No dis allowance can be made in case of payment to non-residents in view of Article 26(3) of the DTAA between India and the USA; deduction of bad debts to be reduced by provision for rural advances
In brief
Dis allowance under section 40(a)(ia)
In a recent decision, in the case of the Central Bank of India v. DCIT [2010-T11-183-ITAT-MUM-INTL] and in the context of payments made to VISA and Master Card (non-resident credit card agencies based in the USA), the Mumbai Income-tax Appellate Tribunal (the “Tribunal”) held that even if a foreign company had taxable income in India, a payment to a non-resident without deduction of tax at source could not be disallowed in view of the non¬discrimination provisions as contained in Article 26(3) of the Double Taxation Avoidance Agreement between India and the USA (“DTAA”).
Dis allowance of bad debts under section 36(1)(vii)
The Tribunal also held that bad debt which arose out of rural advances should be reduced only by provision for doubtful debts created under section 36(1)(viia) of the Income-tax Act, 1961 (the “Act”) for such debts (and not the entire provision for doubtful debts) and the excess should be allowed as a deduction.
Facts
Dis allowance under section 40(a)(ia)
• The credit cards issued by the assessee bank were affiliated with VISA and Master Card.
• These international agencies facilitated credit card transactions and also provided required customized hardware and software to the member banks. The member banks were charged for the various services received from the International Agencies.
• The assessee, during the years under consideration, had made payments to these agencies, on which no tax had been deducted at source.
• In the assessments for the assessment years 1997-98, 1998-99 and 1999-2000, the assessing officer (“AO”) held that the payment made to VISA and Master Card on which no tax had been deducted at source was to be disallowed under the provisions of section 40(a)(i) of the Act.
• In connection with the payments made to VISA and Master Card, the assessee submitted before the Commissioner of Income-tax (Appeals) [“CIT(A)”] that the income arising to VISA and Master Card was not taxable in India as these international agencies did not have any permanent establishment in India. The income had also arisen outside India. Therefore, no tax was required to be deducted.
• The CIT(A) held that these agencies were having permanent establishment in India as they had installed computers and machinery in India and had also acquired leased telephone lines, without which it was not possible to render services in India. Therefore the income received by them was taxable in India and accordingly confirmed the order of AO disallowing the claim of deduction on account of these payments as admittedly no tax had been deducted at source.
• Aggrieved by the decision of the CIT(A), the assessee preferred an appeal before the Tribunal.
Dis allowance of bad debts under section 36(1)(vii)
• The assessee claimed deduction of bad debts in excess of provided for advances made by rural branches.
• In the assessments for the assessment years under consideration, the AO held that aggregate provision for rural and non-rural debts had to be considered for the purpose of proviso to clause (vii) of section 36(1) and only bad debt which is in excess of the credit balance in the provision account will be allowed.
• The CIT(A) affirmed the order of the AO in connection to applicability of the proviso to section 36(1)(vii).
Assessee’s contentions
Dis allowance under section 40(a)(ia)
• The assessee argued that even if the income of the International Agencies were taxable in India, no tax was required to be deducted in view of Article 26(3) of the DTAA which protects non-residents against any discrimination favoring residents.
• It was pointed out that Article 26(3) would be applicable in the case of the assessee, in which case the expenditure on account of payments to non-residents had to be allowed if the same was allowable if the payments were made to residents.
• It was further contended that as per the provisions applicable for the relevant period, expenditure on account of payment to residents could not be disallowed on grounds of non-deduction of tax at source.
• The assessee placed reliance on the decision of the Delhi Tribunal in case of Herbalife International India Pvt. Ltd. v. ACIT [2006] 101 ITD 450 (Delhi). in which it has been held that even if the payments were taxable in case of the non-residents, no dis allowance could be made on account of non-deduction of tax in view of the Article 26(3) of the DTAA between India and USA.
Dis allowance of bad debts under section 36(1)(vii)
• The assessee pointed out that this issue was covered by the decision of the Tribunal in the assessee’s own case in assessment year 1989-90 in ITA No.3602/M/93.
Revenue’s contentions
• The revenue placed reliance on the order of the CIT(A) and the AO.
Observations and findings of the Tribunal
Dis allowance under section 40(a)(ia)
• Article 26(3) protects the interests of the non-residents in relation to residents and provides that payments made to non-residents will be deductible under the same conditions as if payments were made to a resident.
• As per the provisions of section 40(a)(i) applicable for the relevant year, no disallowance could be made in respect of payments to the residents on the grounds of non-deduction of tax at source.
• Therefore, in view of the provisions of Article 26(3), it was held that no dis allowance can be made in the case of payments to non-residents even if the amount is found taxable in India in their hands.
Dis allowance of bad debt under section 36(1)(vii)
• The Tribunal relied on its own decision in the case of the assesee as well as the decision of the Cochin Tribunal Special Bench (“Special Bench”) in the case of Catholic Syrian Bank Ltd.4 wherein it was noted that the provisions of clause (viia) apply only to rural advances by a bank.
• In view of lack of clarity over quantification of bad debt related to rural and non-rural advances, the Tribunal referred the matter back to the AO, with a direction to pass a fresh order after necessary examination in light of the decision of the Special Bench.
In view of the above, the Tribunal set aside the order of the CIT(A) and allowed the claim of the assessee and against the Revenue.
Conclusion :- The Tribunal held that in view of the provisions of Article 26(3) of the DTAA between India and USA, no dis allowance can be made in case of payments to the non-residents even if the amount is found taxable in India in their hands. The Tribunal also clarified that bad debt which arose out of rural advances should be reduced only by provision for doubtful debts created under section 36(1)(viia) of the Act for such debts (and not the entire provision for doubtful debts) and that the excess should be allowed as a deduction.
