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TMI Blog2016 (5) TMI 697X X X X Extracts X X X X X X X X Extracts X X X X ..... ssee was incorporated as a company in India with 100% foreign equity participation, pursuant to an approval granted by the Department of Industrial Policy and Promotion, Secretariat for Industrial Assistant, Ministry of Industry, Government of India. The approval was obtained by HII. In terms of the approval, the Assessee was to manufacture herbal products on contract basis in India and should not import these items. 3. It is stated that HII developed significant expertise over the years. It provided data processing services, record keeping, distributor/supervisor information and order and shipment processing etc. HII also provided financial and marketing services. Apart from the direct services, HII also rendered some indirect administrative services. Thus, services are rendered to several subsidiaries worldwide and the costs incurred in this regard are centralized costs, which is allocated to the overseas subsidiaries on a scientific basis. 4. The Assessee entered into an Administrative Services Agreement ('ASA') dated 10th November 1999 with M/s. Herbalife International of America Inc. (HIAI) in terms of which HIAI agreed to provide data processing services, accounting, financ ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... approval. The Assessee accordingly treated the expenditure as having accrued only during the previous year relevant to AY 2001-02. 8. The further submission was that by 31st March 2000 when the accounting year for AY 2000-01 ended, the Assessee had not received the details regarding the share of common expenses payable by it to HIAI. The Assessee pointed out that since the ASA commenced only from 11th September 2000 (M/s. HIAI had waived ASA fee from 11th September 2000 to 31st December 2000) there was no past precedent which enabled the Assessee to make a provision for administrative fee on an estimate basis. The Assessee stated that an interim invoice was received on 30th June 2000 for US$ 333,333. The second interim invoice for the same sum was raised on 30th September 2000 and the final invoice on the same amount on 31st December 2000. The last invoice duly supported with cost allocation sheets was received on 31st January 2001 and the total amount payable to HIAI towards administrative fee worked out to US$ 1,015,240. In terms of the approval granted by the RBI only an amount of US$ 1 million was remitted. The balance US$ 15,240 was waived by HIAI. According to the Assessee, ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... The AO has, therefore, not allowed the said expenses. 12. The AO has also disallowed the claim of Rs. 53,63,731 on account of lease hold improvements made by the Assessee during the AY in question although the amount had been capitalized in its books. The AO observed that the details filed by the Assessee showed that the expenditure was on account of fixing of new aluminium sliding windows, new interior work including aluminium partition, cupboards, counters, storage, tables, chairs, electrical fittings etc. This was treated as capital expenditure by the AO as the expenditure was not in the nature of current repairs and depreciation was allowed on the same 13. The third issue related to the loss in the sum of Rs. 73,17,184 on account of foreign exchange ('FE') fluctuation. The Assessee had booked a net loss of Rs. 5,97,184 on account of year and re-statement of liabilities. The AO observed that the loss on account of exchange rate would arise only at the time of remission and therefore, disallowed the said loss. Order of the CIT (A)) 14. Aggrieved by the aforementioned assessment order, the Assessee filed an appeal before the Commissioner of Income Tax (Appeals) ['CIT (A)']. B ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 3 crores as deduction. 17. The ITAT also allowed expenditure of Rs. 53,63,731 towards improvements carried out in respect of the premises taken on lease, relying on the earlier order passed by the ITAT in the case of same Assessee for the AYs 1999-2000 and 2000-01 in ITA Nos. 3098 and 2664/Del/04. Relying on the decision of the Special Bench of the ITAT in ONGC Limited v. Deputy Commissioner of Income Tax (2002) 83 ITD 151 [ITAT(Del)], the ITAT allowed a sum of Rs. 5,97,184 towards loss on account of FE fluctuation. Questions of law 18. At the time of admission of the appeal, on 21st October 2009 the following questions of law were framed by the Court: " (a) Whether the ITAT was correct in law in allowing the sum of Rs. 5.83 crores being administrative fee paid by the Assessee to M/s. Herbalife International of America Inc.? (b) Whether the ITAT was correct in holding that the sum of Rs. 5.83 crores was not taxable in the hands of payee in India either as fees for technical services or as business income? (c) Whether the ITAT was correct in holding that the provisions of Section 40 (a) (i) of the Act is discriminatory and therefore not applicable in the present case as per ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... is taxable in India. The Bangalore Bench of the ITAT had also directed that TDS under Section 195 of the Act ought to be deducted at 25% of the administrative expenses amount. 21. The first submission made by Ms. Vibhooti Malhotra, learned counsel also appearing on behalf of the Revenue in the present appeal, is that without determining the character of the payment it is not possible to resort to the provisions of non-discrimination contained in Article 26 (3) of the DTAA. It is submitted that non-discrimination in deduction rule in terms of Article 26(3) of the DTA applies only when the payments in question are in the nature of either interest, royalty and FTS or other disbursements. Further, on the question of allowability of the payment as deduction, such payment have to be tested on the 'same condition' as if the payment in question has to be made to a resident, and where the exceptions mentioned in Article 26 (3) are not applicable. It is submitted that in the absence of a determination of the character of administrative fees, the first step of enquiry for applying the non-discrimination rule fails. 22. It is further submitted that if the exceptions mentioned in Art ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... efault and the tax shall be recovered from it. Section 40 (a) (i) was also a deterrent provision which promotes compliance on the part of resident payers. Section 40 (a) (i) provided that the in the event the resident payers do not deduct tax on payments to non-residents, they will not be entitled to deduction for the said expenditure. The distinction in Section 40 (a) (i) is situs of payment which was not a prohibited differentia under the DTAA. 25. It is further submitted that Section 40 (a) (i) of the Act did not create any classification between resident payments and non-resident payments. It deals with disallowance of expenditure where TDS has not been deducted. Secondly, assuming that Section 40 (a) (i) creates a distinction between resident payments and non-resident payments, it was built on intelligible differentia having a rational nexus with the object of Section 40 (a) (i) of the Act. The basis is that while there are several sources for collection and recovery of tax from resident, the same opportunities may not be available in the case of a non-resident. Consequently, the Act envisages TDS only on non-resident payments to collect tax at the very source of income. Refe ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... nce is made to Article 24 of the OECD Model Convention which is pari materia with Article 26 (3) of the DTAA. The OECD Commentary on Article 24 explains that the above article was designed to end a particular form of discrimination resulting from the fact that the deduction of interest, royalties and other disbursements allowed without restriction when the recipient is resident, is restricted or even prohibited when he is a non-resident. Reference is also made to Article 24 (4) of the UN Model Convention which is also identical terms as Article 26 (3) of the DTAA. (f) Relying on the decisions in Union of India v. Azadi Bachao Andolan (2003) 263 ITR 706 (SC), Ishikawajima Harima Heavy Industries Ltd. v. DIT (2007)288 ITR 408 (SC), DIT v. Morgan Stanley & Co. (2007) 292 ITR 416 (SC), Asia Satellite Tel. Co. Ltd. v. DIT (2011) 332 ITR 340 (Del) and CIT v. EKL Appliances Ltd. (2012) 345 ITR 241 (Del) it is submitted that international commentaries can be relied upon on the interpreting the provisions of DTAA. Reference is also made to the book 'The International Tax Primer' authored by Brain J. Arnold and Michael J. Mcintyre as well as 'Double Taxation Conventions and International T ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ical Industries Limited v. CIT (1995) 213 ITR 523 (Guj). (l) The remittance for the period from 1st April 2000 onwards, did not require the prior approval of the RBI. As regards the period up to 31st March 2000, the RBI approval was received on 30th June 2000 for remittance of amount up to US$ 1 million. The said expenditure cannot be said to have accrued under law without approval having being so accorded by the RBI. (m) Reliance is placed on the decisions in Nonsuch Tea Estate Ltd. v. CIT (1975) 98 ITR 189 (SC), Dorr-Oliver (India) Ltd. v. CIT (1998) 234 ITR 723 (Bom), and Pfizer Corporation v. CIT (2003) 259 ITR 391 (Bom). (n) As regards the disallowance of the expenses pertaining to the period 1st January 2001 to 31st March 2001, a reasonable estimate was made on the basis of the invoices raised by HIAI for the period 1st January 2000 to 31st December 2000. This formed a prudent basis for accrual of such expenses for the first quarter of the year 2001 in the books of the period ended 31st March 2001. After the enactment of FEMA, the payment in question by the Assessee to HIAI would fall in the category of current account transaction. Therefore, such payments did not call fo ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... been framed by this Court revolve around the interpretation of Article 26 (3) of the DTAA and Section 40 (a) (i) of the Act. 32. Article 26 (3) of the DTAA reads as under: " "Except where the provisions of paragraph 1 of Article 9 (Associated Enterprises), paragraph 7 of Article 11 (Interest), or paragraph 8 of Article 12 (Royalties and Fees for included Services) 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." 33. There are specific kinds of payments mentioned in Article 26 (3) of the DTAA. These require treatment in the same manner vis-a-vis a resident and a non-resident. They include interest, royalty and "other disbursements". Article 26 (3) therefore states that for the purpose of determining the taxable profits of a resident of a contracting State (in the present case the Assessee who is a resident and HIAI of the other contracting State, i.e., USA). The payment of the above amounts sh ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 39;other disbursements' for the purpose of Article 26 (3) DTAA? 39. To recapitulate, the case of the Revenue is that the expression 'other disbursements' should take colour from the context and would apply only to income which is of passive character just like interest and royalties. The Revenue invokes the doctrines of 'noscitur-a-sociis' and 'ejusdem generis'. It is submitted that FTS does not qualify as 'other disbursements' since it is not a passive character like royalties and interest. 40. The Court is unable to agree with the above submissions of the Revenue. In the context of which the expression 'other disbursement' occurs in Article 26 (3), it connotes something other than 'interest and royalties'. If the intention was that 'other disbursements' should also be in the nature of interest and royalties then the word 'other' should have been followed by 'such' or 'such like'. There is no warrant, therefore, to proceed on the basis that the expression 'other disbursements' should take the colour of 'interest and royalties'. 41. The expression 'other disbursements' occurring in Article 26 (3) of the DTAA is wide enough to encompass the administrative ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... r profession or assessed at a proportion of, or otherwise on the basis of, any such profits or gains; (iia) any sum paid on account of wealth-tax. Explanation.-For the purposes of this sub-clause, "wealth-tax" means wealth-tax chargeable under the Wealth-tax Act, 1957 (27 of 1957), or any tax of a similar character chargeable under any law in force in any country outside India or any tax chargeable under such law with reference to the value of the assets of, or the capital employed in, a business or profession carried on by the assessee, whether or not the debts of the business or profession are allowed as a deduction in computing the amount with reference to which such tax is charged, but does not include any tax chargeable with reference to the value of any particular asset of the business or profession; (iii) any payment which is chargeable under the head "Salaries", if it is payable outside India and if the tax has not been paid thereon nor deducted therefrom under Chapter XVII-B; (iv) any payment to a provident or other fund established for the benefit of employees of the assessee, unless the assessee has made effective arrangements to secure that tax shall be deducted ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... educted in the previous year but paid in any subsequent year after the expiry of the time prescribed under sub-section (1) of section 200, such sum shall be allowed as a deduction in computing the income of the previous year in which such tax has been paid. Explanation.- For the purposes of this sub-clause,- (i) "commission or brokerage" shall have the same meaning as in clause (i) of the Explanation to section 194H; (ii) "fees for technical services" shall have the same meaning as in Explanation 2 to clause (vii) of sub-section (1) of section 9; (iii) "professional services" shall have the same meaning as in clause (a) of the Explanation to section 194J; (iv) "work" shall have the same meaning as in Explanation III to section 194C ; (ib) any sum paid on account of securities transaction tax under Chapter VII of the Finance (No. 2) Act, 2004; (ii) any sum paid on account of any rate or tax levied on the profits or gains of any business or profession or assessed at a proportion of, or otherwise on the basis of, any such profits or gains; (iia) any sum paid on account of wealth-tax. Explanation.-For the purposes of this sub-clause, "wealth-tax" means wealth-tax chargea ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ring the AY in question i.e. 2001-02, did not provide for deduction in the TDS where the payment was made in India. The requirement of deduction of TDS on payments made in India to residents was inserted, for the first time by way of Section 40 (a) (ia) of the Act with effect from 1st April 2005. Then again as pointed out by Mr. M.S. Syali, learned Senior Advocate for the Intervener, Section 40 (a) (ia) refers only to payments of 'interest, commission or brokerage, fees for professional services or fees for technical services payable to a resident, or amounts payable to a contractor or sub-contractor etc. It does not include an amount paid towards purchases. Correspondingly, there is no requirement of TDS having to be deducted while making such payment. 49. However, the element of discrimination arises not only because of the above requirement of having to deduct TDS. The OECD Expert Group which brought out a document titled "Application and Interpretation of Article 24(Non-Discrimination), Public discussion Draft, May 2007" did envisage deduction of tax while making payments to non-residents. It is viewed only as additional compliance of verification requirement which would n ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... which speaks of preventing discrimination on the basis of nationality and which provision employs the phrase 'same circumstances'. Article 26 (2) which talks of prevention of discrimination vis-a-vis computing tax liability of PEs and employs the expression 'same activities'. The expression used in Article 26 (3) is 'same conditions'. Learned counsel for the Revenue sought to justify the difference in the treatment of payments made to non-residents by referring to Article 14 of the Constitution of India and contended that the line of enquiry envisaged examining whether (a) the classification was based on an intelligible differentia and (b) whether the classification had a rational nexus with the object of the statute. 52. Section 40 (a) (i), in providing for disallowance of a payment made to a non-resident if TDS is not deducted, is no doubt meant to be a deterrent in order to compel the resident payer to deduct TDS while making the payment. However, that does not answer the requirement of Article 26 (3) of the DTAA that the payment to both residents and non-residents should be under the 'same conditions' not only as regards deduction of TDS but even as regards the allowa ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 0 (a) (i), as it then stood, the allowability of the deduction of the payment to a non-resident mandatorily required deduction of TDS at the time of payment. On the other hand, payments to residents were neither subject to the condition of deduction of TDS nor, naturally, to the further consequence of disallowance of the payment as deduction. The expression 'under the same conditions' in Article 26 (3) of the DTAA clarifies the nature of the receipt and conditions of its deductibility. It is relatable not merely to the compliance requirement of deduction of TDS. The lack of parity in the allowing of the payment as deduction is what brings about the discrimination. The tested party is another resident Indian who transacts with a resident making payment and does not deduct TDS and therefore in whose case there would be no disallowance of the payment as deduction because TDS was not deducted. Therefore, the consequence of non-deduction of TDS when the payment is to a non-resident has an adverse consequence to the payer. Since it is mandatory in terms of Section 40 (a) (i) for the payer to deduct TDS from the payment to the non-resident, the latter receives the payment net of TDS. The ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... come under Section 5 of the Act, then there was no purpose in making those sections 'subject to the provisions of the Act. The very object of grafting the said two sections with the said clause is to enable the Central Government to issue a notification under Section 90 towards implementation of the terms of the DTAs which would automatically override the provisions of the Income tax Act in the matter of ascertainment of chargeability to income tax and ascertainment of total income, to the extent of inconsistency with the terms of the DTAC." 59. Consequently, the Court negatives the plea of the Revenue that unless there are provisions similar to Section 40 (a) (i) of the Act in the DTAA, a comparison cannot be made as to which is more beneficial provision. 60. The reliance by the Revenue on the decision of this Court in Hyosung Corporation v. AAR (2016) 382 ITR 371 (Del) is misplaced. There the Court negatived a challenge to the constitutionality of Section 245R (2)(i) of the Act on the ground that it was violative of Article 14 of the Constitution as well as Article 25 of the DTAA between India and South Korea. Section 245R (2) of the Act barred a non-resident applica ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... s year related to AY 1959-60. The High Court did not agree with the plea of the Assessee but the Supreme Court reversed the High Court and held that liability towards royalty accrued only when the approval was granted by the Central Government for the appointment of the managing agent. 66. Consequently, the Court concurs with the view expressed by the ITAT in the present case, that the expenses for the period 1st January 2000 to 31st March 2000 accrued as a liability to the Assessee only during the previous year and that the said expenditure was rightly allowed as deduction during the AY in question. Question (c) is answered in the affirmative, i.e., in favour of the Assessee and against the Revenue. 67. Question (d) pertains to the payment of administrative fee by the Assessee to HIAI during the period 1st January 2001 to 30th March 2001. The reason given by the AO for the disallowance that there was no evidence to show that the Assessee applied for such permission to the RBI for the period subsequent to 31st December 2000. 68. As noted by the ITAT, after 1st June 2000 consequent to the repeal of Foreign Exchange Regulation Act, 1973 ('FERA') and introduction of FEMA 19 ..... X X X X Extracts X X X X X X X X Extracts X X X X
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