Section 40a(i)- Income Tax Act- Practically Non-operational

Section 40a(i)- Income Tax Act- Practically In-operational

In this article, analysis is being done to analyse whether section 40(a)(i), which provides for disallowance of expenses, payable to Non-resident , on non-deduction/non-deposit of TDS thereon, still holds force in view of certain recent developments.

The expenses are Royalty, Interest, fees for technical services or other sum chargeable under this Act

The utility of section 40a(i) is being judged specially with reference to Interest, Royalty,  fees for technical services, hereinafter referred to as specified expenses.

The entire analysis is divided into two parts

1.       Point of time (paid or payable basis) of incurring specified expenses, non -deduction of TDS thereon will trigger disallowance u/s 40a(i).

2.       Point of time (paid or payable basis) at which specified expenses is chargeable to tax in the hands of Non-resident and consequent liability to deduct TDS thereon.

Ø  Point of time (paid or payable basis) of incurring specified expenses, non -deduction of TDS thereon will trigger disallowance u/s 40a(i).

Section 40a(i), as amended by Finance Act (No. 2), 2014, provides as under:-

1.       Interest, Royalty or fees for Technical Services (Specified Expenses) is payable by assesse to Non-Resident in assessment year.

2.       Assessee either fails to deduct TDS on such specified Expenses or after deducting TDS, failed to deposit TDS before due date of filing Income Tax Return for said assessment year as per section 139(1).

3.       Assessee will not be allowed deduction of such specified expenses for said assessment year.

Thus under section 40a(i), two types of TDS default are contemplated:-

a)      Non-deduction of TDS on specified Expenses

b)      Non-deposit of TDS deducted on specified expenses

Hereinafter analysis is being done in case, where no TDS has been deducted on specified expenses

Till certain judicial pronouncements, disallowance u/s 40a(i) is applicable in both of the following situations:-

a)      Specified Expenses PAID in Financial Year and TDS is not deducted thereon

b)      Specified Expenses PAYABLE as at the end of financial and TDS is not deducted thereon.

Recently, the words “PAYABLE” appearing in section 40a(i) was matter of interpretation at highest level of judicial forum and it was held by Supreme Court in Vector Shipping that words “PAYABLE” be taken in its ordinary sense and accordingly disallowance contemplated u/s 40a(i)

·         will be applicable to only specified expenses payable at the end of financial year on which no TDS is deducted and

·          will not be applicable to specified expenses paid during the financial year on which no TDS is deducted.

The itinerary of cases leading to above-said interpretation of word “Payable” is as under:-

a)      Merilyn Shipping& Transports v. Add. CIT (2012)  (SB-Visakhapatnam)

b)      CIT vs. Vector Shipping Services (P) Ltd (2013) 357 ITR 642(All)(HC)

c)       The department filed a Special Leave Petition (SLP) in the Supreme Court against Allahabad High court judgement in Vector Shipping. The said SLP has been dismissed by the Supreme Court in limine. (SLP No. 8068/2014, dt. 02/07/2014)

Earlier CBDT has issued a Circular No. 10/DV/2013 dated 15.12.2013 clarifying that section 40a(i) disallowance will be applicable on both the amount paid and payable.

Now in view of Supreme Court ruling, the said circular has no authority and  accordingly section 40a(i) disallowance will be applicable only where amount of specified expenses are payable as at the end of financial year on which no TDS is deducted.

Ø  Point of time (paid or payable basis) at which specified expenses is chargeable to tax in the hands of Non-resident and consequent liability to deduct thereon

Disallowance u/s 40a(i) for non-deduction of TDS will be applicable to only those cases where deduction of TDS is mandated by section 195.

Section 195 provides for deduction of TDS on following amount paid or payable to Non-resident

a)      Interest

b)      Any other sum chargeable under the Act, which inter-alia includes Royalty and Fees for Technical services.

The point of taxability or chargeability of Interest , Royalty or fees for Technical Services in the hands of Non-resident is be evaluated with reference to Provisions of Income Tax Act or DTAA.

Provisions of Income Tax Act

a)      Section 5 provides that, among other things, total income of non-resident shall include the income deemed to accrue or arise in India

b)      Clause v, vi & vii of Section 9(1), inter-alia, provides that Interest , Royalty or fees for Technical services shall be deemed to accrue or  arise in India, when same is payable by person resident in India.

Thus under Income Tax Act,  the Interest, Royalty or fees for Technical Services are taxable or chargeable in the hands of Non-resident on accrual basis

Provisions under DTAA

The DTAA entered into by India are mostly based on UN model and relevant article dealing with Interest, Royalty or Fees for Technical Services are analysed as under:-

Article 11- Interest

1. Interest arising in a Contracting State and paid to a resident of the other Contracting State may be taxed in that other State.

2. However, such interest may also be taxed in the Contracting State in which it arises and according to the laws of that State-----

 

Article 12- Royalty

1. Royalties arising in a Contracting State and paid to a resident of the other Contracting State may be taxed in that other State.

2. However, such royalties may also be taxed in the Contracting State in which they arise and according to the laws of that State,----

Fees for Technical Services

The UN model does have specific clause for  Fees for Technical Service, but in various DTAA entered into by India, the clause relating to FTS, wherever specifically provided is  as under:-

1. Fees for Technical Services arising in a Contracting State and paid to a resident of the other Contracting State may be taxed in that other State.

2. However, such fees for Technical Services may also be taxed in the Contracting State in which they arise and according to the laws of that State,----

Thus, afore-said clauses in the context of Indian Resident and Non-resident can be interpreted as under:-

a)      Interest, Royalty or Fees for Technical Services PAID by Indian resident to non-resident is taxable in the county of non-resident.

b)      SUCH Interest , Royalty & fees for Technical services are also taxable in India at prescribed rates

Now question of consideration is that whether word “Paid” is to be interpreted in strict sense or in liberal sense to cover payable also.

In certain recent judicial decisions rendered in the context of Royalty & FTS, the words PAID is interpreted in strict sense and held that Royalty & FTS is taxable in the hands of non-resident in India on paid basis or not on accrual basis.

a)      CSC Technology Singapore Pte. Ltd. vs ADIT (2012) 50 SOT 399 (Delhi)

b)      Siemens Aktiengesellschaft vs JCIT (2009) 34 SOT 16 (Mumbai)

c)       The above decision of Mumbai Tribunal Confirmed by Mumbai High Court - (2012-TII-59-HC-MUM-INTL) dated October 22, 2012

d)      ADIT vs Pizza Hut International LLC (2012) 54 SOT 425

e)                      Booz Allen and Hamilton India Ltd. and Co. Kg. vs ADIT (2013) 56 SOT 96

Based on afore-said ruling, similar interpretation can be drawn for taxability of Interest also.

Thus point of taxability of Royalty, Interest or fees of Technical Services are summarised as under:-

a)      Income Tax Act- Payable basis.

b)      DTAA- Paid basis

Thus in terms of DTAA, Interest, Royalty or Fees for Technical Services will be not considered as Income Chargeable to Tax in India, till same is paid to Non-resident.

 

Now in respect of Royalty, Interest or fees for technical services payable, at the end of year, assessee can always take the position that since said amount is not taxable in the hands of Non-resident under DTAA, there is no liability to deduct TDS u/s 195 on said amount.

Thus based on afore-said discussion , with reference to expenses on account of Royalty, Interest or fees for technical services, there will not be any disallowance u/s 40a(i)  on account of non-deduction of TDS as under:-

a)      Non deduction of TDS on amount paid in Financial Year- No disallowance as per Ruling of SC in Vector shipping

b)      Non Deduction of TDS on amount payable at the end of Year- Such amount is not chargeable to tax in the hands of Non-resident in said financial year under DTAA  and hence no liability to deduct TDS u/s 195.

TDS on Foreign Comission

TDS on Foreign Commission

In the present article, attempt is made to evaluate TDS implication u/s 195 of the Income Tax Act on commission charges paid by Indian exporters to foreign agent for their services availed outside India.

In this article analysis is done from three angles to arrive at the conclusion:-

1.       Circulars issued by CBDT

2.       Precedent Case laws on foreign commission.

3.       Position in Double Taxation avoidance agreement

CBDT Circulars

1.       Circular No. 23 dated 23-07-1969

Foreign agent of Indian Exports – Where a foreign agent of India exporters operates in his own country and his commission is usually remitted directly to him and is, therefore, not received by him or his behalf in India. Such an agent is not liable to income tax in India on the commission

2.       Circular No. 786 dated 07-02-2000

As clarified in circular No. 23 dated 23-07-1969, where non-resident agent operates outside the country, no part of his income arises in India and since the payment is usually remitted directly abroad, it cannot be held to have been received by or on behalf of agent in India. Such payment were therefore, held to be not taxable in India.

3.       Circular No. 7 dated 22-10-2009

Circular No. 23 dated 23-07-1969 & Circular No. 786 dated 07-02-2000 were withdrawn, reasoning that interpretation of the Circular by some of the taxpayers to claim relief is not in accordance with the provisions of section 9 of the Income-tax Act, 1961 or the intention behind the issuance of the Circular

CBDT has not has given any cohesive reason for withdrawl of Circular Nos 23 & 786, except that claim by taxpayers under those circulars were not in accordance with provision of section 9. In other words, CBDT has not clarified/commented on whether where non-resident agent operates outside India, whether his income will deemed to accrue or arise in India or not. The matter has been left for determination by Courts.

Thus in the absence of any specific reason for withdrawal of circular and major change in taxation law at that point of time (22/10/2009), can only withdrawal of circular will also change the position accepted by CBDT for 40 years i.e where non-resident agent operate outside India, no part of his income arise in India ?

Though on withdrawal of Circular , Income Tax Department is not bound by  circular nos 23 & 786, but position remained the same that where non-resident agent operate outside India, no part of his income arise in India and hence no liability for TDS u/s 195 on foreign commission.

Case laws

1.       CIT v Toshoku (1980) 125 ITR 525 (SC)

In the instant case, the non-resident assessee did not carry on any business operations in the taxable territories. They acted as selling agents outside India. The commission amounts which were earned by non-resident for services rendered outside India cannot, therefore, be deemed to be incomes which have either accrued or arisen in India

2.       CIT v EON Technology (P) Ltd 343 ITR 366 (Delhi HC)

In the instant case, commission was paid to non-resident agent on the sales and amounts realize on exports contract procured by it for assessee.

Held, no income deemed to accrue to arise in India for non-resident agent.

In the said judgement, Delhi High court explained the concept of business connection as mentioned in section 9(1)(i).

“The term "business connection" has been interpreted by the Supreme Court to mean something more than mere business and is not equivalent to carrying on business, but a relationship between the business carried on by a non-resident, which yields profits and gains and some activities in India, which contributes directly or indirectly to the earning of those profits or gains. It predicates an element of continuity between the business of the non-resident and the activity in India [CIT v. R.D. Aggarwal and Co. [1965] 56 ITR 20 (SC), Carborandum and Co. v. CIT[1977] 108 ITR 335 (SC) and Ishikawajma-Harima Heavy Industries Ltd. v. DIT [2007] 158 Taxman 259 (SC). The test which is to be applied is to examine the activities in India and whether the said activities have contributed to the business income earned by the non-resident, which has accrued, arisen or received outside India.”

In other words High Court simply reiterated what is stated in Explanation 1(a) to section 9(1)(i). The said explanation run as under:-

“in the case of a business of which all the operations are not carried out in India, the income of the business deemed under this clause to accrue or arise in India shall be only such part of the income as is reasonably attributable to the operations carried out in India”

Thus for income deemed to accrue or arise in India on account Business connection, operations/activity in India is must.

3.       SKF Boilers and Driers (P) Ltd 284 CTR 121 (AAR)

In the instant case, the AAR was required to evaluate the source of income of the non-resident agents who had earned commission from the business activity of the applicant.

Held, Sections 5 and 9 of the Act thus proceed on the assumption that income has a situs and the situs has to be determined according to the general principles of law. The words 'accrue' or 'arise' occurring in section 5 have more or less a synonymous sense and income is said to accrue or arise when the right to receive it comes into existence. No doubt the agents rendered services abroad and have solicited orders, but the right to receive the commission arises in India when the order is executed by the applicant in India

We therefore hold that the income arising on account of commission payable to the two agents is deemed to accrue and arise in India, and is taxable under the Act in view of the specific provision of Section 5(2)(b) read with section 9(1)(i) of the Act.

At this juncture it is important to discuss the words “Business Connection” and “Source of Income” appearing in section 9(1)(i)

Section 9(1)(i) provides as under:-

“all income accruing or arising, whether directly or indirectly^, through or from any business connection in India, or through or from any property in India, or through or from any asset or source of income in India, or through the transfer of a capital asset situate in India”

Attempt is being made here, to arrive at the meaning of the words “Source of Income”

The words “Source of Income” is part of section 9, which itself is deeming section, providing for certain income to  deemed to accrue or arise in India. In deeming section, the words have to be interpreted in the context of section and not to be loosely interpreted.

Had the words “source of income arising in India” being defined to include any income having connection with India, then such interpretation will rendered entire section 9(1)(i) will rendered otiose.

There is a principle of interpretation, ejusdem generis, which provides that meaning of general words should be gathered from specific words preceding general words.

The words “Source of Income” is preceded by words property or assets. Thus words “source of income arising in India” can be interpreted to include income arising from any asset based in India.

Further, from plain reading of section 9(1)(i), it appears that said section talks about broadly three type of income:-

a)      Active Income – Business Connection/Business Activity

b)      Passive Income – Property, asset, source of income etc.

c)       Capital gain – Transfer of Capital asset

The taxability rules, for being taxable in India, can be summarised as under;-

a)      Active Income –  carrying of activity in India

b)      Passive Income – Situs of Income in India

c)       Capital Gain- Situs of Capital asset in India

The activity of foreign agent rendering service to exporter in India can be best describe as income accruing from business connection, thus carrying on some activity in India is must for making their foreign commission taxable in India, as also held by Hon’ble Supreme court CIT v Toshoku (1980) 125 ITR 525 (SC). Thus in the absence of any service rendered in India, foreign commission paid to non-resident for service rendered outside India is not taxable in India and hence no liability to deduct TDS u/s 195.

Double Taxation Avoidance Agreement (DTAA)

India has entered into DTAA with most of the countries and most of them are based on UN model convention.

The commission income earned by foreign agent can be at best fall in either of following two distributive rules:-

1.       Article 7 – Business Profit

2.       Article -21- Other Income

If commission income is falling under Article 7, then for its taxability in India, it is essential that foreign agent has PE in India. Since foreign agent is not carrying on any activity in India, commission income taxability in India is ruled out absolutely under DTAA.

For Article 21, sub Article 3 is relevant, which provide as under;-

“Notwithstanding, provisions of paragraph 1 and 2, items of income of resident of a contracting state not dealt with in the foregoing articles of convention and arising in the other contracting state may also be taxed in that other state.”

In said Article, the “arising in other contracting state” has not been defined.

In order to attempt to arrive at meaning of these words, we need to look at following articles:

1.       Article 3(2)- Interpretation of terms used in DTAA

2.       Article 7- Business Profit

3.       Article 11- Interest Income

4.       Article 12- Royalty

5.       Article 14 – Independent Personal Service

Article 3(2)

It provides that for interpretation of any terms used in DTAA, unless context otherwise requires, reference shall be made to domestic tax laws. The words arising in contracting state has also not expressly defined in Indian Taxation laws. For interpretation of these words, it become necessary to see other articles to understand the context in which said words are used in DTAA.

Article 7

It provides profits of enterprise of contracting shall be taxable in that state only, unless enterprise carry on business in other contracting state through PE. In that case, other contracting state shall be entitled to tax so much tax of the profits of enterprise as attributable to PE

Article 11

It provides that interest arising in contracting state may be taxed in both source and resident state.

It further provides that interest shall be deemed to arise in contracting, where payer is resident of contracting state.

Article 12

It provides royalty arising in contracting state may be taxed in both source and resident state.

It further provides that royalty shall be deemed to arise in contracting, where payer is resident of contracting state.

Article 14

It provides that income derived by a resident of contracting state in respect of professional services shall be taxable in that state only, except in the following circumstances, when such income may also be taxed in other contracting state:-

a)      If he has fixed based regularly available to him in other contracting state for the purpose of performing or

b)      If his stay in other contracting states exceed specified period; in that case only so much of income as is derived from his activities performed in that other state may also be taxed in that other state.

From afore –said Articles, source based taxation pre-requisites under DTAA can be summarise as under:-

1.       Business Profit – Performance of activity in source state

2.       Interest – Deemed in source state where payer is resident

3.       Royalty – deemed in source state where payer is resident

4.       Independent person services- Performance of activity is source state.

Thus the context of DTAA is that for any income to be taxed in source state, performance of activity in that state is essential, unless otherwise provided as in case of Interest and Royalty, where it is deemed.

Based on this, it can be interpreted that for other income falling under article 21, it shall be deemed to arise in contracting state, when resident of contracting state carry on some activity in source state.

Thus for foreign agent, not carrying on any activity in india, his commission income cannot be deemed to arise in India under Article 21 and hence not taxable in India.

Conclusion

It can concluded that commission paid to non-resident agent for services rendered outside India is not taxable in India, because no services are rendered in India.

Re-assessment Jurisdiction by Assessing Office- Income Tax Act

Re-assessment Jurisdiction by Assessing Officer

1.       Initiation of re-assessment proceedings (issue of notice u/s 148) should be strictly in accordance with the cumulative conditions stipulated in sections 147, 149 & 151 of Income Tax Act, 1961, otherwise same may be void-ab-initio.

2.       Accordingly, the notice u/s 148 should be issued within the timeliness specified in the section 149 and also simultaneously satisfying the conditions laid down in sections 147 & 151

3.       The summary of assuming jurisdiction to commence  re-assessment proceedings are abridged here as under:-

S.No	Conditions	Timeliness for issue of Notice u/s 148
		Before 4 years from end of relevant assessment year	After 4 years but before 6 years from the end of relevant assessment year	After 4 years but before 16 years from the end of relevant assessment year
1.	AO must have reason to believe that Income Chargeable to Tax has escaped assessment	Mandatory	Mandatory	Mandatory
2	Assessment u/s 143(3) or 147 has been made for relevant assessment year and the Income Chargeable to tax has escaped assessment on account of either of following reasons:-         I.            Assessee failed to file Return u/s 139       II.            Assessee failed to file Return in pursuance of Notice issued u/s 142(1) or 148     III.            Assessee failed to disclose fully & truly all material facts necessary for assessment for relevant assessment year	Not Mandatory (For example, even if assessee has disclosed all material facts during the course of assessment of relevant assessment year, It will not bar AO to issue notice u/s 148 within 4 years, if he has reason to believe that income chargeable to tax has escaped assessment)	Mandatory	Not Mandatory
3.	Income Chargeable to Tax, which has escaped assessment for relevant assessment year amounts to or is likely to amount to Rs. 1,00,000 or more.	Not Mandatory (Irrespective of quantum of income escape assessment)	Mandatory	Not Mandatory
4.	Income in relation to any asset (including financial interest in any entity) located outside India, has escaped assessment for relevant assessment year.	Not Mandatory	Not Mandatory	Mandatory
5.	Rank of AO for issue of Notice u/s 148, where NO assessment u/s 143(3) or us/ 147 has been made for relevant assessment year	AO of any rank	a)      AO of any rank below Joint Commissioner, with the approval of Joint Commissioner b)      Joint Commissioner
6.	Rank of AO for issue of Notice u/s 148, where assessment u/s 143(3) or us/ 147 has been made for relevant assessment year	a)      AO of any rank below Asstt. Commissioner or Dy. Commission, with the approval of Joint Commissioner b)      AO at a rank of Asstt. Commissioner or above.	AO of any rank with the approval of Commissioner or Chief Commissioner.