The ITAT ruling in the Herbalife case is important while applying the non-discrimination clause in DTAAs prior to assessment year 2004-05.
The non-discrimination clause in DTAAs (Double Taxation Avoidance Agreements) states that nationals of one contracting state shall not be subjected in the other contracting state to any taxation or any requirement connected therewith which is much more onerous, than it is on the nationals of that other contracting state.
A recent ruling of the Delhi Tribunal in the Herbalife International India Private Ltd (101 ITD 450) case owes its genesis to this concept of taxation.
The Herbalife case
The facts in the case was that the assessee Herbalife India had entered into an Administrative Service Agreement (ASA) dated November 10, 1999, with Herbalife International of America, Inc. (HIAI), a company formed in accordance with the laws of the State of California.
Under the said agreement, HIAI had agreed to provide data-processing, accounting, marketing, financial and planning services, besides long-term financial planning for the assessee, analysis of prospects, obtain approval for parent company products from government and regulatory bodies, assist in protecting the trademark, trade name logo of products, etc.
The expenses were incurred by HIAI in the US not only for providing services to the assessee but also to its various other subsidiaries across the world by maintaining its centralised staff and other resources.
The cost so incurred was apportioned and claimed on a scientific basis. As per the agreement, the assessee had to pay an administrative fee of Rs 5.83 crore to HIAI.
For the assessment year 2001-02, the assessee had claimed deduction for expenditure of Rs 5.83 crore in respect of administrative fee paid to HIAI pursuant to the ASA. In the assessment proceedings, the assessing officer (AO) held that the deduction cannot be allowed under Section 40(a)(i) of the Income-Tax Act.
The AO held that the payment to HIAI was in the nature of "fees for technical services" as per Section 9(1)(vii) of the I-T Act and since the assessee had not deducted tax under Section 40(a)(i), the deduction for the said expenditure cannot be allowed.
The assessee had raised a plea before the AO that the amount paid to HIAI represented reimbursement of actual cost incurred by HIAI on behalf of the assessee and, therefore, such reimbursement will not be income of HIAI taxable in India. Further, the assessee also pleaded that the nature of services were not such that the expenditure can be said to be payment of "fees for technical services". The Commissioner (Appeals) confirmed the action of the AO.
The main issue before the Income-Tax Appellate Tribunal (ITAT) was whether, applying the provisions of Section 40(a)(i) of the I-T Act, the lower authorities were justified in making the disallowance of administrative fee of Rs 5.83 crore to HIAI .
The ITAT decision
The ITAT observed that Section 40(a)(i), as applicable for the assessment year in question, provided for disallowance of payment made to non-resident only where tax was not deducted at source.
Before the ITAT, the assessee raised a plea that the disallowance under the Section cannot be made in view of Article 26 of the DTAA.
The ITAT referred to Article 26 of India-US DTAA dealing with "Non-discrimination". As per Article 26(1), nationals of one contracting state shall not be subjected in the other contracting state to any taxation or any requirement connected therewith which is much more onerous, then it is on the nationals of that other contracting state.
Further, as per Article 26(3) of the DTAA, except where the provisions of paragraph 1 of Article 9, Paragraph 7 of Article 11, Paragraph 8 of Article 12 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.
The ITAT also referred to OECD commentary on Article 24(4) which is pari materia to Article 26(3) of the India-US DTAA and the commentary by Philip Baker in the book on Double Taxation Conventions and International Tax Law.
The ITAT observed that a similar payment to a resident did not result in disallowance in the event of non-deduction of tax at source. Thus, a non-resident left with a choice of dealing with a resident or a non-resident in business would rather deal with the former owing to Section 40(a)(i).
The ITAT observed that to this extent the non-resident is discriminated against, as the non-resident does not get the deduction.
Article 26(3) seeks to prevent such discrimination and states that deduction should be allowed on the same condition as if the payment is made to a resident.
This clause in the DTAA thus neutralised the rigour of Section 40(a)(i). Accordingly, the ITAT held that as per Section 90(2), the law which is beneficial to the assessee should be followed and directed the AO not to invoke Section 40(a)(i) to disallow the assessee's claim.
This decision pertained to assessment year 2001-02. Section 40(a) of the I-T Act, as amended by Finance Act 2003 with effect from April 1, 2004, are applicable to both residents and non-residents. Therefore, this decision may not be applicable after the amendment.
This ruling is important while applying non-discrimination clause contained in DTAAs prior to assessment year 2004-05 while dealing with non-residents.
Rajesh C. Patil
(The author, a chartered accountant, is with Deloitte Haskins & Sells, Mumbai.)