In absence of any adverse material, AO cannot question the wisdom & business expectancy of Assessee

ACIT Vs Chadha Power (ITAT Delhi)

Insofar as disallowance of reimbursement of expenses made to two non-resident entities i.e. Chadha Projects JLT, Dubai of Rs.1,30,51,568/- and Rs.21,33,805/-to Chadha Power (SA) Pty. Ltd., South Africa. The assessee’s case has been that the said reimbursement of expenses of both the entities were for carrying out market research for feasibility and expansion of market in neighboring countries particularly in Gulf and African region and day-to-day coordination in activities for the assessee, negotiation and procurement of orders, securing of materials, supply and distribution of materials to destination sites, logistic support and follow up and liaisoning for projects under execution etc.. It is also undisputed fact that these firms were actually carrying out these activities as it has secured work order of more than Rs. 35 crores for the assessee. The copy of work orders were filed before the AO along with various documents and relied upon the correspondence which shows that the efforts were made for getting the new business there. Sans any adverse material, AO cannot question the wisdom and business expectancy in which wake of such evidences and record which has been duly appreciated and taken note of by the ld. CIT (A). The documents which have been referred to in the first appellate order, as incorporated above, clearly show that both the entities i.e. Dubai based and South Africa based has assisted in the business development as well as procurement of huge business orders which was in line with the assessee’s business i.e. supply, installation, commissioning and maintenance of DG sets, power equipment and its spares/accessories. There is no adverse material on record to rebut the aforesaid documents as highlighted by the ld. CIT (A) above. Therefore, we do not find any reason to uphold the addition on the ground that there are no commercial activities. Accordingly, the finding of ld. CIT (A) is confirmed.

FULL TEXT OF THE ORDER OF ITAT DELHI

Aforesaid appeal has been filed by the assessee against the impugned order dated 22.11.2017 passed by the ld. CIT (Appeals)-10, New Delhi for the quantum of assessment passed under section 143(3) of the Income-tax Act, 1961 (for short ‘the Act’) for the assessment year 2013-14.

2. In the grounds of appeal, the Revenue has raised the following grounds :-

“i) On the facts and circumstances of the case, the Ld. CIT(A) erred in deleting the addition of Rs. 1,30,51,568/- made on account of reimbursement of expenses which is not backed by commercial expediency and at the same time cannot be allow as per the provision of section 40(a)(ia) as on the same TDS has not been deducted.

ii) On the facts and circumstances of the case, the Ld. CIT(A) erred in deleting the addition of Rs.1,07,70,378/- made on account of diversion of income belonging to the assessee firm to an entity incorporated in tax-free jurisdiction avoidance of tax.

iii) On the facts and circumstances of the case, the Ld. C!T(A) erred in deleting the addition of Rs.21,33,805/- made on account of by treating the same as non-business expenditure and also u/s 40(a)(i) and further erred in holding that the entire amount paid to Chadha power (SA) Pty. Ltd on account of reimbursement of expenses is not backed by commercial expediency.

iv) On the facts and circumstances of the case, the Ld. CIT(A) erred in not appreciating the fact that the reimbursement expenses can be reasonably attributed as ‘fee for management services’ and as per the provisions of section 40(a)(i) any amount paid to a non resident is not deductable as an expense if the requisite TDS under Chapter -XVIIB has not been deducted and paid.

v) On the facts and circumstances of the case, the Ld. CIT(A) erred in not appreciating the fact that It is only if the business or profession is carried outside India, ‘Fee for technical/management services’ payable by a resident is not taxable in India.

vi) On the facts and circumstances of the case, the Ld. CIT(A) erred in not appreciating the fact that the so-called support services provided by Chadha Projects JL T to the assessee is in the nature of fee for technical services since the so-called work order procured by Dubai entity for the benefit of the assessee firm have been executed from India and hence taxable in India.

vii) On the facts and circumstances of the case, the Ld. CIT(A) erred in not appreciating the fact that there were only two employees of Dubai entity, one of which is already a partner in assessee firm and hence diverting the income of assessee firm but also inflating the expenses of the assessee firm in the garb of support services where no such services were required from the angle of commercial expediency.”

3. In nutshell, in the grounds of appeal, the Revenue has challenged the deletion of addition made u/s 40(a)(i) for reimbursement of expenses to a non-resident placed at Dubai and South Africa; and the addition of Rs.1,07,70,378/- on account of diversion of income.

4. Facts in brief are that the assessee is a partnership firm engaged in the business of supply, installation, commissioning and maintenance of DG sets, power equipments and its spare parts and accessories. AO noted that the assessee has claimed expenses aggregating to Rs.1,30,51,568/- on account of reimbursement of expenses towards business development which were paid to Chadha Projects JLT Dubai. In response to show-cause notice, the assessee contended as under :-

“1.1 Chadha Power in order to develop a base in Dubai incorporated a wholly owned subsidiary in the form of Chadha Projects JLT to act as representative/ liaison officer for Chadha Power.

1.2 The said entity in Dubai was incorporated in order to:-

(a) carry out market research for feasibility and expansion of market in neighbouring countries particularly in gulf and African region.

(b) day to day co-ordination in activities for Chadha Power India in i) negotiation and procurement of orders ii) securing of materials iii) supply & distribution of materials to destination sites iv) logistics support v) follow up and liaisoning for projects under execution etc.”

5. AO further noted that in the balance sheet of Chadha Projects JLT, Dubai for the year ending 31.12.2012, revealed that the said entity earned gross income of 1,483,450 AED, out of which sales were 980,664 AED and management fee of Rs.502,786 AED. Against this, revenue expenses have been shown at 526,718 AED, Finance cost of 1148 AED and net profit of 792,674 AED. The amount of management fees aggregating to 502,786 AED was in the form of reimbursement of expenses by Chadha Power, India to Chadha Projects JLT, Dubai with a 10% mark-up. After considering the assessee’s detailed reply, the AO held that entire amount paid to Chadha Projects JLT, Dubai on account of reimbursement of expenses is not backed by commercial expediency and, therefore, needs to be disallowed. He further disallowed that said expenditure has to be examined from another dimension i.e. the amount is paid to a non-resident and, therefore, provisions of section 40(a)(i) is applicable because TDS is not deducted and paid. The observation of AO in this regard is as under:-

“ However, in the reply dated 23.03.2016 it is stated that the assessee firm was benefited by Chadha Projects JLT by securing a work order worth INR 14 crores by ZPC, another work order of Rs. 14 crores from Petrozim Line Pvt. Ltd. and a work order of Rs. 7 crores from Lesotho Electricity Company. Copies of the work orders have been filed along with the reply and in addition to the same documents have been filed which comprises of related correspondence reflecting the efforts of Mr. Pradeep Chadha for getting new business. Further, it has been stated in the reply that the efforts made by Mr. Pradeep Chadha and his team resulted in procurement of the above work orders. Pertinently, there is no other activity which benefited the assessee firm viz. Logistics support, supply, and distribution of material, market research for feasibility and expansion etc. Although, much stress has been made on the efforts of the Dubai team, however, facts placed on records reveal that apart from Mr. Pradeep Chadha and his daughter, there was no employee in Chadha Power JL T for execution of any work. Therefore, this is a simple case wherein an entity has been introduced in the form of Chadha Power JL T for not only diverting the income of assessee firm but also inflating the expenses of the assessee firm in the garb of support services where no such services were required from the angle of commercial expediency. Whatever services are being claimed to have been provided by Chadha Power JLT through Mr. Pradeep Chadha could have been provided by him directly in his capacity as Partner of the assessee firm without there being any need for introduction of a new entity in the form of Chadha Power JLT. It is also apparent why this entity was incorporated in Dubai, which is a tax-free jurisdiction. There is no work order received from any entity in GCC or Middle East. Whatever work orders are being claimed have been received from entities in Africa and therefore if there was a real need for setting up any entity for providing market support services, it could have been set up either in South Africa or Zimbabwe (from where the work orders have been procured). Setting up of the entity in Dubai is therefore with a motive to divert the income of the assessee firm to a tax-free jurisdiction….

6.1 In view of the facts discussed above in detail, it cannot but be concluded that the entire amount paid to Chadha Projects JLT aggregating RS.1,30,51,568/- on account of reimbursement of expenses is not backed by commercial expediency and therefore needs to be disallowed. Accordingly, a disallowance allowance of Rs.1,30,51,568/-is being made. Further, the allowability of expenditure of Rs.1,30,51,5681- needs to be examined from another dimension i.e. deduction and deposit of withholding tax. As per the provisions of section 40(a)(i) any amount paid to a non-resident i.e. Chadha Projects JLT in the present case, is not deductable if the requisite TDS under Chapter-XVIIB has not been deducted and paid. In the present case, the so-called support services provided by Chadha Projects JL T to the assessee firm is in the nature of fee for technical services since the so-called work order procured by Dubai entity for the benefit of the assessee firm have been executed from India. Therefore, the support services so provided have been utilized in India and hence the income of Chadha Projects JL T for providing such services is taxable in India. Since no withholding tax has been deducted on such payment reimbursed to Chadha Projects JL T along with mark up of 10% the said expenditure needs to be disallowed as per the provisions of section 40(a)(i) of the I. T. Act, 1961 …”

6. He has also disallowed similar expenses of Rs.21,33,805/- paid by the assessee to Chadha Power (SA) Pte Ltd. wholly and exclusively incorporated in South Africa for similar reasons.

7. CIT (A) has discussed this issue after considering various documents placed on record as well as the submissions made by the assessee in the following manner:-

“5.1a It is gathered from the appellant’s submissions in para 4 above that in respect of the above-mentioned disallowance of expenditure reimbursed to M/s. Chadha Projects JLT (Dubai) and M/s. Chadha Power (SA) (Pty.) Ltd. on the ground that business expediency was not established and due taxes were not withheld, the total disallowance could not exceed Rs.1,26,15,697/-(1,04,81,892 + 21,33,805), the balance Rs.4,35,871/- represented local expenses.

5.1b It is also gathered that the appellant is in the business of supply, installation, commissioning and maintenance of DG Sets, power equipment and its spares/ accessories. Its business is in different countries where from it receives orders for execution, which are executed by the assessee. An entity was opened in Dubai with the name of Chadha Projects JL T and in South Africa in the name of The Chadha Power (SA) Pty. Ltd. (CPSAPL). While the South African entity was set up in 2009, the Dubai Unit was set up in AY 2012-13.

It appears from the appellant’s submissions that both entities supported and coordinated its business activities – marketing and distribution and provided logistical support. The appellant apparently made these submissions at the assessment stage as well as reiterated them at the appellate stage. In support of its contention, the AR of the appellant filed copies of the following –

• • Rationale for setting up Dubai entity
  • Details of Service Support Agreement with Dubai entity and its compensation plus full details of amounts reimbursed during the A Y
  • Audited financial statements of Dubai entity
  • Appointment of Mr. Pradeep Chadha as Manager (statutory appointment) of Dubai entity to oversee all operations and provide leadership guidance and direction
  • Funding of the entity – a wholly owned subsidiary of the assessee
  • Details of the partners interest in the Dubai entity
  • Copies of other relevant business issues raised during assessment proceedings
  • Details of Business Development expenditure debited to P&L account including reimbursements to Dubai and South Africa entities
  • Detailed write ups on the two entities at Dubai and South Africa
  • Brief summary of benefits derived from operations of these entities
  • Supporting the case of commercial expediency – their role in tendering and procurement
  • of new business / contracts
  • Comprehensive justification for setting up of these entities
  • Note on activities of the Dubai entity vis-a-vis the appellant’s business – negotiating and
  • procuring orders
  • Certificate of Registration of Dubai entity (dated 1610112012) – trading in power generation, transmission and distribution equipment – the appellant’s primary line of business
  • Support Service Agreement with Dubai entity (dated 8/03/2012) – compensation package – reimbursement of expenses with 10% markup
  • Statement of detailed reimbursement of expenses of Dubai entity (A Y 2013-14)
  • Documents and invoices – evidence of logistical support service by Dubai entity in procuring material for Zimbabwe Power Company (ZPC) – contract bagged by the appellant
  • Contract ZPC 96112 for USD 879,150 with ZPC Ltd. – refurbishment of water pre-treatment plant at Hwange Power Station – coordination by Dubai entity
  • Contract ZPC 10112 for USD 818,500 + USD 78,000 with ZPC Ltd. – repairing 30 MW Turbine Alternator at Harare Power Station – coordination by Dubai entity
  • Contract ZPC 27112 for USD 622,329.50 with ZPC Ltd. – supply & delivery of Reverse Osmosis spares and chemicals to Hwange Power Station – coordination by Dubai entity
  • Contract ZPC 15113 for USD 179,500 with ZPC Ltd. – supply & delivery of HP Turbine set seals – coordination by Dubai entity
  • Contract PZU01111 for USD 2,673,295 with Petrozim Line Pvt. Ltd. – design, supply, delivery, installation and commissioning Metering & Prover Loop System – coordination by Dubai entity
  • Contract LECIPOP – 003 for USD 1,270,144 with Lesotho Electric Company Pty. Ltd. – Lesotho contract – coordination by Dubai entity
  • Contract ZPC 28/11 for USD 400,500 with ZPC Ltd. – follow up and execution – coordination by Dubai entity
  • Contract ZPC 83/12 for USD 92,500 with ZPC Ltd. – supply, delivery and commissioning of Vibro Feeders at Harare Power Station – commercial negotiations by Dubai entity
  • Contract ZPC 124/12 for USD 220,000 with ZPC Ltd. – supply and delivery of five portable ash probes at Hwange Power Station – coordination by Dubai entity
  • Commercial tender bid ZPC/HO 70 for USD 1,902,000 with State Procurement Board for Harare Power Station – assisted by Dubai entity though contract not awarded
  • Tender bidding for Kenya Power and Lighting Company Ltd. – coordination by Dubai entity with NEI Zimbabwe
  • Note on activities of the South Africa entity vis-a-vis the appellant’s business – registration with CIOB (Construction Industry Development Board of South Africa) for GRADE 6 level
  • Support Service Agreement with South Africa entity (dated 30/0312012) – compensation
  • package – reimbursement of expenses with 10% markup
  • Audited financial statements of CPSAPL for A Y 2013-14
  • Statement of detailed reimbursement of expenses of South Africa entity (AY 2013-14) along with copies of invoices raised by CPSAPL on the appellant
  • Participation in exhibition in Mozambique (13-15 November 2012) – Infrastructure Partnerships for African Development – coordination by CPSAPL
  • Getting ECSA (Engineering Council of South Africa) accreditation – coordination by CPSAPL
  • Contract for City Power in Johannesburg – contract bid failed – coordination by Dubai and SA entities

5.1c From the above documents including e-mails etc., it can safely be inferred that the appellant’s two subsidiaries set up in Dubai (UAE) and South Africa assisted it in its business development – coordination as well as follow up in procurement of business (orders / bidding for contracts) in Africa in line with the appellant’s business – supply, installation, commissioning and maintenance of DG sets, power equipment and its spares / accessories (as already mentioned). However, in the impugned order, despite scrutinizing all the above submissions I documents, the aforementioned additions were made therein rejecting the appellant’s contention of ‘commercial expediency’ – reimbursement of expenses with a 10% mark-up.”

8. Thereafter, the ld. CIT (A) has referred to the principles laid down by Hon’ble Supreme Court in the case of SA Builders Ltd. reported in 288 ITR 1. As regards the applicability of section 40(a)(i), ld. CIT(A) observed that first of all, expenses claimed in computing the income chargeable under the head ‘profits and gains of business or profession’ towards royalty, fee for technical services or other sum chargeable under the Act which is payable outside India or in India to a non­resident on which TDS is applicable, is not applicable in the present case for the reason that even if these services are taken as technical services, the DTAA with UAE did not mention anything regarding f fee for technical services, therefore, Article 22 for other income would be applicable and, therefore, no tax is required to be withheld because Article 22 provides that income of a resident of a contracting state wherever arising which is not expressly dealt within the DTAA shall be taxable only in the resident state. Accordingly, he deleted the expenses of Rs.1,30,51,568/-.

9. Similarly, with regard to disallowance of Rs.21,33,805/- on account of reimbursement of expenses by the appellant to Chadha Power (SA) Pty. Ltd., the relevant observation of ld. CIT (A) reads as under :-

“5.3 In connection with the ground at (g) relating to the disallowance (Rs.21,33,805/-) of reimbursement of expenses by the appellant to M/s. Chadha Power SA (Pty.) Ltd. (South Africa) in the impugned order, it is mentioned therein, inter alia, “….8 As regards the reimbursement of expenses aggregating Rs.21,33,805/- by the assessee firm to Chadha Power (SA) Pty Ltd. It has been stated by the assessee in its reply dated 23.3.2016 that the wholly owned subsidiary was incorporated for representation in South African region where Chadha Power India already had a presence. As regards the commercial expediency of such reimbursement, it has been stated in the reply that the administrative support provided resulted in procuring work order of Rs.7 crores from Lesotho Electricity Company (Pty) Ltd. Here it may be pointed out that the assessee company has already claimed the so-called benefit of getting the very same work order against the expenses reimbursed to Dubai entity viz Chadha Power JL T Apart from the same, there is no other significant contribution of Chadha Power (SA) Pty Ltd. Highlighted by the assessee firm in its reply.

Therefore, the reimbursement of Rs.21,33, 805/- by the assessee firm to Chadha Power (SA) Pty Ltd. is not backed by any commercial expediency ….

.. Examining the allowability from the dimension of the provisions of section 40(a)(i) here also no withholding tax has been deducted and therefore the same argument as afore stated in the case of Chadha Power JLT would apply and from this angle also the expenditure will get disallowed …”

From the above portion of the impugned order, it is observed that the reasons for the aforementioned disallowance is the inability of the appellant to substantiate its claim for reimbursement of expenses and that no TDS was made thereon u/s 40(a)(i).

5.3a It is gathered from the appellant’s submissions at para 4 above that even in this case, similar disallowance of the appellant’s claim of reimbursement of expenses along with 10% markup to M/s. Chadha Power SA (Pty.) Ltd. (South Africa) has been made as was made in respect of the appellant’s claim towards M/s. Chadha Projects JL T (Dubai) on the reasoning that the appellant could not substantiate its claim at the assessment stage. Also, no TDS was made on the aforesaid payment made by it u/s 40(a)(i).

5.3b In the preceding sub-para from 5.1 through 5.1 d, this issue has been discussed in this order and thereafter the appellant’s claim has been accepted. For the same reasons, this disallowance made in the impugned order (Rs.21,33,805/-). Further, the appellant’s contention, vide its submission filed at the appellate stage, that this disallowance is a part of the total disallowance (Rs.1,30,51,568/-) made in the impugned order and hence, is duplicated appears to be plausible as it is borne out from available records (refer sub-paras

Accordingly, the aforesaid disallowance of Rs.21,33,805/- made in the impugned order towards the appellant’s claim of reimbursement of expenses along with 10% markup to M/s. Chadha Power SA (Ply.) Ltd. (South Africa) is deleted. The ground at (g) is allowed.”

10. Coming to the issue of addition made to diversion of income of Rs.1,07,17,378/-, ld. AO from the perusal of balance sheet of Chadha Projects JLT held that the said entity earned net profit of 7,92,674 AED and this forms nothing but division of income from the assessee firm to an entity incorporated in tax free jurisdiction for avoidance of tax. It is just a paper company from India to Dubai and he has made the addition by observing as under :-

“7.   From the audited balance sheet of Chadha Projects JLT filed during the course of assessment proceedings, it emerges that the said entity earned a net profit of 7,92,674 AED for the calendar year ended 31.12.2012. As discussed in preceding paragraphs, this is nothing but diversion of income belonging to the assessee firm to an entity incorporated in tax free jurisdiction for avoidance of tax. As per the facts discussed earlier the said entity has only been created on paper for diversion of income from India to Dubai. The profit of AED 7,92,674 also includes 10 % management fees, earned from the assessee firm, aggregating AED 45,708 (01.04.2012 to 31.12.2013) and AED 18,523 (01.01.2013 to 31.03.2013) in all aggregating to AED 63,961. This amount of AED 63,961 is already included in disallowance of expenses of INR 1.30,51,568/-. Hence to avoid double addition amount of AED 63,961 is reduced from the net profit of AED 7,92,674 and the resultant figure comes to AED 7,28713. Accordingly, the profit of 7,28,713 AED which comes to Rs.1,07,70,378/- (AED 7,28,713 * 14.78 exchange rate prevailing as on 31.3.2013 source www.xe.com) is taxed as income of the assessee firm on account of diversion of income. Penalty proceedings u/s271(1)(c) of the I.T. Act are separately initiated.

[Addition of Rs 1,07,70,378/-]”

11. CIT (A), after considering the entire documents as well as the replies and explanations given before AO and him, he held that Dubai entity is an independent entity incorporated under the laws of UAE as observed from the relevant documents filed on record. The said company has earned profits of 7,92,674 AED which included AED 63,961 as mark-up. He held that there is no evidence to prove that that the arrangement of reimbursement of expenses along with mark­up is sham and there is nothing on record from where any adverse inference could be drawn. Therefore, he has deleted the said addition made by the AO.

12. We have carefully considered the submissions and gone through the impugned order as well as material placed on record. Insofar as disallowance of reimbursement of expenses made to two non-resident entities i.e. Chadha Projects JLT, Dubai of Rs.1,30,51,568/- and Rs.21,33,805/-to Chadha Power (SA) Pty. Ltd., South Africa. The assessee’s case has been that the said reimbursement of expenses of both the entities were for carrying out market research for feasibility and expansion of market in neighboring countries particularly in Gulf and African region and day-to-day coordination in activities for the assessee, negotiation and procurement of orders, securing of materials, supply and distribution of materials to destination sites, logistic support and follow up and liaisoning for projects under execution etc.. It is also undisputed fact that these firms were actually carrying out these activities as it has secured work order of more than Rs. 35 crores for the assessee. The copy of work orders were filed before the AO along with various documents and relied upon the correspondence which shows that the efforts were made for getting the new business there. Sans any adverse material, AO cannot question the wisdom and business expectancy in which wake of such evidences and record which has been duly appreciated and taken note of by the ld. CIT (A). The documents which have been referred to in the first appellate order, as incorporated above, clearly show that both the entities i.e. Dubai based and South Africa based has assisted in the business development as well as procurement of huge business orders which was in line with the assessee’s business i.e. supply, installation, commissioning and maintenance of DG sets, power equipment and its spares/accessories. There is no adverse material on record to rebut the aforesaid documents as highlighted by the ld. CIT (A) above. Therefore, we do not find any reason to uphold the addition on the ground that there are no commercial activities. Accordingly, the finding of ld. CIT (A) is confirmed.

13. Insofar as the disallowance made u/s 40(a)(i) of the Act is concerned, the AO held that the said payment of reimbursement of expenses is in the nature of fee for technical services. As noted by the ld. CIT (A), there is no FTS clause in the India UAE DTAA regarding fee of technical services and, therefore, there cannot be any question of withholding of tax. Accordingly, disallowance u/s 40(a)(i) cannot be made. The aforesaid finding of ld. CIT (A) is accordingly confirmed.

14. Lastly, coming to the addition on account of diversion of income, we are unable to subscribe to the view taken by the AO that it is a paper entity and, therefore, there was diversion of profit. First of all, Chadha Projects JLT, Dubai is an independent entity incorporated under the laws of UAE and was carrying out various activities helping, assisting and getting contracts and procurements of orders for assessee firm and has also disclosed profits in its balance sheet of AED 7,92,674 including mark-up. If the non-resident entity has shown profit, then same cannot be added in the hands of the assessee company as income in India. Firstly, there is no evidence to prove that this was some kind of sham arrangement of profits along with mark­up and secondly, catena of documents and evidences were filed that the said entity is working there and for which mark-up of 10% of management fees is given, therefore, it cannot be held that all those documents are bogus or sham without any material information on record. Accordingly, findings of ld. CIT (A) on this score are also confirmed.

15. In the result, the appeal filed by the Revenue is dismissed.

Order pronounced in open court on this 23^RD day of December, 2021.