Disallowance under Section 40(a)(i) is unsustainable because payments made in India are not taxable

Facts and Issues of the case

The common issue arising in both these appeals are as under:-

(i) Deletion of addition made u/s. 14A of the Act

(ii) Deletion of addition made u/s. 40(a)(i)

For the AY 2013-14, the revenue raised one more ground pertaining to CIT(Appeals) deleting the addition of Rs.9,74,734 made by the AO treating as capital in nature. During the course of hearing, the ld. DR did not press for this ground, therefore the same is dismissed a not pressed.

The assessee is into the business of manufacture and export of software. The assessee filed the return of income for AY 2013-14 on 17.3.2014 by declaring an income of Rs.8,67,63,830 and return for AY 2014-15 on 12.9.2014 declaring an income of NIL. The case was selected for scrutiny through CASS and notice u/s. 143(2) was duly served on the assessee. The AO made the following disallowances:-

Disallowance u/s. 14A r.w. Rule 8D
Addition towards foreign exchange gain
Disallowance of expenses for setting up of office
Onsite project expenses without TDS disallowed u/s. 40(a)(i)

Aggrieved, the assessee preferred an appeal before the CIT(Appeals). The CIT(Appeals) gave partial relief to the assessee by deleting the disallowances made u/s. 14A and section 40(a)(i). The revenue is in appeal against the order of the CIT(Appeals).

Disallowance u/s. 14A r.w. Rule 8D

The AO noticed during the course of assessment that the assessee has made certain investments the income from which is exempt from tax. The AO also noticed that the assessee has not worked out any disallowance towards income from investments exempt under the Act. The assessee submitted before the AO that during the year under consideration, it is not having any exempt income and therefore no disallowance u/s. 14A is warranted. However, the AO did not agree with the contention of the assessee and proceeded to invoke section 14A r.w. Rule 8D. In this regard, the AO relied on Circular No.5 / 2014 dated 11.2.2014 issued by the CBDT and also the decision of the ITAT, Kolkata in the case of M/s. Champion Commercial Co. Ltd.

Before the CIT(Appeals), in addition to the submission that there is no exempt income earned, the assessee also submitted that the investments are made out of the proceeds of Initial Public Offer and equity capital and no interest expenses is incurred on these investments.

The assessee further submitted that the investments are strategic investments specialized in the areas of IT & ITeS in the process of acquiring major stake in those companies to have business interest. The CIT(A) allowed the appeal in favour of the assessee by stating that the investments are made out of the IPO funds and other resource and therefore no disallowance is called for. The CIT(Appeals) also relied on the coordinate Bench decision of the Tribunal in the case of J P Distilleries P. Ltd. v. ITO wherein it was held that when there is no exempt income, no disallowance can be made u/s. 14A. Aggrieved, the revenue is in appeal before the Tribunal.

The ld. DR supported the order of the AO and contended that the explanation inserted to section 14A is clarificatory in nature and therefore even if the assessee does not have exempt income the AO is right in invoking the provisions of section 14A. The ld AR brought to our attention the latest decision of the Delhi High Court in the case of PCIT v. Era Infrastructure India Ltd. where the Hon’ble High Court has held that the Explanation to section 14A is prospective in nature and therefore no disallowance is warranted in assessee’s case since there is no exempt income earned.

In the given case, on perusal of the statement of computation of income it is noticed that for the AYs 2013-14 & 2014-15 the assessee does not have any exempt income) and therefore applying the ratio laid down by the Hon’ble Delhi High Court in the case of PCIT v. Era Infrastructure India Ltd. we delete the addition made by the AO u/s. 14A for both the assessment years.

Observation by the Court

The court have considered the rival submissions and perused the material on record. The ground under which the AO is contending that TDS provisions are applicable to the payment made by the assessee to the vendors is that the manpower employed are doing highly technical job whereby the technical knowledge is ‘made available’ to the assessee. The payments made by the assessee to Datamatics Solutions Inc., USA need to be analysed from the applicability of article 12 of the Double Taxation Avoidance Agreement with US, which states that the provisions of fees for technical service would be attracted if services rendered ‘make available’ technical knowledge, experience, skill, know-how, or processes or consists of the development and transfer of a technical plan or technical design.

With regard to payments made by the assessee to Link List Ltd., UAE., the court notice that as per the DTAA between India and UAE, there is no specific clause with regard to the taxability of fees for technical services, and therefore in our considered view the nature of income would take the character of Business Income which can be taxed only when there is a permanent establishment (PE) for the recipient of the payment. In this regard we place reliance on the decision of Ahmedabad Bench of Tribunal in the case of Dy. CIT v. Welspun Corporation Ltd.

What follows from the above is that since DTAA provisions are more beneficial to the entities based in such countries, with which India has tax treaty, but such tax treaty do not have FTS clause, then there is no question of taxability of such receipts under the Income Tax Act, either as business income or other income. A similar view is held by the Pune Bench of the Tribunal in the case of Deputy Director of Income-tax, (International Taxation)-II, Pune vs Tetra Pak India (P.) Ltd.

Now the court will consider the facts of the present case to decide the applicability of the above decisions to assessee’s case. From the perusal of the materials it is noticed that the assessee has entered into a contract with the vendors Linklist Ltd.,UAE and Datamatics Solutions Inc., USA to provide required manpower directly to the ultimate clients Tech Caliper Inc, (ICI) and DataAssured Inc (DA). The assesse could not carry out its commitment given to the customers due to the retrenchment /attrition of the professionals that resulted in project work not getting completed on time. The assessee entered into agreement with Datamatics Solutions Inc., USA and Link List Ltd., UAE for the purpose of using their services towards providing required manpower who would be directly employed in clients location in order to complete the pending project works. The CIT(Appeals) has made a note that this is substantiated by the email correspondence between the assessee and its customers. The CIT(Appeals) has also given a detailed finding which is extracted above to state that there is no transfer of technology by the employees of the vendor to the assessee. The scheme of arrangement as can be seen from the facts of this case is that the assessee has entered into agreement with Datamatics Solutions Inc., USA and Link List Ltd., UAE for supply of manpower to be employed in customer locations instead of assessee’s own staff being employed. It is also noticed that the vendor employees work as per the directions of the ultimate customers without much interaction with the assessee. Therefore, it can be said that the services rendered by third party vendors can be described as payroll services and in the invoices raised by the vendors the description is towards reimbursement of salaries of the manpower hired. Considering the nature of service rendered by the vendors to the assessee, there is no use of technology in the services provided. The vendor is not employing any technology but is providing manpower service to the assessee in order to enable the assessee to meet the project commitments given to the customers. Though the deployed employees may possess the technical knowledge to carry out the services to the customers, no technology is made available to the assessee.

Therefore, following the ratio laid down by the jurisdictional High Court in the case of CIT v. De Beers India Minerals (P.) Ltd (supra), the court hold that the assessee is not liable to deduct tax at source for the reimbursement of the salary cost made to the vendor Datamatics Solutions Inc., USA for deployment of manpower. Further the vendor Link List Ltd., UAE does not have a permanent establishment in India and therefor the impugned payments cannot be taxed in India and thereby no tax is deductible at source on these payments. In view of these discussions as per the DTAA between India and USA / UAE, the impugned payments are not fees for technical services and not business income taxable in India. Therefore no disallowance is warranted u/s. 40(a)(i) for non-deduction of tax at source by the assessee.

For the AY 2014-15, the assessee made payment of 42,42,99,232 under the same agreement with Datamatics Solutions Inc., USA and Link List Ltd., UAE and the amount is disallowed by the AO on the similar grounds u/s.40(a)(i). In view of our decision above with regard to the impugned payments made by the assessee to the third party vendors and on similar facts, the court hold that the assessee was not liable to deduct tax at source and therefore no disallowance is warranted.

During the course of hearing, the ld. AR made alternate submissions with regard to the applicability of exception provided in section 9(1)(viib) of the Act for the payments made by the assessee to the vendors. Since the court have allowed the claim of the assessee in the above paragraph, this alternate plea has become academic and does not warrant any adjudication.