ITAT Jaipur Quashes Disallowance Under Section 40(a)(i): Commission Paid to Non-Resident Not Taxable in India
1. Facts and Issues of the Case
The case of Derewala Industries Limited Vs ACIT/DCIT (ITAT Jaipur, Assessment Year 2017–18) revolves around the disallowance made under Section 40(a)(i) of the Income Tax Act, 1961. The crux of the issue was the payment of commission by the assessee—Derewala Industries Ltd.—to a non-resident agent outside India, without the deduction of tax at source (TDS). The Assessing Officer (AO), during assessment proceedings, disallowed the said commission payment on the grounds that the assessee had failed to deduct TDS under Section 195, thereby invoking disallowance under Section 40(a)(i).
Specifically, the AO assessed the total loss of the assessee at ₹4,48,87,707 after making various disallowances: ₹3,63,287 under Section 40(a)(i) for non-deduction of TDS on commission, ₹5,73,999 under Section 14A related to expenses incurred to earn exempt income, and ₹75,000 under Section 37(1), which deals with allowability of general business expenditure. The Commissioner of Income Tax (Appeals) [CIT(A)] upheld the AO’s decision via order dated 23.12.2019, confirming the disallowance made under Section 40(a)(i). Aggrieved by the CIT(A)’s order, Derewala Industries approached the Income Tax Appellate Tribunal (ITAT), Jaipur Bench.
The key issue that the tribunal had to examine was whether the payment of commission to a non-resident for services rendered outside India constitutes “income deemed to accrue or arise in India” under the Income Tax Act. If not, then the requirement to deduct TDS under Section 195 would not arise, and consequently, the disallowance under Section 40(a)(i) would be unsustainable.
2. Observations by the Tribunal
The ITAT Jaipur, in its detailed examination, focused on the nature of the commission payment and the location of the services rendered by the non-resident agent. It was clearly established that the services for which commission was paid were rendered entirely outside India. There was no evidence suggesting that the non-resident agent had any permanent establishment (PE) in India or that any part of the services were performed within the Indian territory.
The Tribunal referred to the settled legal position that income is deemed to accrue or arise in India under Section 9 of the Act only if the activities of the non-resident have a nexus with the Indian territory. Since the non-resident commission agent operated entirely outside India, without any business connection or presence in India, the payment in question could not be regarded as income chargeable to tax under the Act.
The ITAT also took note of various judicial precedents, including rulings where courts have consistently held that if services are rendered outside India and the payment is also made outside India, the income does not accrue or arise in India and, therefore, cannot be subjected to TDS under Section 195. In this context, the Tribunal highlighted that the AO and the CIT(A) had incorrectly applied the provisions of Section 40(a)(i) without evaluating the territorial nexus or taxability of the income in India.
3. Law Applicable
The relevant legal provisions at play in this case are Section 40(a)(i), Section 195, and Section 9 of the Income Tax Act, 1961. Section 40(a)(i) deals with the disallowance of payments made to non-residents without TDS. Section 195 mandates the deduction of tax at source on payments to non-residents if such payments are chargeable to tax in India. Section 9 outlines the circumstances under which income is deemed to accrue or arise in India.
For Section 195 to apply, the payment to the non-resident must be “chargeable under the provisions of this Act.” In simpler terms, if the income is not taxable in India under Section 9, there is no requirement to deduct TDS under Section 195, and therefore, no disallowance can be made under Section 40(a)(i).
The Tribunal’s reasoning aligns with the Supreme Court’s judgment in GE India Technology Centre Pvt. Ltd. v. CIT (2010), which clearly held that the obligation to deduct tax at source arises only when the remittance is chargeable to tax in India. The burden to prove taxability lies on the Revenue. In the present case, the Revenue failed to demonstrate how the commission income of the non-resident agent was taxable in India.
4. Conclusion and Final Ruling by ITAT Jaipur
After considering all facts, legal provisions, and judicial precedents, the ITAT Jaipur ruled in favor of Derewala Industries Limited. The Tribunal quashed the disallowance made under Section 40(a)(i), holding that the payment of commission to a non-resident agent for services rendered outside India was not taxable in India. Consequently, there was no requirement to deduct TDS under Section 195, and the disallowance made by the AO was unsustainable in law.
This judgment once again reinforces a vital principle of cross-border taxation: the mere act of making a payment to a non-resident does not automatically attract TDS provisions under Indian tax laws. The nature of the service, the place of service delivery, and the existence of a business connection or permanent establishment in India are key factors in determining taxability.
The decision is significant for Indian exporters and businesses engaging international agents or consultants. It brings clarity and relief by ensuring that genuine international transactions involving offshore services are not unfairly taxed or disallowed due to procedural lapses. It also serves as a reminder to tax officers to thoroughly examine the facts and legal applicability before invoking penal provisions like Section 40(a)(i).
Key Takeaway for Layman:
If you are an Indian business paying commission to someone abroad for services done completely outside India, and that person has no office or business connection in India—you are not required to deduct tax on that payment. This judgment supports that view and protects such payments from disallowance under Indian tax laws.
