2008 (1) TMI 437 - AT - Income Tax

Disallowance u/s 40(a)(i) - Liability to deduct tax at source u/s 195(1) - payments to non-residents on account of rentals for hosting the websites on their servers located in USA - Nature of the payments for rentals for hosting of website is ''interest'' or ''royalty'' or ''fee for technical services'' or ''other sum chargeable to tax in India'' ? - HELD THAT - We find that paragraph 3(b) of article 12 takes into its ambit the payments of any kind received as consideration for the use of, or the right to use any industrial, commercial or scientific equipment other than equipments relating to Shipping and Air Transport described in paragraph 2(c) or 3 of Article 8. Though the DTAA between India and USA provides for taxing of royalties for the use of, or the right to use any industrial, commercial or scientific equipment in the Contracting State in which they arise and according to the laws of that State but the same could not be taxed in India up to assessment year 2001-02 as clause (iva) of Explanation 2 to section 9(1)(vi) was inserted with effect from 1-4-2002. Under the new procedure, the revenue can recover the tax along with interest, if any, from the assessee in a case the tax authorities later on find that short or no deduction of tax at source was made. The assessee is also liable for penalty prosecution for the default committed by him. Thus CBDT with effect from 18-11-1997 prescribed a new procedure for the purposes of the remittance of payments under which issue of No Objection under section 195(2) by the income-tax authorities has been dispensed with. However under section 195(2) the person responsible for paying any such sum, other than salary, chargeable under the Act to a non-resident considers that the whole of such sum would not be income chargeable in the case of the recipient, he may make application to the Assessing Officer to determine, by general or special order, the appropriate portion of such sum so chargeable, and upon such determination, tax shall be deducted under sub-section (1) only on that proportion of the sum which is chargeable. Thus, the payments made to non-residents are neither in the nature of interest nor fee for technical services or royalty. The sums are not chargeable to tax under the Act as business income on the ground that none of the payee had permanent establishment in India. The memorandum explaining the Finance Bill, 2001 makes it clear that prior to amendment, the consideration for the use of, or the right to use, industrial, commercial or scientific equipment was liable to be assessed as business income in the source country. Since the payment for use of space in servers is in nature of royalty and income arising on use of, or the right to use, industrial, commercial or scientific equipment was not royalty before the amendment by the Finance Act, 2001 with effect from 1-4-2002, within the meaning of provisions of Explanation 2 to section 9(1)(vi) of the Act, the same was to be assessed in other Contracting State i.e., USA as per paragraph 1 of article 12 of DTAA and not in India. Whether the resident assessee could take advantage of provisions of article 26(3) of DTAA - Similar payment to a resident does 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 opt to deal with a resident owing to the provisions of section 40(a)(1) of the Act. To this extent the non-resident is discriminated. Article 26(3) of Indo-US DTAA seeks to provide relief against such discrimination by saying that deduction should be allowed on the same condition as if the payment is made to a resident. Thus, this clause in DTAA neutralizes the rigour of the provisions of section 40(a)(i) of the Act. Hence by virtue of the provisions of section 90(2), the law which is beneficial to the assessee to whom DTAA applies, should be followed. This view is supported by the decision of Hon'ble Supreme Court in the case of Union of India v. Azadi Bachao Andolan 2003 (10) TMI 5 - SUPREME COURT . We therefore hold that in view of the provision of article 26(3) of DTAA, the Assessing Officer cannot seek to invoke the provisions of section 40(a)(i) of the Act for deduction while computing the profits and gains of business or profession. A similar view was taken by ITAT Delhi Bench in the case of Herbalife International India (P.) Ltd. 2006 (2) TMI 220 - ITAT DELHI-D . To sum up, the payments made on account of rentals for hosting of web sites on servers are not in nature of interest or royalties or fee for technical services or other sum chargeable to tax in India. CBDT has revised the procedure for deduction of tax at source on remittances made out of the country. The provisions of DTAA are also in favour of the assessee. Accordingly, the assessee was not required to deduct tax at source under section 195 of the Act while making payments outside India. We decide this issue in favour of the assessee. In the result, the appeal filed by the assessee is partly allowed.

Summary

Issues Involved:
1. Sustaining of disallowance under section 40(a)(i) of the Income Tax Act, 1961.
2. Determination of whether payments for domain registration and server charges are subject to tax deduction at source (TDS) under section 195.
3. Interpretation of payments as fees for technical services or royalties under section 9(1)(vi) and 9(1)(vii).

Issue-Wise Detailed Analysis:

1. Sustaining of Disallowance under Section 40(a)(i):
The primary issue for consideration was whether the disallowance of Rs. 3,26,386 under section 40(a)(i) of the Act was justified. The assessee claimed this amount as revenue expenditure for domain registration and server charges paid to non-resident foreign companies. The Assessing Officer disallowed the amount, holding that the assessee was liable to deduct tax at source under section 195, and since no tax was deducted, the amount was disallowed under section 40(a)(i).

2. Determination of TDS Applicability under Section 195:
The assessee argued that the payments made to non-resident entities for domain registration and server charges were not subject to TDS under section 195 because the services were rendered outside India and no income accrued in India. The Assessing Officer, however, relied on the ITAT Hyderabad Bench decision in Cheminor Drugs Ltd. and the Kerala High Court decision in Fertilizer & Chemicals Travancore Ltd., asserting that TDS provisions applied to payments made to non-residents.

On appeal, the CIT(A) upheld the Assessing Officer's view, stating that the payments for domain registration and server charges amounted to technical services and royalties, which are deemed to accrue or arise in India under section 9(1)(vi) and 9(1)(vii). The CIT(A) also emphasized that the obligation to deduct tax at source is mandatory unless the Assessing Officer determines that the sum is not chargeable to tax.

3. Interpretation as Fees for Technical Services or Royalties:
The assessee contended that the payments were not for technical services or royalties but for leasing server space, which did not involve the transfer of technology or provision of technical services. The assessee relied on the Supreme Court decision in Transmission Corpn. of A.P. Ltd. and the ITAT Delhi Bench decision in Lufthansa Cargo India (P) Ltd., arguing that only the income portion of the sum was subject to TDS.

The CIT(A), however, treated the payments as technical services and royalties based on the nature of the services provided, such as domain security features and web hosting, which involved the use of processes and were akin to royalties under Explanation 2 to section 9(1)(vi).

Tribunal's Findings:
1. Nature of Payments:
- The Tribunal examined whether the payments were for technical services or royalties. It referred to the definition of "fees for technical services" under Explanation 2 to section 9(1)(vii) and concluded that providing server space for hosting websites did not constitute technical services. The Tribunal cited the Madras High Court decision in Skycell Communication Ltd., which clarified that not all services involving technology are technical services.

2. Royalty Definition:
- The Tribunal analyzed the definition of "royalty" under Explanation 2 to section 9(1)(vi) and noted that the payments did not fall under any of the clauses defining royalties. It highlighted that clause (iva), which includes payments for the use of industrial, commercial, or scientific equipment, was inserted by the Finance Act, 2001, effective from 1-4-2002, and was not applicable for the assessment year 2001-02.

3. Double Taxation Avoidance Agreement (DTAA):
- The Tribunal considered the DTAA between India and the USA, which provides that royalties and fees for included services may be taxed in the source country. However, since clause (iva) was not in effect for the relevant assessment year, the payments were not taxable as royalties in India.

4. Circulars and Undertakings:
- The Tribunal referred to CBDT Circular No. 759, which dispensed with the requirement of obtaining a No Objection Certificate from the Assessing Officer for remittances. It emphasized that the assessee had followed the prescribed procedure by submitting an undertaking and a certificate from a chartered accountant, thus fulfilling the requirements for remittance without TDS.

5. Non-Discrimination Clause in DTAA:
- The Tribunal also addressed the non-discrimination clause under Article 26(3) of the DTAA, which mandates that payments to non-residents should be deductible under the same conditions as payments to residents. It concluded that the provisions of section 40(a)(i) could not be invoked due to this clause.

Conclusion:
The Tribunal held that the payments made by the assessee were neither fees for technical services nor royalties and were not chargeable to tax in India. Consequently, the assessee was not required to deduct tax at source under section 195. The disallowance under section 40(a)(i) was not justified, and the appeal was partly allowed in favor of the assessee.