2017 (11) TMI 1427 - HC - Income Tax

TDS u/s 195 - Deduction u/s 40(a)(i) - applicability of the provisions of the Double Tax Avoidance Agreement between the Indian and Japan and India and the USA - PE in India - Held that - It is significant that even while the Court was hearing the submissions in Herbalife HC, it permitted the present Assessee to intervene and make submissions. These submissions were noted in paragraphs 28 to 30 of the said judgment. Therefore, even in Herbalife HC 2016 (5) TMI 697 - DELHI HIGH COURT this Court was conscious of the changes brought about by introduction of Section 40 (a) (ia) in the Act with effect from 1st April, 2005. However, even after this change, the element of discrimination continued in AY 2006-07. The distinction between sub-clauses (i) and (ia) as regards the consequence of disallowance of the sum paid to a non-resident towards purchases as a deduction on account of the failure to deduct TDS, continued. That distinction was ultimately done away with only by the amendment of sub-clause (ia) by the FA 2014 with effect from 1st April, 2015. Therefore, the assertion by the Revenue in para 4 of its written submissions that discrimination as held by CIT v. Herbal Life Supra has been done away with is true only after 1st April, 2015 and not during the relevant AY 2006-07. The contention about the situs of payment has been raised for the first time in this Court in the written submissions. It was not the case of the Revenue earlier that the payments were made outside India and not in India. It was only argued that the discrimination pointed out in Herbalife HC no longer exists whereas, as demonstrated earlier, it did even during AY 2006-07. The inevitable conclusion is, therefore, that the decision of this Court in Herbalife HC squarely applies and answers question (i) against the Revenue. Since Section 40 (a) (i) of the Act as it stood in AY 2006-07 continued to discriminate in the above manner and was inconsistent with Article 24 (3) of the Indo Japan DTAA or Article 26 (3) of the Indo US DTAA, the Assessee was entitled to rely on the above DTAA provisions to claim deduction of the sums paid to entities in Japan and USA. - Decided in favour of the Assessee Payments made by the Assessee for purchases made to non-resident entities incorporated in Thailand and Singapore - Held that - It is plain that the Revenue had not discharged its onus of showing that the Thailand and Singapore entities had a PE in India. The AO had simply relied on the AO s own earlier decision holding that Metal One Corporation Japan had a PE in India and on that basis held that the Thailand and Singapore entities also had a PE in India. This conclusion had no factual basis since neither entity had even an LO in India. In any event the ITAT itself subsequently set aside that decision of the AO in the case of Metal One Corporation, Japan and held that even the latter did not have a PE in India. In the circumstances, the conclusion of the ITAT in this regard cannot be faulted. Question (ii) is accordingly answered in the negative, i.e. in favour of the Assessee and against the Revenue.

Summary

Issues Involved:

1. Applicability of Section 40(a)(i) of the Income Tax Act, 1961 in view of the Double Tax Avoidance Agreement (DTAA) between India and Japan and India and the US.
2. Existence of Permanent Establishments (PEs) in India for the non-resident entities involved.

Issue-wise Detailed Analysis:

1. Applicability of Section 40(a)(i) in View of the DTAA:

The primary question was whether the Income Tax Appellate Tribunal (ITAT) erred in holding that Section 40(a)(i) of the Income Tax Act, 1961 could not be applied due to the provisions of the DTAA between India and Japan and India and the US. The court examined the payments made by the Indian entity (MI) to various non-resident entities, including Mitsubishi Corporation Japan (MC), Metal One Corporation Japan, and others.

The court noted that the payments were for purchases and not for services, thus falling under the category of "other disbursements" as per Article 24(3) of the Indo-Japan DTAA and Article 26(3) of the Indo-US DTAA. These Articles mandate that payments to non-residents should be treated the same as payments to residents for the purpose of determining taxable profits.

The court referred to the decision in Herbalife HC, which interpreted similar provisions in the Indo-US DTAA. It was held that the expression "other disbursements" is broad and includes payments for purchases. The court also noted that the discrimination highlighted in Herbalife HC continued to exist during the relevant assessment year (AY 2006-07) because Section 40(a)(i) disallowed deductions for payments to non-residents without TDS, while no such disallowance existed for payments to residents.

The court concluded that the decision in Herbalife HC applied, and the Assessee was entitled to rely on the DTAA provisions to claim deductions for payments made to entities in Japan and the US. Therefore, the ITAT was correct in its decision, and the court answered the first question in favor of the Assessee.

2. Existence of Permanent Establishments (PEs) in India:

The second issue was whether the ITAT erred in reversing the findings of the Dispute Resolution Panel (DRP) regarding the existence of PEs in India for the non-resident entities, particularly those in Thailand and Singapore.

The court noted that the AO had inferred the existence of PEs based on the business model of Metal One Corporation Japan, which was held to have a PE in India. However, the ITAT found that the entities in Thailand and Singapore did not have PEs in India, and the Revenue had not provided sufficient evidence to prove otherwise.

The court emphasized that the insertion of Explanation 2 to Section 195 by the Finance Act 2012 did not eliminate the requirement to establish that the sum paid was chargeable to tax in India. The Explanation emphasized the obligation of the payer to deduct TDS but did not dispense with the need to show that the sum was chargeable to tax.

The court referred to the decision in GE India, which clarified that TDS is deductible only from sums that are chargeable to tax under the Act. The court held that the Revenue had not discharged its onus of proving the existence of PEs for the entities in Thailand and Singapore. Consequently, the ITAT was correct in its decision, and the court answered the second question in favor of the Assessee.

Conclusion:

The court concluded that the ITAT was correct in its decisions regarding both issues. The appeal was allowed, and the questions were answered in favor of the Assessee and against the Revenue.