDT on the
question as to what the assessing officers would have to do when they
find that the provision of a DTAA treaty is not in conformity with the
Act.:
Thus, where a Double Taxation Avoidance Agreement
provided for a particular mode of computation of income, the
same should be followed, irrespective of the provision of the
Income Tax Act. Where there is no specific provision in the
Agreement, it is the basic law, i.e., Income Tax Act, that will
govern the taxation of income."
58. Further in Union of India v. Azadi Bachao Andolan (supra), after
taking note of the decisions of various high courts on the purpose of
Double Taxation Avoidance Conventions qua Section 90 of the Act, the
Supreme court observed as under:
ITA No. 7/2007 Page 31 of 35
"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 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 DTAs
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.
59. Consequently, the Court negatives the plea of the Revenue 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 more beneficial provision.
60. The reliance by the Revenue on the decision of this Court in Hyosung
Corporation v. AAR (2016) 382 ITR 371 (Del) is misplaced. There the
Court negatived a challenge to the constitutionality of Section 245R (2)(i)
of the Act on the ground that it was violative of Article 14 of the
Constitution as well as Article 25 of the DTAA between India and South
Korea. Section 245R (2) of the Act barred a non-resident applicant from
approaching the Authority for Advance Ruling (AAR) where the matter
was pending before any income tax authority. The matter, therefore, only
pertained to the procedure of filing a petition before the AAR and not as
regards any substantive right. The decision of the Pune Bench of the ITAT
ITA No. 7/2007 Page 32 of 35
in Automated Securities Clearance Inc. v. Income Tax Officer (supra)is
no assistance to the Revenue since the said decision is said to be overruled
by the Special Bench of the ITAT in the case of Rajeev Sureshbhai
Gajwani vs ACIT (2011) 8 ITR (Trib) 616 (Ahmedabad).
61. In light of the above discussion, question (b) is answered in the
affirmative, i.e., in favour of the Assessee and against the Revenue by
holding that Section 40 (a) (i) of the Act is discriminatory and therefore,
not applicable in terms of Article 26 (3) of the Indo-US DTAA.
62. Accordingly, question (a) is answered in the affirmative, i.e., in favour
of the Assessee and against the Revenue by holding that the ITAT was
correct in allowing a deduction of Rs. 5.83 crores being the administrative
fee paid by the Assessee to HIAI.
Questions (c) and (d)
63. Question (c) concerns the prior expenses for the period 1 st January
2000 to 31st March 2000 which was allowed to the Assessee as deduction
by the ITAT.
64. The case of the Revenue which was accepted by the AO as well as by
the CIT (A) is that the expenses for the above period did not accrue in the
previous year relevant to AY 2001-02 and therefore, could not be allowed.
The ITAT accepted the plea of the Assessee that the remittance could not
have been made to HIAI without prior approval of the RBI. The approval
could be obtained only on 30th June 2000. It is not in dispute that HIAI
first raised a debit note/invoice on 30th June 2000 on the Assessee and
there was no possibility of an estimation of the liability in the absence of
any past precedent. There was no basis on which an estimate of the
expenses could be ascertained.
ITA No. 7/2007 Page 33 of 35
65. In Nonsuch Tea Estates Limited v. CIT (supra), the payments made
by the Assessee to its managing agent which required the permission of
the Central Government under the Companies Act, 1956. Though the
remuneration paid by the Assessee to the managing agent related to the
period prior to AY 1959-60, it was claimed during the said AY on the
ground that the central government`s approval was obtained only in the
previous year related to AY 1959-60. The High Court did not agree with
the plea of the Assessee but the Supreme Court reversed the High Court
and held that liability towards royalty accrued only when the approval was
granted by the Central Government for the appointment of the managing
agent.
66. Consequently, the Court concurs with the view expressed by the ITAT
in the present case, that the expenses for the period 1st January 2000 to
31st March 2000 accrued as a liability to the Assessee only during the
previous year and that the said expenditure was rightly allowed as
deduction during the AY in question. Question (c) is answered in the
affirmative, i.e., in favour of the Assessee and against the Revenue.
67. Question (d) pertains to the payment of administrative fee by the
Assessee to HIAI during the period 1st January 2001 to 30th March 2001.
The reason given by the AO for the disallowance that there was no
evidence to show that the Assessee applied for such permission to the RBI
for the period subsequent to 31st December 2000.
68. As noted by the ITAT, after 1st June 2000 consequent to the repeal of
Foreign Exchange Regulation Act, 1973 ('FERA') and introduction of
FEMA 1999, there was no requirement of RBI permission for making
remittances. The payment to HIAI in terms of FEMA 1999, fell within the
ITA No. 7/2007 Page 34 of 35
meaning of current account transactions. Authorized dealers were
permitted to make remittances in connection with the current account
transactions without prior permission of the RBI. Although the Assessee
did not receive any bill from HIAI for this period it had made an estimate
on the basis of the bill that it had received from HIAI for the period 1 st
January 2000 to 31st December 2000. In terms of the law explained by the
Supreme Court in Bharat Earthmovers v. Commissioner of Income Tax
(supra) if a business liability has definitely arisen in the accounting year,
the deduction should be allowed although the liability may have to be
quantified and discharged at a future date. What should be certain in the
incurring of the liability. It should also be capable of being estimated with
reasonable certainty though the actual quantification may not be
possible.
69. For the aforesaid reasons, the Court concurs with the view expressed
by the ITAT that in respect of the fee paid for the period relating to the
period 1st January 2001 to 31st March 2001, the liability should be held as
accrued and arisen during the previous year relevant to the AY 2001-02
and therefore, is rightly allowed by the ITAT. Question (d) is answered in
the affirmative, i.e., in favour of the Assessee and against the Revenue.
Conclusion
70. The appeal is accordingly dismissed but, in the facts and
circumstances of the case, with no orders as to costs.
S. MURALIDHAR, J
VIBHU BAKHRU, J
MAY 13, 2016
Rm
ITA No. 7/2007 Page 35 of 35
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