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 allowability of such payment as deduction. It has to be seen that in those ‘same conditions‘ whether the consequences are different for the failure to deduct TDS.
It is argued by the Revenue that since in the present case no condition of deduction of TDS was attracted, in terms of Section 40 (a) (i) of the Act as it then stood, to payments made to a resident, but only to payments made to non-residents, the two payments could not be said to be under the ‗same condition‘. The further submission is that if they are not made under the same condition’, the non-discrimination rule under Article 26 (3) of the DTAA is not attracted.
In the first place it requires to be noticed that DTAA is as a result of the negotiations between the countries as to the extent to which special concessional tax provisions can be made notwithstanding that there might be a loss of revenue. In Union of India v. Azadi Bachao Andolan (supra) the Supreme Court noted that treaty negotiations are largely ―a bargaining process with each side seeking concessions from the other, the final agreement will often represent a number of compromises, and it may be uncertain as to whether a full and sufficient quid pro quo is obtained by both sides.‖ The Court acknowledged that developing countries allow ‘treaty shopping‘ to encourage capital and technology inflows which developed countries are keen to provide to them. It was further noted that the corresponding loss of tax revenues could be insignificant compared to the other non-tax benefits to the economies of developing countries which need foreign investment. The Court felt that this was a matter best left to the discretion of the executive as it is ―dependent upon several economic and political considerations.‖
Consequently, while deploying the nexus test to examine the justification of a classification under a treaty like the DTAA, the line of enquiry cannot possibly be whether the classification has nexus to the object of the ‗statute‘ for the purposes of Article 14 of the Constitution of India, but whether the classification brought about by Section 40 (a) (i) of the Act defeats the object of the DTAA.
The argument of the Revenue also overlooks the fact that the condition under which deductibility is disallowed in respect of payments to non-residents, is plainly different from that when made to a resident. Under Section 40 (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 nonresident 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 object of Article 26 (3) DTAA was to ensure non-discrimination in the condition of deductibility of the payment in the hands of the payer where the payee is either a resident or a non-resident. That object would get defeated as a result of the discrimination brought about qua non-resident by requiring the TDS to be deducted while making payment of FTS in terms of Section 40 (a) (i) of the Act.
A plain reading of Section 90 (2) of the Act, makes it clear that the provisions of the DTAA would prevail over the Act unless the Act is more beneficial to the Assessee. Therefore, except to the extent a provision of the Act is more beneficial to the Assessee, the DTAA will override the Act. This is irrespective of whether the Act contains a provision that corresponds to the treaty provision. In Union of India v. Azadi Bachao Andolan (supra) the Supreme Court took note of the Circular No. 333 dated 2nd April 1982 issued by the CBDT on the question as to what the assessing officers would have to do when they find that the provision of a DTAA treaty is not in conformity with the :
“Thus, where a Double Taxation Avoidance Agreement provided for a particular mode of computation of income, the same should be followed, irrespective of the provision of the Income Tax Act. Where there is no specific provision in the Agreement, it is the basic law, i.e., Income Tax Act, that will govern the taxation of income.”
Further in Union of India v. Azadi Bachao Andolan (supra), after taking note of the decisions of various high courts on the purpose of Double Taxation Avoidance Conventions qua Section 90 of the Act, the Supreme court observed as under:
“A survey of the aforesaid cases makes it clear that the judicial consensus in India has been that Section 90 is specifically intended to enable and empower the Central Government to issue a notification for implementation of the terms of a double taxation avoidance agreement. When that happens, the provisions of such an agreement, with respect to cases to which where they apply, would operate even if inconsistent with the provisions of the Income Tax Act. We approve of the reasoning in the decisions which we have noticed. If it was not the intention of the Legislature to make a departure from the general principle of chargeability to tax under Section 4 and the general principle of ascertainment of total income 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.“
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.
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 applicant from approaching the Authority for Advance Ruling (AAR) where the matter was pending before any income tax authority. The matter, therefore, only pertained to the procedure of filing a petition before the AAR and not as regards any substantive right. The decision of the Pune Bench of the ITAT in Automated Securities Clearance Inc. v. Income Tax Officer (supra)is no assistance to the Revenue since the said decision is said to be overruled by the Special Bench of the ITAT in the case of Rajeev Sureshbhai Gajwani vs ACIT (2011) 8 ITR (Trib) 616 (Ahmedabad).
In light of the above discussion, question (b) is answered in the affirmative, i.e., in favour of the Assessee and against the Revenue by holding that Section 40 (a) (i) of the Act is discriminatory and therefore, not applicable in terms of Article 26 (3) of the Indo-US DTAA.