2016 (12) TMI 1478 - AT - Income Tax

TDS u/s 195 - Disallowance u/s 40(a)(i) - whether the payment made to HRD constitutes fees for technical services or not? - India-Belgium DTAA - Held that - We affirm the conclusion of CIT(A) that the impugned payment cannot be characterised as fees for technical services having regard to the meaning and scope of the expression fees for technical services provided in the India-United Kingdom DTAA which is amenable for application in the instant case having regard to MFN clause in the India- Belgium DTAA. As a consequence once it is held that such payment is not to be regarded as fees for technical services as inferred by the Assessing Officer and considering that HRD does not have any PE in India the CIT(A) has rightly concluded that such payments are not liable to be taxed in India in the hands of HRD. Thus there was no justification for the Assessing Officer to have invoked Sec. 40(a)(i) of the Act citing failure of the assessee to deduct tax at source u/s 195(1) of the Act. In the result we hereby affirm the decision of CIT(A) on this aspect and Revenue fails. Retrospective amendment is determinative of the tax liability in the hands of a recipient of income but so far as the present case is concerned what is held against the assessee is the failure to deduct tax at source at the time of payment of such income. Ostensibly de hors the aforesaid amendment the impugned income was not subject to tax deduction in India as per the prevailing legal position when the payments were made. Thus the taxability of a sum in the hands of the recipient on account of a subsequent retrospective amendment would not expose the payer of income to an impossible situation of requiring deduction of tax at source on the anterior date of payment of such income. Thus on this count also assessee cannot be held to be in default for not deducting tax at source so as to trigger the disallowance u/s 40(a)(i) of the Act. In the absence of any contrary decision the aforesaid plea of assessee is also liable to be upheld and thus the disallowance made by Assessing Officer by invoking Sec. 40(a)(i) of the Act stands correctly deleted by the CIT(A) which we hereby affirm.- Decided in favour of assessee. Claim for Additional depreciation @ 20% in terms of Sec. 32(1)(iia) - activity of cutting and polishing of diamonds - Held that - The decision of the Tribunal in the case of Sheetal Diamonds Ltd. (2011 (3) TMI 1044 - ITAT MUMBAI ) is quite eloquent wherein the entire process involved in the activity of cutting and polishing of rough diamonds into polished diamonds has been examined and it has been held that it constituted manufacture. CIT(A) made no mistake in holding that the activity of cutting and polishing of diamonds amounts to manufacture so as to enable the assessee to claim Additional depreciation u/s 32(1)(iia) of the Act. Thus on this aspect also Revenue fails.- Decided in favour of assessee.

Summary

Issues Involved:
1. Disallowance under Section 40(a)(i) of the Income Tax Act due to non-deduction of tax at source on payment to HRD, Antwerp NV, Belgium.
2. Entitlement to additional depreciation under Section 32(1)(iia) of the Income Tax Act for cutting and polishing diamonds.

Issue 1: Disallowance under Section 40(a)(i) due to Non-Deduction of Tax at Source

The Revenue challenged the deletion of disallowance of ?22,95,152/- under Section 40(a)(i) of the Income Tax Act, which was made by the Assessing Officer (AO) on the grounds that the assessee failed to deduct tax at source on payments made to HRD, Antwerp NV, Belgium. The CIT(A) set aside the disallowance, holding that Section 40(a)(i) was inapplicable as the assessee was not required to deduct tax at source on such payments.

The assessee, a partnership firm engaged in importing, cutting, polishing, and selling diamonds, paid HRD for grading and certification services conducted entirely in Belgium. The AO contended that these payments were for technical services, thus taxable in India under Section 9(1)(vii) of the Act and the India-Belgium DTAA, requiring tax deduction at source under Section 195(1). The CIT(A) disagreed, citing HRD's lack of a Permanent Establishment (PE) in India and the nature of services not constituting 'fees for technical services' as per the India-United Kingdom DTAA, which applies due to the Most Favoured Nation (MFN) clause in the India-Belgium DTAA.

The Tribunal upheld the CIT(A)'s decision, noting that the services did not involve the transfer of technical knowledge to the assessee and thus did not qualify as 'fees for technical services.' The Tribunal also supported the alternative plea that the retrospective amendment to Section 9(1)(vii) by the Finance Act, 2010, could not retroactively impose a tax deduction obligation on the assessee for payments made when no such obligation existed.

Issue 2: Entitlement to Additional Depreciation under Section 32(1)(iia)

The Revenue contested the CIT(A)'s decision allowing additional depreciation of ?18,26,347/- under Section 32(1)(iia) for new plant and machinery used in cutting and polishing diamonds. The AO denied the claim, referencing the Supreme Court's decision in Gem India Manufacturing Co., which held that diamond cutting and polishing did not constitute manufacturing.

The CIT(A) allowed the additional depreciation, relying on the Tribunal's decision in Sheetal Diamonds Ltd., which considered the process of cutting and polishing as manufacturing. The Tribunal affirmed this, referencing multiple decisions that supported the view that cutting and polishing diamonds constitutes manufacturing, thus entitling the assessee to additional depreciation under Section 32(1)(iia).

Conclusion:

The Tribunal dismissed the Revenue's appeal, upholding the CIT(A)'s decisions on both issues. The payments to HRD were not subject to tax deduction at source, and the assessee was entitled to additional depreciation for its manufacturing activities involving diamond cutting and polishing.