Subex Technologies Limited Vs JCIT (ITAT Bangalore)
ITAT Bangalore held that disallowance u/s 40(a)(i) unsustainable as assessee is not liable to deduct TDS for reason that consideration received couldn’t have been regarded as income deemed to accrue or arise in India.
Facts-
The Tribunal had disposed of the above case vide its order dated 29.07.2016. The Tribunal decided the issue in favour of the assessee. The Tribunal held that the payment made to the Associate Enterprise (AE) in USA amounting to Rs.62,49,83,348 was merely a journal entry, hence, need for tax deduction at source u/s 195 of the I.T.Act does not arise and the lower authorities erred in disallowing the impugned expenditure u/s 40(a)(i) of the I.T.Act. The Revenue being aggrieved by the order of the ITAT, filed an appeal before the Hon’ble High Court u/s 260A of the I.T.Act. The Hon’ble High Court vide judgment dated 21.12.2020 in ITA No.180/2017, restored the matter to the ITAT. The Hon’ble High Court directed the Tribunal to consider afresh, the claim of the assessee u/s 40(a)(i) of the I.T.Act.
Conclusion-
Held that the Explanation substituted by the Finance Act, 2010 w.r.e.f 01.06.1976 does not apply to the case of assessee (person responsible for deducting tax at source). Hence, the assessee is not liable to deduct tax at source for the reason that consideration received by the STI from the assessee could not have been regarded as income deemed to accrue or arise in India as per the law then existing. Since, we hold that the assessee is not liable to deduct tax at source at the relevant point of time, the other contentions raised by the assessee, whether payment made to STI is income deemed to accrue or arise in India is not adjudicated and is left open
The very fact that revenue invoked section 40(a)(i) of the I.T.Act implies that revenue is otherwise satisfied about the allowability of impugned expenditure under section 37(1) of the I.T.Act.
FULL TEXT OF THE ORDER OF ITAT BANGALORE
These appeals are at the instance of two assessees. The relevant assessment year is 2008-2009. Common issues are raised in these appeals, hence, they were heard together and are being disposed of by this consolidated order.
2. The solitary issue raised in both the appeals is with regard to disallowance u/s 40(a)(i) of the I.T.Act (disallowance of Rs.62,49,85,438 in case of M/s.Subex Technologies Limited and Rs.42,76,35,600 in case of M/s.Subex Limited). As regards the ITA No.715/Bang/2014 is concerned, the same is a High Court directive case. We shall first adjudicate the High Court directive case.
ITA No.715/Bang/2014 (M/s.Subex Technologies Limited)
3. The Tribunal had disposed of the above case vide its order dated 29.07.2016. The Tribunal decided the issue in favour of the assessee. The Tribunal held that the payment made to the Associate Enterprise (AE) in USA amounting to Rs.62,49,83,348 was merely a journal entry, hence, need for tax deduction at source u/s 195 of the I.T.Act does not arise and the lower authorities erred in disallowing the impugned expenditure u/s 40(a)(i) of the I.T.Act. The Revenue being aggrieved by the order of the ITAT, filed an appeal before the Hon’ble High Court u/s 260A of the I.T.Act. The Hon’ble High Court vide judgment dated 21.12.2020 in ITA No.180/2017, restored the matter to the ITAT. The Hon’ble High Court directed the Tribunal to consider afresh, the claim of the assessee u/s 40(a)(i) of the I.T.Act. The relevant finding of the Hon’ble High Court reads as follow:-
“10. Thus, from perusal of the aforesaid paragraph, it is evident that the tribunal has merely recorded its conclusion and has not assigned any reasons in support of the conclusion. Thus, for the aforementioned reasons, the impugned order dated passed by the tribunal is hereby quashed. The substantial question of law is answered accordingly. The tribunal is directed to decide the claim of the assessee under Section 40(a)(ia) of the Act afresh on the basis of the material available on record and on the basis of the reasoning assigned by the Assessing Officer as well as Commissioner of Income Tax (Appeals) and shall also advert to the issue whether the condition precedent for invocation of Section 40(a)(ia) of the Act have been fulfilled in the fact situation of the case.”
4. The brief facts of the case are as follows:
During the impugned assessment year, under the scheme of arrangement approved by the Hon’ble Karnataka High Court, certain business’s of Subex Limited (the parent company of the assessee) were transferred to the assessee. All the contracts / agreements entered by the parent company of the assessee with its AE, i.e., Subex Tehcnologies INC, USA (hereinafter referred to as “STI”) were also transferred to the assessee. Accordingly, STI became direct overseas wholly owned subsidiary of the assessee. For the assessment year 2008-2009, the return of income was filed by the assessee on 06.09.2008 declaring total income of Rs.1,70,10,894. The assessment was selected for scrutiny and notice u/s 143(2) of the I.T.Act was issued. During the course of assessment proceedings, the matter was referred to the Transfer Pricing Officer (TPO) to determine the Arm’s Length Price (ALP) of the international transaction undertaken by the assessee its AE (STI). The TPO passed order u/s 92CA of the I.T.Act on 31.10.2011 concluding that no adjustment was required to be made to the ALP. Later on, the A.O. passed an order u/s 143(3) of the I.T.Act on 29.12.2011 by disallowing the payment made by the assessee to its overseas subsidiary, namely, STI by invoking the provisions of section 40(a)(i) of the I.T.Act. The A.O. made the disallowance of Rs.62,49,85,438 holding that the payments made to STI requires tax deduction at source u/s 195 of the I.T.Act and since the assessee has not deducted tax at source, the same is liable to be disallowed u/s 40(a)(i) of the I.T.Act.
5. Aggrieved by the order of the A.O., the assessee has preferred an appeal before the first appellate authority. The assessee filed additional grounds and elaborate written submissions. The CIT(A), during the course of appellate proceedings, called for a remand report from the A.O. The A.O. on 31.12.2013 submitted the remand report to the written submissions filed by the assessee. In response to the same, the assessee filed a rejoinder. All the contentions raised before the first appellate authority was rejected and the appeal of the assessee was dismissed. The CIT(A) held that 87% of the gross receipts of the assessee was passed on to the STI and it is only reasonable to conclude that the services rendered by STI were vital and crucial to the business of the assessee and not merely a support service. Therefore, it was concluded by the CIT(A) that all evidence on record points to the fact that the payments are in the nature of FTS and tax was required to be deducted at source.
6. Aggrieved by the order of the CIT(A), the assessee preferred appeal before the Tribunal. As mentioned earlier, the Tribunal disposed of the matter in favour of the assessee by holding that the payment was merely a journal entry, hence, there was no necessity of tax deduction at source u/s 195 of the I.T.Act. On further appeal, the Hon’ble High Court had restored the matter to the Tribunal. Pursuant ot the Hon’ble High Court’s remand to ITAT, the case was heard on 01.09.2022.
7. The learned AR had made various submissions stating that the assessee is not liable for deduction of tax at source u/s 195 of the I.T.Act. Further, the learned AR contended that the assessee cannot be held liable for default in not deducting tax at source when there is no such liability as per the law in force at that point of time of payment to STI. In this context, the learned AR referred to grounds II(5) and (6). The learned AR also relied on various judicial pronouncements and especially the judgment of the Hon’ble Bombay High Court in the case of CIT v. KPMG reported in TS 602 HC 2019 (Bom.).
8. The learned DR, on the other hand, submitted that the entire issue has to be examined afresh and the question of genuineness of the said payment also needs to be examined by the Tribunal u/s 37 of the I.T.Act. It was submitted that the assessee has not provided necessary evidence to prove that services were rendered by STI for such payment. The learned DR has filed a written submission and case law compilation in support for her contentions, namely, (i) no fetter on the power the Tribunal to examine the subject matter before it from different angle, (ii) Revenue may be allowed to raise the contention of allowability u/s 37 of the I.T.Act for the first time before the Tribunal.
9. In the rejoinder, the learned AR submitted that Tribunal is not empowered to improve the case of the Assessing Officer and embark upon on the allowability of the expenditure u/s 37 of the I.T.Act. In this context, the learned AR relied on various judicial pronouncements.
10. We have heard rival submissions and perused the material on record. The primary contention of the assessee is that it cannot be made liable for default for non-deduction of tax at source when there is no such liability as per the law in force at the time of payment of the same to the foreign AE, namely, STI. This plea of the assessee was also raised before the first appellate authority. The CIT(A) by referring to the substituted explanation by Finance Act, 2010 with effect from 01.06.1976, decided the issue against the assessee. The relevant observation of the CIT(A) reads as follows:-
“Considering this amendment which has retrospective effect w.e.f. 1.10.1976, it is clear that the territory of rendering of services by STI is not material and not germane to deciding the taxability of income u/s 9(1)(vii) of the Act.”
11. We shall first adjudicate the contention of the learned AR that the assessee cannot be held liable for default in not deducting tax at source, when there was no such liability as per the law in force at the that time. As per the law prevalent during the assessment year 2008-2009, the income is deemed to accrue or arise in India only when the services are rendered in India and as well as utilized in India. The Hon’ble Apex Court in the case of Ishikawajima – Harima Heavy Industries Ltd. v. DIT [2007] 288 ITR 408 (SC) has held that for Section 9(1)(vii) of the I.T.Act to be applicable, it is necessary that services provided by a non-resident assessee under a contract should not only be utilized within India, but should also be rendered in India or should have such a live link with India that entire income from fees as envisaged in Article 12 of DTAA becomes taxable in India. The Hon’ble Apex Court also held that whatever is payable by a resident to a non-resident by way of fees for technical services would not always come within purview of section 9(1)(vii) of the I.T.Act but it must have sufficient territorial nexus with India so as to furnish a basis for imposition of tax. In order to overcome the decision of the Hon’ble Supreme Court an Explanation was inserted by the Finance Act, 2007 to Section 9(2) of the Act w.r.e.f 01.06.1976, which read as follows:-
“Explanation.—For the removal of doubts, it is hereby declared that for the purposes of this section, where income is deemed to accrue or arise in India under clauses (v), (vi) and (vii) of sub-section (1), such income shall be included in the total income of the non-resident, whether or not the nonresident has a residence or place of business or business connection in India.”
12. As per the aforesaid Explanation, income is deemed to accrue or arise in India whether or not the non-resident has a residence or place of business or business connection in India. However, the amended Explanation does not seek to explain anything about the rendering of service in India and utilization of such service in India. The Hon’ble jurisdictional High Court in the case of Jindal Thermal Power Company Ltd v. DCIT [2010] 321 ITR 31 (Kar.) held that aforesaid amended Explanation had no effect on the ratio laid down by the Hon’ble Supreme Court in Ishikawajma Harima Heavy Industries Ltd.’s case (supra). The relevant extract of the Hon’ble jurisdictional High Court, reads as follow:-
“The Explanation incorporated in section 9(2) declares that ‘where the income is deemed to accrue or arise in India under clauses (v), (vi), (vii ) of sub-section (1), such income shall be included in the total income of the non-resident; whether or not the resident has a residence or place of business or business connection in India.’ The plain reading of the said provision suggests that criterion of residence, place of business or business connection of a non-resident in India has been done away with for fastening the tax liability. However, the criteria of rendering service in India and the utilisation of the service in India laid down by the Supreme Court in Ishikawajma Harima Heavy Industries Ltd.’s case (supra) to attract tax liability under section 9(1)(vii) remains untouched and unaffected by the Explanation to section 9(2).
When the purport of the Explanation to section 9(2) is plain in its meaning, it is unnecessary and impermissible to refer to the Memorandum explaining the Finance Bill, 2007. Therefore, it is explicit from the reading of section 9(1)(vii)(c ) and Explanation to section 9(2) that the ration laid down by the Supreme Court in Ishikawajma Harima Heavy Industries Ltd.’s case (supra) still holds the field.”
13. In the instant case, the impugned assessment year is A.Y. 2008-2009. The law that was applicable is the law which existed during the impugned assessment year i.e., the aforesaid Explanation inserted by the Finance Act, 2007 and the laid down by the Supreme Court in the case of Ishikawajima – Harima Heavy Industries Ltd. v. DIT [2007] 288 ITR 408 (SC). In other words, the income is deemed to accrue or arise in India in the hands of the recipient when the services are rendered in India as well as utilized in India. In the instant case, admittedly, services by STI to the assessee are not rendered in India. The aforesaid Explanation was thereafter substituted by the Finance Act, 2010, w.r.e.f 01.06.1976. The newly substituted Explanation reads as follows:
“Explanation.—For the removal of doubts, it is hereby declared that for the purposes of this section, income of a non-resident shall be deemed to accrue or arise in India under clause (v) or clause (vi) or clause (vii) of sub-section (1) and shall be included in the total income of the non-resident, whether or not,—
(i) the non-resident has a residence or place of business or business connection in India; or
(ii) the non-resident has rendered services in India.”
14. The newly substituted Explanation provides that income is deemed to accrue or arise in India whether or not the nonresident has a residence or place of business or business connection in India; or whether or not the non-resident has rendered services in India. In other words, the even if the services are not rendered in India, the income of the nonresident is deemed to accrue or arise India. The said Explanation was made retrospective with effect from 01.06.1976.
15. The Hon’ble Apex Court in the case of In Engineering Analysis Centre of Excellence Private Limited v. CIT [2021] 432 ITR 471 (SC), had held as follows:-
“80. The learned Additional Solicitor General then argued that being covered by explanation 4 of section 9(1)(vi) of the Income Tax Act, the persons liable to deduct TDS under section 195 of the Income Tax Act ought to have deducted tax at source on the footing that explanation 4 existed on the statute book with effect from 1976. We have, therefore, to examine as to whether persons liable to deduct TDS under section 195 of the Income Tax Act can be held liable to deduct such sums at a time when explanation 4 was factually not on the statute book, all deductions liable to be made and the assessment years in question being prior to the year 2012.
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85. It is thus clear that the “person” mentioned in section 195 of the Income Tax Act cannot be expected to do the impossible, namely, to apply the expanded definition of “royalty” inserted by explanation 4 to section 9(1)(vi) of the Income Tax Act, for the assessment years in question, at a time when such explanation was not actually and factually in the statute.”
16. In case of ACIT vs. NGC Networks (I) Pvt. Ltd., [TS-415-ITAT-2014(Mum)], the ITAT, Mumbai Bench has held that the Assessee was not supposed to foresee the subsequent retrospective amendment in the statute to be held liable to tax deduction at source. The said order of the ITAT was upheld by the Honourable Bombay High Court in CIT v. NGC Networks (India) Pvt. Ltd. [TS-41-HC-2018(BOM)]/(2021) 432 ITR 326 (Bom). The same is approved in Engineering Analysis Centre of Excellence Private Limited Engineering [supra].
17. The Hon’ble High Court of Bombay in the case of CIT v. KPMG TS-602-HC-2019(Bom), had held as under:-
“7. In any view of the matter, the impugned order further holds that at the relevant time there was no obligation to deduct tax at source in respect of fees paid to service providers, on the basis of its deemed income under Section 9(1)(vii) of the Act. It was only by the amendment made by the Finance Act, 2010 with retrospective effect by adding an Explanation to Section 9(1)(vii) of the Act, that the requirement of the service providers providing the same in India was done away with, for its application. Thus, making it deemed income subject to tax in India and require tax deduction at source by the respondent. However, the Tribunal held that yet the obligation to deduct tax cannot be created with the aid of an amendment made with retrospective effect, when such obligation was absent at the time of making payment to the service providers.
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11. So also, question (ii) as proposed is academic as no occasion to deduct tax at source would arise in the absence of any income in the hands of the service providers outside India in view of Section 195 of the Act. Even otherwise a retrospective amendment cannot cast an obligation to deduct tax when not in force at the relevant time i.e. when payment was made. In fact, this Court in Commissioner of Income Tax V/s. M/s. NGC Networks (India) Pvt. Ltd. (Income Tax Appeal No.397 of 2005, decided on 29th January, 2018) has held that a party cannot be called upon to perform an impossible act i.e. to comply with the provision which was not in force at the relevant time. Admittedly, the Explanation if applicable is introduced later by a retrospective amendment. Thus, there could be no obligation to deduct tax at source when the payments have been made to the service providers abroad in the absence of a specific provision at the time when the payments were made.”
18. In the case of CIT v. Virola International [2014] 147 ITD 519 (Agra – Trib.), the Agra Bench of the Tribunal has held as under:
“7. The law laid down by Hon’ble Supreme Court, in the case of Ishikawajma-Harima Heavy Industries Ltd. (supra), binds everyone under Article 141 of the Constitution of India. The legal position thus was that unless the services are rendered in India, the same cannot be brought to tax as ‘fees for technical services’ under Section 9. However, this legal position did undergo a change when Finance Act 2010 received assent of the President of India on 8th May 2010.
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8. It is thus clear that till 8th May 2010, the prevailing legal position was that unless the technical services were rendered in India, the fees for such services could not be brought to tax under Section 9(1)(vii). The law amended was undoubtedly retrospective in nature but so far as tax withholding liability is concerned, it depends on the law as it existed at the point of time when payments, from which taxes ought to have been withheld, were made. The tax-deductor cannot be expected to have clairvoyance of knowing how the law will change in future. A retrospective amendment in law does change the tax liability in respect of an income, with retrospective effect, but it cannot change the tax withholding liability, with retrospective effect. The tax withholding obligations from payments to non-residents, as set out in Section 195, require that the person making the payment “at the time of credit of such income to the account of the payee or at the time of payment thereof in cash or by the issue of a cheque or draft or by any other mode, whichever is earlier, deduct income-tax thereon at the rates in force”. When these obligations are to be discharged at the point of time when payment is made or credited, whichever is earlier, such obligations can only be discharged in the light of the law as it stands that point of time. Section 40(a)(i) provides that, inter alia, notwithstanding anything to the contrary in sections 30 to 38, any amount payable outside India, or payable in India to a non-resident, shall not be deducted in computing the income chargeable under the head ‘profits and gains of business or profession ‘ “on which tax is deductible at source under Chapter XVII-B and such tax has not been deducted”. The disallowance under section 40(a)(i) is not for the payments made to nonresidents, which are taxable in India, but for the payments on which tax was deductible at source but tax has not been deducted, and such deductibility of tax at source, as we have discussed above, has to be in the light of the legal position as it stood at the point of time when payment was made or credited- whichever is earlier. Clearly, therefore, the disallowance under section 40(a)(i) can come into play only when the assessee had an obligation to deduct tax at source from payments to non-residents, and the assessee fails to comply with such an obligation. In view of these discussions, so far as payments made before 8th May 2010 are concerned, the assessee did not have any tax withholding liabilities from foreign remittances for fees for technical services unless such services were rendered in India, and a fortiori no disallowance can be made under section 40(a)(i) for assessee’s failure to deduct tax at source from such payments.”
19. In the following judicial pronouncements, the Courts have held that the liability to deduct tax at source arises in accordance with the provisions of law prevailing during the relevant assessment year:
