Automobile manufacturer wins on Transfer Pricing, 14A, R&D deduction and Capital vs Revenue characterization

7. “We have heard both the parties and perused the material available on record. Considering the corrigendum dated 12.17.2018 for Assessment Year 2008-09 passed by the Tribunal in assessee’s own case, we are hereby substituting earlier directions which should be read as under:-

Page 145 of the order dated 17.10.2018

“Thus, the issue is identical in assessee’s own case for A.Y. 2008-09. Therefore, we are remanding back this issue to the file of the Assessing Officer with direction to decide the issue afresh after giving opportunity of hearing to the assessee. Hence, Ground Nos.9 to 9.5 are partly allowed for statistical purposes.

And issuing the fresh direction as under:-

“Following the reasoning adopted by the Co-ordinate Bench of this Tribunal Bench for the Assessment Years 2007-08 & 2008-09 vide corrigendum dated 12.07.2018, we direct the Assessing Officer to delete the disallowance of Rs.36.38 crores on account of provisional liability relating to expenditure on account of FPI-OE components. Ground Nos. 9 to 9.5 are disposed of accordingly.”

78. “We have heard both the parties and perused all the relevant material available on record. It is pertinent to note that the Ld. AR submitted before us that the CSR expenditure is allowable as a business deduction under the provisions of the Income Tax Act (‘the Act”). In this regard, the Ld. AR pointed out to provisions of section 37(1) of the Act, and submitted that under section 37(1) of the Act the fundamental condition for allowability is that the expenditure must be incurred “for the purpose of business”. The said expression is, much wider than “for the purpose of earning income”. For any expenditure to be eligible for deduction, such expenditure must be incurred for the purposes of business, irrespective of fact whether incurring of such expenditure is voluntarily and without any compelling necessity or mandatory. It is, in this regard, also relevant to refer to the legislative history of section 37(1) of the Act, wherein the Income Tax Bill of 1961 initially proposed to lay down that “necessity” of the expenditure would be a condition for claiming deduction under that section. The implication of the aforesaid is that the fact that somebody other than the assessee is also benefitted by the incurring of the expenditure does not come in the way of the expenditure being allowed by way of deduction under section 37(1) of the Act. What is important for the purpose of allowability of deduction under section 37(1) of the Act is that the expenditure must be incurred for the purpose of business. Again, the words, “for the purpose of business” should not be limited to the meaning of “earning profit alone”. It is also important to note that the purpose has to be seen from the point of view of the businessman and should not be seen with reference to narrow objective of earning profits immediately. Certain expenditure may not reap profits immediately, but may be advantageous in the long run, by creating goodwill and brand image. These submissions of the Ld. AR are supported by the Income Tax statute. But at the same time, it can be seen that Explanation 2 has been inserted in section 37 of the Act by the Finance (No.2) Act, 2014 w.e.f. 1.04.2015 to provide that CSR expenses referred in section 135 of the Companies Act, 2013 shall not be deemed to be incurred for the purpose of business. The aforesaid Explanation inserted w.e.f. 1.04.2015. Therefore, in the present assessment year the said explanation will not be applicable. Hence, the expenditure has to be allowed because ultimately the assessee was publicizing its product at the prominent places by maintaining them such as parks and this has direct impact on the sales promotions of the assessee company. Therefore, Ground Nos. 11 to 11.12 are allowed.”

“‘Capital asset’ means property of any kind held by an assessee, whether or not connected with his business or profession, but does not include— any stock-in-trade, consumable stores or raw materials held for the purposes of his business or profession;”

4. The Central Board of Direct Taxes (CBDT) through Instruction No. 1827 dated August 31, 1989 had brought to the notice of the assessing officers that there is a distinction between shares held as investment (capital asset) and shares held as stock-in-trade (trading asset). In the light of a number of judicial decisions pronounced after the issue of the above instructions, it is proposed to update the above instructions for the information of assessees as well as for guidance of the assessing officers.

5. In the case of Commissioner of Income Tax (Central), Calcutta v. Associated Industrial Development Company (P) Ltd (82 ITR 586), the Supreme Court observed that:

Whether a particular holding of shares is by way of investment or forms part of the stock-in-trade is a matter which is within the knowledge of the assessee who holds the shares and it should, in normal circumstances, be in a position to produce evidence from its records as to whether it has maintained any distinction between those shares which are its stock-in-trade and those which are held by way of investment.

6. In the case of Commissioner of Income Tax, Bombay v. H. Holck Larsen (160 ITR 67), the Supreme Court observed:

The High Court, in our opinion, made a mistake in observing whether transactions of sale and purchase of shares were trading transactions or whether these were in the nature of investment was a question of law. This was a mixed question of law and fact.

“Investments are assets held by an enterprise for earning income by way of dividends, interest, and rentals, for capital appreciation, or for other benefits to the investing enterprise. Assets held as stock-in-trade are not ‘investments’.”

“10. One very important fact here is that the entire transaction is on account of redemption of mutual fund which is neither freely tradable nor exchangeable in the market. It is a transaction between two persons, that is, person buying the MF and the other is Mutual Fund Manager who facilitates the fund and it can only be redeemed from the same mutual fund manager from whom it has been purchased. Therefore, it would be very difficult to hold that one would carry out business of mutual funds and will not make any investment. If any item is purchased from one person which can be sold or redeemed to that person alone, then it cannot fall into the category of freely traded commodity…………..The concept of ‘business’ alludes to the concept of systematic activity carried out with an object to earn profit……………. Here it is not a case where the mutual funds have been rotated again and again to purchase and sell the same which is a typical feature in a business, albeit here in this case as pointed out earlier, only 15 transactions have been undertaken for redemption of mutual funds and investment in the same mutual funds have not been made and redeemed again and again. The purchase of mutual funds has been classified as ‘investment’ in the books of account and in the balance sheets and such a treatment is continuing in the subsequent periods also and at no point of time, they have been treated as ‘stock in trade’ in the books of accounts. Thus, the intention of the assessee right from the day one was to make investment in the form of mutual fund and not for the trading. This is also fortified by the fact that no borrowed funds have been utilised in such an investment………….Hon’ble Gujarat Court in the case of Pr. CIT v. Bhanuprasad D Trivedi (HUF) , held that, if the assessee had an intention of being an investor and held shares by way of investment in the books of account then it has to be treated as investor and any gain arising out of transfer of shares should be treated as capital gains and not business income. Hon’ble High Court has also referred to the CBDT circular dated 29.2.2016 in which guidelines have been provided and one such guidelines is that, if the assessee in respect of the listed shares and securities heldfor a period of more than twelve months before transfer and treats the same as transfer of shares, then it has to be treated as “capital gain”. This circular was later on modified to include unquoted shares also. Though here in this case redemption of mutual funds are for a period less than 12 months, but it is quite clear from the CBDT circular that intention of the assessee and the treatment given by the assessee in the books has been given paramount importance. SLP against the said decision of the Hon’ble Gujarat High Court has been dismissed. The same principle has been earlier reiterated by Hon’ble Bombay High Court in Gopal Purohit (supra) and Delhi High Court in PNB Finance & Industries Ltd. (supra). Accordingly, on facts and circumstances of the case we hold that Ld. CIT (A) has rightly held that redemption of units of mutual funds is to be taxed as capital gains and not as business. In the result ground No. 1 raised by the revenue is dismissed.” (emphasis supplied)

“84. We have heard Ld. Authorized Representatives of the parties and perused the material available on record. It is not in dispute that the AO in earlier years has allowed the claim of the assessee regarding treatment of transactions related to sale and purchase of mutual funds/securities etc. as the investment. In the year under consideration, the AO has taken a different stand and treated the surplus arising out of the sale of mutual funds/securities as income from business. It is also not in dispute that the investment made by the assessee is out of non-interest bearing fund. The AO did not accept the contention of assessee made during the course of assessment proceedings on the basis that most of the investments were held for a period of 13 months in respect of long term capital gain and in respect of short term capital gain also there was frequent sale and purchases. He was also view of the fact that looking to the volume of transaction, the total purchase price of mutual fund is Rs.1004,58,57,202/- in respect of long term capital gain and Rs.1587,10,65,228/- in respect of short term capital gain which is substantial by any standard. Hence, he treated the transaction as the business activity of the assessee. Law is well settled now that intent is required to be examined whether it is for investment or otherwise for business of course to arrive at any conclusion certain factors need to be kept in mind. If such factors point towards business activity certainly then any surplus arising would partake character of business profit however, if it for parking surplus fund or is mandatorily made under government policy or otherwise then it will fall in category of investment. Therefore, Considering the totality of the facts, to verify the claim of the assessee that the transaction in question are pure investments by the assessee, the impugned disallowance is hereby set aside and the issue is restored back to the file of AO for decision afresh. The AO would consider all the objections of the assessee in the light of binding precedents. The Ground Numbers 13 to 13.5 are allowed for statistical purpose only.” (Emphasis supplied)

‘It is, however, clarified that the above shall not apply in respect of such transactions in shares/securities where the genuineness of the transaction itself is questionable, such as bogus claims of Long Term Capital Gain/Short Term Capital Loss or any other sham transactions. ”

“It is, however, clarified that the above would not be necessarily applied in the situation where: (i) the genuineness of the transaction in unlisted shares itself is questionable; or (ii) the transfer of unlisted shares is related to an issue pertaining to lifting of corporate veil: or (iii) the transfer of unlisted shares is made along with the control and management of underlying business.”

“96. We have heard Ld. Authorized Representatives of the parties and perused the material available on record. The contention of the assessee against the disallowance are multifolds; firstly, the transaction took place outside India and there was no transfer of title of goods within territory of India; secondly, there was no service PE as claimed by the AO; thirdly, there was no dependent agency; and fourthly, the issue is squarely covered by the decision of the Coordinate Bench and also the judgement of the Hon ‘ble Supreme Court and finally even it is assumed there was PE and the transaction took place within the territory of India. Even in that event, the attribution of profit is erroneous and contrary to the settled position of law. In this regard, it was submitted that the AO had disallowed a sum of Rs.1956,78,37,510/- made by the assessee to SMC out of which 50% profits have been alleged to be attributable to the alleged PE in India. However, had the AO correctly attributed the profit, it would have come at Rs.1.82 crores only and without prejudice to the submissions, the amount of disallowance could be restricted to this extent.

97. The issue needs to be examined whether the AO was correct in holding that the assessee was required to deduct tax on the payments made to SMC. The broad submissions of the assessee are that in the light of the principle of consistency, the disallowance is unjustified. Moreover, there is no dependent or service PE and the entire transaction took place off shore. The assessee also placed upon the judgement of Hon’ble Delhi High Court in the case of DIT v. Ericson AB  wherein Hon’ble Delhi High Court answered the question in favour of the assessee, holding that having regard to the fact that goods manufactured outside India as passing of property from seller to buyer. Hence, the assessee had not earned income through or from any business connection.

98. After considering the totality of facts and in the light of the judicial pronouncements we find merit in the contention of the assessee even if it is assumed that there was PE even then correct attribution of profit is required to be made. To meet the ends of justice we hereby set aside the issue to the file of AO. The impugned disallowance is hereby set aside. The AO is hereby directed to decide the issue afresh after adjudicating all the objections of the assessee. The Ground Numbers 15 to 15.10 are allowed for statistical purpose only.”

“An order of remand prolongs and delays the litigation and hence, should not be passed unless the appellate court finds that a re-trial is required, or the evidence on record is not sufficient to dispose of the matter for reasons like lack of adequate opportunity of leading evidence to a party, where there had been no real trial of the dispute or there is no complete or effectual adjudication of the proceedings, and the party complaining has suffered material prejudice on that account. Where evidence has already been adduced and a decision can be rendered on appreciation of such evidence, an order of remand should not be passed remitting the matter to the lower court, even if the lower court has omitted to frame issue(s) and/or has failed to determine any question of fact, which, in the opinion of the appellate court, is essential. The first appellate court, if required, can also direct the trial court to record evidence and finding on a particular aspect/issue in terms of Rule 25 to Order XLI, which then can be taken on recordfor deciding the case by the appellate court.

In the present case, the High Court, as the first appellate court, which is also a court of fact and law, has passed an order of remand observing that the judgment of the trial court was, in its opinion, not written as per the mandate of Section 33 and Rule 4(2) and 5 of Order XX of the Code, as the discussion and reasoning on certain aspects was not detailed and elaborate.”

“We find that the Tribunal in its very detailed order recorded the rival submissions of the parties. In this background, in our view, there was no purpose of remanding the matter back to the DRP on a small aspect, namely whether the appellant had made any concession with regard to the existence of its PE in the India. The same was a matter of record, if at all. The Tribunal could have decided the said issue and all other issues arising from answer to the said issue, or in consequences thereof. We, therefore, answer the question framed in favour of the appellant. We set aside the impugned order in so far as the operative direction contained in paragraph 88 is concerned. ”

“The third member also rightly observed that when all the facts were before the Tribunal to take a view on this aspect, the accountant member was not correct in remanding the case to the A.O. for this purpose. ” The power to remand is an exception and should be used sparingly and cannot be exercised if there is a lack of finding or investigation by Assessing officer. Remand in a casual manner as a shortcut is totally prohibited under the law.”

“ARTICLE 7

1. The profits of an enterprise of a Contracting State shall be taxable only in that Contracting State unless the enterprise carries on business in the other Contracting State through a permanent establishment situated therein. If the enterprise carries on business as aforesaid, the profits of the enterprise may be taxed in that other Contracting State but only so much of them as is directly or indirectly attributable to that permanent establishment.

2. Subject to the provisions of paragraph 3, where an enterprise of a Contracting State carries on business in the other Contracting State through a permanent establishment situated therein, there shall in each Contracting State be attributed to that permanent establishment the profits which it might be expected to make if it were a distinct and separate enterprise engaged in the same or similar activities under the same or similar conditions and dealing wholly independently with the enterprise of which it is a permanent establishment. ”

“ARTICLE 5

1. For the purposes of this Convention, the term ‘permanent establishment’ means a fixed place of business through which the business of an enterprise is wholly or partly carried on.

2. The term ‘permanent establishment’ includes especially :

3 to 6……………………….

7. Notwithstanding the provisions of paragraphs 1 and 2, where a person other than an agent of an independent status to whom paragraph 8 applies – is acting in a Contracting State on behalf of an enterprise of the other Contracting State, that enterprise shall be deemed to have a permanent establishment in the first-mentioned Contracting State, if

8. An enterprise shall not be deemed to have a permanent establishment in a Contracting State merely because it carries on business in that Contracting State through a broker, general commission agent or any other agent of an independent status, provided that such persons are acting in the ordinary course of their business.

9. The fact that a company which is a resident of a Contracting State controls or is controlled by a company which is a resident of the other Contracting State, or which carries on business in that other Contracting State (whether through a permanent establishment or otherwise), shall not of itself constitute either company a permanent establishment of the other.”

“Para (1) of Article 5 defines a PE to mean a fixed place of business through which the business of an enterprise is wholly or partly carried on. The term ‘fixed place of business’ includes premises, facilities, offices which are used by an enterprise for carrying on its business. The fixed place must be at the disposal of an enterprise through which it carries on its business wholly or partly. Although, the word ‘through’ has been interpreted liberally but the very least, it indicates that the particular location should be at the disposal of an Assessee for it to carry on its business through it. These attributes of a PE under Article 5(1) of the Indo-US DTAA were elucidated by the Supreme Court in Morgan Stanley & Co. Ltd. (supra). In a recent decision, a Division Bench of this Court in DIT v. E-Funds IT Solution   (Delhi) reiterated the abovestated attributes; after quoting from various authors, this Court held that “The term ‘through’ postulates that the taxpayer should have the power or liberty to control the place and, hence, the right to determine the conditions according to its needs”.

“Paragraph 1 of Article 5 provides an overarching general definition of the expression ‘Permanent Establishment’ (PE). It defines a PE to mean a fixed place of business through which the business of an enterprise is wholly or partially carried on. It is clear from the aforesaid definition that the expression ‘Permanent Establishment’ entails (a) a fixed place of business; and (b) business of the enterprise being carried on wholly or partially through the said fixed place of business. These two conditions must necessarily be satisfied for the existence of a PE. In addition, the word permanent in the term ‘Permanent Establishment’ indicates that there should be some degree of permanency attached to the fixed place of business before the same can be construed as a PE of an enterprise. The word permanent does not imply for all times to come but merely indicates a place which is not temporary, interim, short-lived or transitory”

“…… 32. We have considered the observations of Id. DRP in the light of the above statements. There is no doubt that there is seemless information exchange between the employees of the assessee and the expat employees. However, on a careful consideration of the entire matter including the statements of the expatriate employees, extracted supra, we are of the considered opinion that the statements show that such information exchange relates to the models/designs to the liking of the Indian consumers, plans and strategies relating to the sale of the products, detailed stock/logistical status, the market strategies both the mid and long terms etc.

33. As rightly argued by the Ld. AR that none of the statement would go to show that the any activity of the global business management (GBM) has ever been conducted in India or that the market survey that is conducted in India, as spoken by the expatriate employees has nothing to do with the business of the Indian subsidiary and it is solely for the benefit of the assessee. All the activities that are spoken by the expatriate employees related to the specificity of the products, stock verification, they designs according to the preferences of the Indian consumers, the market strategies to be adopted etc are clearly within the ambit of the business of the Indian subsidiary. Such a communication would primarily benefit the Indian subsidiary, and would help the assessee in its GBM to sustain its supply chain management and to place optimized purchase orders at a right timing or to acquire the most promising manufacturing technologies, as is submitted on behalf of the assessee.

34. At the best, the statements and other material relied upon by the revenue show that by way of the seamless communication between the Indian subsidiary and the assessee, the expatriate employees were only discharging the duties of the subsidiary company towards the holding company. Whatever the benefits that are derived by the Indian subsidiary by such communication are offer to tax in India. We therefore find that the activities spoken by the expatriate employees in their statements are in the nature of reporting required in the course of discharge of the functions of the subsidiary company towards the holding company, and such activities do not constitute a PE under Article 5(4)(d), (e) and (f of the DTAA. ”

“It is entirely foreign to the purpose for which this or any other board exists to contemplate a member of the board being representative of a particular group or a particular body. Once a group has elected a member he assumes office as a member of the board and becomes subject to the overriding and predominant duty to serve the interests of the board in preference, on every occasion upon which any such conflict might arise, to serving the interests of the group which appointment him. With this basic position, there can be no room for compromise.”

“66.The approach of both the corporate and tax laws, particularly in the matter of corporate taxation, generally is founded on the abovementioned separate entity principle, i.e., treat a company as a separate person. The Indian Income Tax Act, 1961, in the matter of corporate taxation, is founded on the principle of the independence of companies and other entities subject to income-tax. Companies and other entities are viewed as economic entities with legal independence vis-a-vis their shareholders and participants. It is fairly well accepted that a subsidiary and its parent are totally distinct tax payers. Consequently, the entities subject to income-tax are taxed on profits derived by them on standalone basis, irrespective of their actual degree of economic independence and regardless of whether profits are reserved or distributed to the shareholders/ participants. Furthermore, shareholders/participants, that are subject to (personal or corporate) income-tax, are generally taxed on profits derived in consideration of their shareholding/participations, such as capital gains. Now a days, it is fairly well settled that for tax treaty purposes a subsidiary and its parent are also totally separate and distinct tax payers.

“67. It is generally accepted that the group parent company is involved in giving principal guidance to group companies by providing general policy guidelines to group subsidiaries. However, the fact that a parent company exercises shareholder’s influence on its subsidiaries does not generally imply that the subsidiaries are to be deemed residents of the State in which the parent company resides. Further, if a company is a parent company, that company’s executive director(s) should lead the group and the company’s shareholder’s influence will generally be employed to that end. This obviously implies a restriction on the autonomy of the subsidiary’s executive directors. Such a restriction, which is the inevitable consequences of any group structure, is generally accepted, both in corporate and tax laws. However, where the subsidiary’s executive directors’ competences are transferred to other persons/bodies or where the subsidiary’s executive directors’ decision making has become fully subordinate to the Holding Company with the consequence that the subsidiary’s executive directors are no more than puppets then the turning point in respect of the subsidiary’s place of residence comes about.”

74……………………………. The directors of the subsidiary under their Articles are the managers of the companies. If new directors are appointed even at the request of the parent company and even if such directors were removable by the parent company, such directors of the subsidiary will owe their duty to their companies (subsidiaries). They are not to be dictated by the parent company if it is not in the interests of those companies (subsidiaries). The fact that the parent company exercises shareholder’s influence on its subsidiaries cannot obliterate the decision-making power or authority of its (subsidiary’s) directors. They cannot be reduced to be puppets. The decisive criteria is whether the parent company’s management has such steering interference with the subsidiary’s core activities that subsidiary can no longer be regarded to perform those activities on the authority of its own executive directors” (Emphasis supplied)

“It cannot be stated as a broad proposition that the TDS provisions which are in the nature of machinery provisions to enable collection and recovery of tax are independent of the charging provisions which determines the assessability in the hands of the employee-assessee. Secondly, whether the Home Salary payment made by the Foreign Company in foreign currency abroad can be held to be “deemed to accrue or arise in India” would depend upon the in- depth examination of the facts in each case. If the home salary/special allowance payment made by the foreign company abroad is for rendition of services in India and if as in the present case of M/s Eli Lilly and Company (India) Pvt. Ltd. no work was found to have been performedfor M/s Eli Lilly Inc Netherlands then such payment would certainly come under Section 192 (1) read with Section 9(1)(ii). As stated above, the postsurvey operations revealed that no work stood performed for the foreign company by the four expatriates to the joint venture company in India and that the total remuneration paid was only for services rendered in India. In such a case the tax-deductor-assessee was statutorily obliged to deduct tax under Section 192 (1) of the 1961 Act”

“32.1 Also, the phrase “authority to conclude contracts in the name of the enterprise” does not confine the application of the paragraph to an agent who enters into contracts literally in the name of the enterprise; the paragraph applies equally to an agent who concludes contracts which are binding on the enterprise even if those contracts are not actually in the name of the enterprise.”

“62.When permanent establishments receive dividends, interest, or royalties such income, by virtue of paragraph 4 of Articles10 and 11 and paragraph 3 of Article12, respectively, comes under the provisions of Article 7 and consequently — subject to the observations made in paragraph 53 above as regards dividends received on holdings of permanent establishment — falls to be included in the taxable profits of such permanent establishments (see paragraph 74 of the Commentary on Article7).

63. According to the respective Commentaries on the above-mentioned provisions of Articles10, 11 and 12 (see respectively paragraphs 31, 24 and 20), these provisions dispense the State of source of the dividends, interest or royalties received by the permanent establishment from applying any limitation provided for in those Articles, which means — and this is the generally accepted interpretation — that they leave completely unaffected the right of the State of source, where the permanent establishment is situated, to apply its withholding tax at the full rate.

64. While this approach does not create any problems with regard to the provisions of paragraph3 of Article 24 in the case of countries where a withholding tax is levied on all such income, whether the latter be, paid to residents (permanent establishments, like resident enterprises, being allowed to set such withholding tax off against the tax on profits due by virtue of Article 7) or to nonresidents (subject to the limitations provided for in ArticleslO, 11 and 12), the position is different when withholding tax is applied exclusively to income paid to non-residents.

65. In this latter case, in fact, it seems difficult to reconcile the levy of withholding tax with the principle set out in paragraph3 that for the purpose of taxing the income which is derived from their activity, or which is normally connected with it — as is recognised to be the case with dividends, interest and royalties referred to in paragraph4 of Articles 10 and 11 and in, paragraph 3 of Article 12 —, permanent establishments must be treated as resident enterprises and hence in respect of such income be subjected to tax on, profits solely”

“…………….2. Disallowance regarding ‘other sum chargeable’ under section 40(a)(i) is triggered when the deductor fails to withhold tax as per provisions of section 195 of the Act. Doubts have been raised about the interpretation of the term ‘other sum chargeable’ i.e. whether this term refers to the whole sum being remitted or only the portion representing the sum chargeable to income-tax under relevant provisions of the Act.

3. Central Board of Direct Taxes has already issued Instruction No. 02/2014 dated 26.02.2014 (F. No. 500/33/2013-FTD-l) regarding deduction of tax at source under sub-section (1) of section 195 read with section 201 of the Act relating to payments made to non-residents in cases where no application is filed by the deductor for determining the sum so chargeable under sub-sec/ion (2) of section 195 of the Act. Vide this Instruction, Board has clarified that in cases where tax is not deducted at source under section 195 of the Act, the Assessing Officer shall determine the appropriate portion of the sum chargeable to tax, as mentioned in sub-section (1) of section 195 to ascertain the tax-liability on which the deductor shall be deemed to be an assessee in default under section 201 of the Act. It has been further clarified that such appropriate portion of the said sum will depend on the facts and circumstances of each case taking into account the nature of remittances, income component therein or any other fact relevant to determine such appropriate proportion.

4. As disallowance of amount under section 40(a)(i) of the Act in case of a deductor is interlinked with the sum chargeable under the Act as mentioned in section 195 of the Act for the purposes of tax deduction at source, the Central Board of Direct Taxes, in exercise of powers conferred under section 119 of the Act, hereby clarifies that for the purpose of making disallowance of ‘other sum chargeable’• under section 40(a)(i) of the Act, the appropriate, portion of the sum which is chargeable to tax under the Act shall form the basis of such disallowance and shall be the same as determined by the Assessing Officer having jurisdiction for the purpose of sub-section (1) section 195 of the Act as per Instruct on No. 2/2014 dated 26.02.2014 of CBDT. Further, where determination of’other sum chargeable’has been made under sub-section (2), (3) or (7) of section 195 of the Act, such a determination will form the basis for disallowance, if any under section 40(a)(i) of the Act.”(emphasis supplied)

“287. We have carefully considered the argument raised by the Department as well as the assessee. In the present case it cannot be disputed that the research and development activities and the manufacture of the GSM equipment took place wholly outside India. We have also found, for reasons stated earlier, that the title and risk in the equipment also passed wholly outside India. The only activities which the assessee carried on in India through its PE were :

In the case of Ahmadbhai Umarbhar , the Supreme Court held that the income attributable to the manufacturing activity should be more then the income attributable to the activity of sale. In the case of Annamalia Timber Trust and Co. v. CIT 41 ITR 781, the Madras High Court approved the tribunal’s decision that 10% of the income can be attributed to the signing of the contracts in India. The Calcutta High Court also approved the same percentage as income attributable to the signing of the contracts in India in the case of CIT v. Bertram Scott Ltd. . We have kept the principles laid down in these judgments in mind. In the present case, as already noted, in addition to the signing of the contracts in India, the preliminary negotiations for the contracts and the network planning were carried out through the PE. We may clarify here that the network planning activity is different from the activities which are of the preparatory or auxiliary character. In respect of signing of contracts, alone, the income attributed is 10% in the decisions cited above. Two more activities have been carried out by the PE in India and, therefore, we have to attribute a higher income than what was attributed in the decided case. The negotiations which ultimately lead to the signing of the contracts may involve more effort on the part of the PE and the signing of the contracts is only the fructification of those efforts. Obviously, therefore, the income attributable to the negotiations part should be more and in addition to the income attributable to the signing of the contracts. Some income has t be attributed to the net work planning also. Taking all these into consideration, we consider it fair and reasonable to attributable 20% of the net profit in respect of the Indian sales as the income attributable to the PE. The following steps are involved in computing the income attributable to the PE.

(1)…

(2)….

(3) Except where the provisions of article 9, paragraph 8 of article 11/ or paragraph 7 of article 12 apply, interest, royalties and other disbursements paid by an enterprise of a Contracting State to a resident of the other Contracting State shall, FOR THE PURPOSE of determining the TAXABLE PROFITS of SUCH ENTERPRISE, be DEDUCTIBLE UNDER THE SAME CONDITIONS as if they had been paid to a resident of the first mentioned Contracting State.

(4) Enterprises of a Contracting State, the capital of which is wholly or partly owned or controlled directly or indirectly; by one or more residents of the other Contracting State, shall not be subjected in the first- mentioned Contracting State to any TAXATION OR ANY REQUIREMENT CONNECTED THEREWITH WHICH IS OTHER OR MORE BURDENSOME THAN THE TAXATION AND CONNECTED REQUIREMENTS TO WHICH OTHER SIMILAR ENTERPRISES OF THE FIRST-MENTIONED CONTRACTING STATE are or may be subjected

(5)……. ”

“38. The question that next arises is whether the payment by the Assessee to HIAI qualifies as ‘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 fee paid by the Assessee to HIAI which the Revenue has chosen to characterize as FTS within the meaning of Explanation 2 to Section 9(1)(vii) of the Act.

42. At one stage of the proceedings, the Assessee sought to contend that the payment was FIS covered under Article 12(4) of the DTAA. The ITAT did not address this issue. It addressed the question whether, even assuming it was FIS, Section 40(a)(i) of the Act cannot be applied and consequently, no disallowance can be made. Before this Court no question has been framed at the instance of the Assessee that the payment is covered by Article 12 (4) of the DTAA. Consequently, this question is not examined by the Court.”

“15. As indicated above, before 1-4-2005, payments specified in clause (i) of Section 40(a) made outside India or to a non-resident could not be deducted while computing the income chargeable to tax under the head “profits and gains from business and profession” unless TAS was deducted or after the deduction the amount was made over, i.e., paid. Inter alia, the payments specified in clause (i) of Section 40(a) concern interest [not being interest on a loan issued for public subscription before the 1st day of April, 1938], royalty, fees for technical services or other sums chargeable under the Act.

15.1 The rigour of the said provision, as it obtained prior to 1-4-2005, did not apply to the aforementioned specified payments made to residents. FA 2004 brought about an amendment in Section 40(a), whereby the resident was also brought within its sway, albeit with respect to payments specified in clause (ia). The payments adverted to in clause (ia) were the following:

“any 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, being resident, for carrying out any work (including supply of labour for carrying out any work)”

15.2 Thus, although parity had been brought about with regard to the power of the AO to deny deduction where TAS was not deducted against payments made outside India or to non-residents and residents, it was limited to certain payments. As is evident upon perusal of clause (ia) of Section 40(a), it did not bring payments made towards purchases to resident- vendors within its net. Therefore, the respondent/assessee argued that even after the amendment in Section 40(a) w.e. f. 1-4-2005, unequal treatment, i.e., discrimination, obtained with regard to payments made against purchases to resident-vendors. The expenditure incurred on payments made to resident-vendors against purchases could thus, be taken into account while computing income chargeable under the head “profits and gains of business or profession”. This disparity was removed by FA 2014, albeit w.e.f. from 1-4-2015, when the ambit of disallowance was enlarged by bringing any sum payable to a resident within the four corners of clause (ia) of Section 40(a).

15.3 Since the period in issue is AY 2006-07, the amendment brought about in Section 40(a) by virtue of FA 2014 would have no relevance. Therefore, in my opinion, the equal treatment or the non-discrimination clause obtaining in Articles 24(3) and 26(3) of the India-Japan/India-USA DTAAs would apply with regard to the payment for purchases made by the respondent/assessee concerning the following five companies: MC (Japan); Metal One Corporation (Japan); Tubular (USA); Petro (Japan) and Miteni (Japan)

16. There can be no cavil with the proposition advanced on behalf of the respondent/assessee that since the provision of Article 24(3)/26(3) of the India-Japan and India-USA DTAAs respectively are more beneficial, it is entitled to rely upon the same, in support of its stand that the disallowance had been rightly deleted by the Tribunal. Section 90(2) of the Act makes it abundantly clear that, “Where the Central Government has entered into an agreement with the Government of any country outside India or specified territory outside India.for granting relief of tax, or.avoidance of double taxation, then, in relation to the assessee to whom such agreement applies, the provisions of this Act shall apply to the extent they are more beneficial to that assessee.” [See Azadi Bachao Andolan (supra)

17. The argument advanced on behalf of the appellant/revenue that since provisions of Article 9 of the respective DTAAs apply, the equal treatment/non-discrimination clause incorporated in Article 24(3)/26(3) would have no application to my mind, is untenable for the following reason:

17.1 Article 9 captures transactions that an assessee may enter with an AE, which may result in a transfer pricing adjustment. In the instant case, the transfer pricing adjustment impacted the payments received by the respondent/assessee against services rendered by it to its group companies. This aspect was concededly not the subject matter of the disallowance ordered under Section 40(a) of the Act. The disallowance under the said provision was confined to payments made by the respondent/assessee against purchases required to conform to the equal treatment clause or the non-discrimination Clause contained in Article 24(3)/26(3). Perhaps for this reason, the AO did not take recourse to the provisions of Article 9 of the respective DTAAs”

“There is also a dispute regarding the words “same activities” used in article 26. The case of the ld. Counsel is that the assessee is engaged in the business of export of software in the same manner in which a number of Indian enterprises are exporting software. The fact that the assessee has been allowed to export software shows that the business does not fall in the prohibited category. Accordingly, the assessee’s case has to be compared with the case of an Indian enterprise engaged in the business of exporting software. If that is done, the assessee would be entitled to deduction under section 80HHE on the same footing and in the same manner as the deduction is admissible to a resident assessee. On the other hand, the case of the ld. DR is that various deductions under section 80HHE, 10A or 10B are area specific or industry specific. However, he was not able to carry this argument any further. The case of the ld. Counsel is that the provision contained in section 80HHE is industry specific and the assessee is not precluded in any manner from conducting this business in India. We agree with this view as no debate seems to be feasible in this regard. Therefore, we are of the view that the assessee is carrying on the activities of export of software. An Indian Company or any other resident person carrying on the business of export out of India of computer software or its transmission from India to a place outside India by any means is entitled to deduction under section 80HHE. Therefore, the deduction admissible to an Indian company or a person resident in India will be allowable to the assessee also. ”

“76. This paragraph forbids a Contracting State to give less favourable treatment to an enterprise, the capital of which is owned or controlled, wholly or partly, directly or indirectly, by one or more residents of the other Contracting State. This provision, and the discrimination which it puts an end to, relates to the taxation only of enterprises and not of the persons owning or controlling their capital. Its object therefore is to ensure equal treatment for taxpayers residing in the same State, and not to subject foreign capital, in the hands of the partners or shareholders, to identical treatment to that applied to domestic capital……”