Case Law Details
Mumbai bench of the Income-tax Appellate Tribunal (the Tribunal) held that interest income earned on fixed deposit made for the purpose of business should be considered as business income and not as income from other sources.
Further, the Tribunal held that salary and welfare expenses of taxpayer’s staff will not be covered under section 44C of the Income-tax Act, 1961 (the Act) since the expenses are directly related to the Indian Project.
The Tribunal also held that the payment made for procurement services cannot be considered to be a payment towards fees for technical services as per India-Korea Tax Treaty (the tax treaty) since procurement services were purely commercial in nature and had nothing to do with rendering of any technical managerial or consultancy services.
Interest received on fixed deposits
Facts of the case
• The taxpayer, a tax resident of Korea, is engaged in turnkey projects relating to procurement, engineering and construction. The taxpayer was awarded a contract by Indian Oil Corporation Ltd. For the purpose of executing the contract, the taxpayer obtained RBI permission to set up a project office and a site office in India.
• The taxpayer had to open letter of credit, performance bond, etc. in favour of various vendors in India and since bankers insisted on margins before opening such letter of credits or for giving guarantees, the taxpayer had to keep fixed deposits on which interest income was earned. The taxpayer treated this interest income as business income.
• The Assessing Officer (AO) held that the interest income has to be assessed as “income from other sources” unless the taxpayer is engaged in the business of money lending. However, the AO accepted the fact that the interest income was effectively connected with the PE.
Taxpayer’s contentions
• Maintaining fixed deposits was required for obtaining letter of credit and other guarantees for the various projects. Hence, the interest income is directly related to the business and should be treated as business income.
• RBI had granted permission to open a Project Office and a Site Office for the purpose of executing the contract. The approval of the RBI for operation in India is restricted exclusively for the execution of the contract and therefore the interest income is inextricably connected with the Project Office in India.
Tribunal’s ruling
• The Tribunal relied on the Delhi High Court’s decision in the case of CIT v. Koshika Telecom (2006) 287 ITR 478 (Bom) and Bombay High Court’s decisions in the case of CIT v. Indo Swiss Jewels Ltd. (2005) 284 ITR 389 (Bom) and Lok Holdings (2008) 308 ITR 256 (Bom) wherein it was held that when deposits are made in connection to business activity, interest earned from such deposits constitutes business income.
• Accordingly, the Tribunal held that interest income earned on fixed deposit made for the purpose of business should be considered as business income.
Salary and welfare expenditure vis-à-vis Section 44C of the Act
Facts of the case
• The taxpayer claimed salary and welfare expenditure of its staff as a deductible expenditure while working out profit/loss of the project carried on in India.
• The taxpayer’s employees submit time sheet on daily basis which are ultimately recorded while working of profit/loss of each of the projects. The taxpayer maintained time sheet for each employee in the organisation and total effective man-hour of the company is recorded on daily basis through ERP software.
• The scientific allocation is done by each department on daily basis since the taxpayer has various projects all over world and each department is in charge of all the projects. The man-hours which are segregated to various projects are verified and certified by auditors.
• The AO held that in absence of the adequate details, a certain portion of the expenses were in the nature of general and administrative overheads and had to be treated as the head office expenditure under Section 44C of the Act and accordingly certain expenditure were disallowed.
Taxpayer’s contentions
• The entire global income of the contract is taxable in India and therefore ‘no PE’ concept was followed.
• The auditor has confirmed in his audit report that all expenditure have been accounted on accrual basis and only direct cost and expenditure relating to the project have been taken under consideration.
• These expenditure are directly related to the Indian project and not in the nature of overheads, since proper time sheets were maintained for each department and they were also certified by a Certified Public Accountant of Korea.
• Reliance was placed on the decision in the case of CIT v. Emirates Commercial Bank Ltd. (2003) 262 ITR 55 (Bom) where the Bombay High Court held that Section 44C of the Act is applicable only in case of those non-residents who carried on the business in India through their branches. However, in case where expenditure is exclusively incurred for the branch, the restrictions contained in Section 44C of the Act have no application.
Tribunal’s ruling
• Expenditure incurred wholly and exclusively for the purposes of Indian business will not fall within the ambit of Section 44C of the Act. It is only in a case where there are common expenditure which are incurred by the head office for various branches the restrictions mentioned in section 44C will come into operation.
• The taxpayer had filed time sheet on daily basis for each employee in the organisation and have recorded the man-hours on daily basis through ERP software. The time spent on the Indian projects was properly segregated. The same was verified and certified by the auditors.
• Provisions of section 44C of the Act will not come into operation since the disputed expenditure were directly related to the Indian Project.
Fees paid for Procurement services
Facts of the case
• The taxpayer paid certain amounts to Samsung Corporation for providing services for identification, procurement of critical imported material, arranging co-ordination between foreign vendors and SECL. These services were provided by Samsung Corporation, from its offices situated in various countries.
• The AO disallowed such sum under Section 40(a)(i) of the Act holding that the services amounted to fees for technical services on which tax should have been deducted at source.
Taxpayer’s contentions
• Commission paid to Samsung Corporation was for rendering services which enabled the taxpayer to carry out procurement of materials at the best possible quality and prices.
• The payment to Samsung Corporation was made by the Head Office and not by the Project Office in India.
• Tax was not deductible under Section 195 of the Act since payment has been made by a non-resident from outside India to another non-resident, for the services which are rendered outside India and therefore no income accrues or arises in India. Accordingly, no tax was deductible at source on these payments.
• Reliance was placed on CBDT Circular No. 786, dated 7 February 2000 wherein it was clarified that when a non-resident agent operates outside the country, no part of income arises in India and therefore, no tax is deductible under Section 195 of the Act.
Tribunal’s ruling
• Article 13(4) of the tax treaty defines fees for technical services as the payment of any kind to any person in consideration for services of a managerial, technical or consultative nature including the provision of services of technical or other personnel.
• The Tribunal relied on the decision in the case of Linde AG v. ITO (1997) 62 ITD 330 (Mum) wherein it was held that procurement services were purely commercial and had nothing to do with rendering any technical managerial or consultancy services. Accordingly, the Tribunal held that the payment made to Samsung Corporation for procurement services cannot be considered to be a payment towards fees for technical services.
• Payments were made by the taxpayer to Samsung Corporation through the head office outside India and since the services were also rendered outside India no income can be said to accrue or arise in India and, therefore, the payments are not chargeable to tax in India.
• Accordingly, the Tribunal held that there was no obligation on the part of the taxpayer to deduct tax at source.
Our comments
This is an important ruling by the Mumbai Tribunal wherein it is held that when business needs demand to keep margins for various purposes such as issuing letter of credit, performance bonds etc. interest income earned on fixed deposit made for the purpose of business should be considered as business income and not as income from other sources.
The Tribunal held that procurement services were purely commercial and had nothing to do with rendering of any technical managerial or consultancy services and accordingly were not taxable as fees for technical services as per the tax treaty. However it is pertinent to note that the Finance Act 2010 introduced explanation to Section 9 of the Act wherein it was stated that income from royalty/ fees for technical services shall be deemed to accrue or arise in India even though the services are rendered outside India. It seems that this amendment has not been brought to the attention of the Tribunal.
