2011 (2) TMI 606 - AT - Income Tax

Payments to employees based in USA without deducting TDS on the basis of the remittance is consideration towards non-compete fee and the beneficiary is an employee and is covered by Article-16(1) of the DTAA between India and USA. - held that -The amount paid to the employees of the assessee company being in the nature of salary is not taxable in India, in view of the Article-16 of DTAA between India and USA and the assessee is not under obligation to deduct TDS. decided in favour of Assessee.

Issues Involved:
1. Employment status of the individuals at the time of payment.
2. Comparison of Non-disclosure Agreement (NDA) and Non-compete Agreement (NCA).
3. Necessity of Non-compete Agreement with the employees.
4. Validity of Non-compete Agreements.
5. Nature of the receipt in the hands of the employees.
6. Accrual or arising of income in India.
7. Taxability of receipts under the Double Taxation Avoidance Agreement (DTAA) between India and the USA.
8. Obligation to apply under section 195(2) of the Income Tax Act before remittance.
9. Default status under section 201(1) of the Income Tax Act.
10. Levy of interest under section 201(1A) of the Income Tax Act.

Detailed Analysis:

1. Employment Status:
The tribunal found that the two employees, Mr. M.S. Kumar and Mr. Kevin Koenig, were employees of SCTL at the time of receiving the payments. Mr. Kumar accepted the employment offer on 31-03-2005, and Mr. Koenig accepted it on 23-05-2005. The Non-compete agreements were signed on 02-05-2005, and payments were made on 31-05-2005.

2. Comparison of NDA and NCA:
The tribunal noted that while many terms and clauses of the NDA and NCA were similar, the NCA contained unique clauses such as non-joining of competing businesses and non-solicitation of existing employees, which were not present in the NDA. The tribunal concluded that the NDAs were standard for all employees, but NCAs were specific to key employees like Mr. Kumar and Mr. Koenig.

3. Necessity of Non-compete Agreement:
The tribunal held that it was necessary for the assessee to enter into NCAs with the two employees to safeguard its interests, given their key positions and the sensitive information they held. The tribunal acknowledged the strategic importance of retaining these employees and protecting the company's interests.

4. Validity of Non-compete Agreements:
The tribunal rejected the AO's finding that the NCAs were sham transactions. It found that the NCAs were genuine and necessary for protecting the business interests of the assessee. The tribunal noted that if the transactions were considered sham, no tax would be deductible, and the assessee would not be in default.

5. Nature of Receipt:
The tribunal concluded that the payments made under the NCAs were related to employment and thus constituted salary or profit in lieu of salary. The tribunal rejected the AO's classification of the payments as business income and the CIT(A)'s classification as income from other sources. It held that the payments fell under the head of salary.

6. Accrual or Arising of Income:
The tribunal held that the income accrued to the recipients in the USA, where they were residents and rendered services. Therefore, the income did not accrue or arise in India.

7. Taxability under DTAA:
The tribunal held that under Article-16 of the DTAA between India and the USA, the salaries were taxable in the country where the services were rendered, which was the USA in this case. Therefore, the payments were not taxable in India.

8. Obligation to Apply under Section 195(2):
The tribunal held that since the payments were in the nature of salary and not taxable in India, the assessee was not required to approach the AO under section 195(2) of the Income Tax Act before making the payments.

9. Default Status under Section 201(1):
The tribunal held that the assessee was not in default under section 201(1) of the Income Tax Act as the payments were not taxable in India, and there was no obligation to deduct tax at source.

10. Levy of Interest under Section 201(1A):
The tribunal held that since the assessee was not in default under section 201(1), the interest under section 201(1A) was not leviable.

Conclusion:
The tribunal allowed the assessee's appeals, holding that the payments made to the employees under the Non-compete Agreements were in the nature of salary, not taxable in India under the DTAA between India and the USA, and thus, the assessee was not in default for not deducting tax at source. Consequently, the interest under section 201(1A) was also not leviable.

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