Data Processing Cost reimbursement did not constitute ‘Royalty’

DCIT Vs KBC NV (ITAT Mumbai)

The issue involved in this ground of appeal i.e., data processing cost paid to head office is in the nature of royalty as per Clause-3, Explanation 1 to Section 9(1)(vi) of the Income Tax Act, 1961 which is liable for withholding tax u/s.194J of the Income Tax Act, 1961 has been the subject matter of discussions by the Co-ordinate Benches of ITAT in assessee’s own case for the A.Y.2012-13. The Co-ordinate Bench, after considering relevant provisions of the Act, and also scope of Article 12(3)(a) of DTAA between India and Netherlands held that data processing cost did not constitute royalty and is merely reimbursement of expenses not liable for withholding tax and therefore, no disallowance could be made u/s.40(a)(i) of the Income Tax Act, 1961.

Relevant paragraphs of the Tribunal order are as under:-

“2.1. The facts in brief are that – assessee paid Data Processing Cost of Rs. 88,26,181/- to its HO, which according to the AO is a copy right protected intellectual property, known as ICT Infrastructure, which is IT Hardware imbedded with software and accordingly, the AO came to the conclusion that the it is a Royalty as per Clause-(iii), Explanation-2 to Section 9(1)(vi) of the Act. Since the assessee has not deducted any tax at source, the AO disallowed the same under the provisions of Section 40(a)(ia) of the Act and added to the income of the assessee. 2.2. At the outset, Ld. Counsel for the assessee pointed out that the issue is squarely covered in favour of assessee in assessee’s own case by the decision of the Co-ordinate Bench in earlier years i.e., AYs. 2004-05, 2006-07 & 2007-08, wherein the Co-ordinate Bench has held that ‘Royalty’ cannot be held to be covered under the scope of Article 12(3)(a) of DTAA (Double Taxation Avoidance Agreement) between India and Netherlands. Ld. CIT(A) following the order of ITAT in these years held that Data Processing Cost did not constitute ‘Royalty’ and is merely a reimbursement of expenses not liable for TDS and therefore, the deduction has to be allowed for reimbursement of cost of data processing charges.

Respectfully following the coordinate bench order, we confirm action of the CIT(A) and decline to interfere in the matter.

FULL TEXT OF THE ITAT JUDGEMENT

By way of this appeal, the Assessing Officer has challenged correctness of the order dated 5^th February 2019, passed by the learned CIT(A)-57, Mumbai for the assessment year 2014-15.

2. Grievances raised by the Assessing Officer are as follows:

1. “Whether on the facts and circumstances of the case and in law, the Ld. CIT(A) has erred in holding that the “Data Processing Cost’ paid by the assessee – Branch to its Head Office does not amount to “Royalty”‘, when such payment is based and determined on the usage of space / capacity and other key determinants towards usage of ICT infrastructure?”

2. “Whether on the facts and circumstances of the case and in law, the Ld. CIT(A) has erred in holding that the usage of the ICT infrastructure of the Bank by the Branch did not amount to “use” or “right to use” as per the provisions of Article 12(3) of the India – Belgium DTAA?”

3. “Whether on the facts and circumstances of the case and in law, the Ld. CIT(A) has erred in holding that Indian branch of the assessee – Bank was not obliged to deduct tax at source while making payment for ‘Data Processing Cost’ of Rs. 34,64,227/- to the Head Office and that Section 40(a)(ia) of the Act is not applicable to this payment?”

4. “Whether on the facts and circumstances of the case and in law, the Ld. CIT(A) has erred in holding that the definition of Royalty u/s 9(1)(vi) of the Act read with Explanation 4 & 5, would not be applicable in case where ‘Royalty’ has been defined under the India – Belgium DTAA?”

5. “On the facts and in the circumstances of the case and in law, the Ld CIT(A) has erred in holding that the interest received by HO of the non-resident bank from its PE in India is not taxable under the Act.”

6. “On the facts and circumstances of the case and in law, the Ld CIT(A) erred in not considering section 9(1)(v)(c) of the Act as a charging section as held by the Hon’ble Supreme Court in the case of A. Sanyasi Rao (1996) 3 SCC 465 and reiterated by the Hon’ble Supreme Court in the case of Sedco Forex International Inc in Civil Appeal No. 4906 of 2010.”

7. “On the facts and circumstances of the case and in law, the Ld CIT(A) erred in not taking into account paragraph 5 of Article 11 of India-Belgium DTAA which provides for applicability of source rule of taxation in the State of source of income in case of payment of interest made by a PE in relation to the business activity in India.”

8. “On the facts and circumstances of the case and in law, the Ld CIT(A) erred in applying the principle of mutuality as laid down by the Hon’ble Special Bench of the Mumbai ITAT in the case of Sumitomo Mitsui Banking Corporation when in fact the assessee has been taxed as per the beneficial provisions of the DTAA under which the Head office and the Branch office of the assessee bank are two distinct and separate entities under Article 7(2)/7(3) of the said DTAA and which allows for deduction of interest expense as also for taxation in source State of the payment of interest by a PE to its HO.”

9. “On the facts and circumstances of the case and in law, the Ld CIT(A) erred in applying the principle of mutuality to when in fact the assessee has been taxed as per the beneficial provisions of the DTAA under which the Head office and the Branch office of the assessee bank are two distinct and separate entities under Article 7(2)/7(3) of the said DTAA and which principle has also been upheld by the Hon’ble Kolkata High Court in the case of ABN Amro Bank in I.TA. No. 458 of 2005.”

10. “On the facts and circumstances of the case and in law, the Ld CIT(A) erred in holding that the interest paid by the Branch office to the Head office/Overseas branches is a deductible expenditure without appreciating that as such interest was an income chargeable to tax in India, tax was liable to be deducted on the same in accordance with the provisions of Section 195 of the Act.”

11. “On the facts of the case and in law, the Ld CIT(A) erred in allowing interest paid by the Branch office to the Head office/Overseas branches without deduction of the tax under the Income-tax Act and Indo-Belgium DTAA as the assessee is a banking company without appreciating that as per Paragraph 3(a) of Article 7 of the India-Belgium DTAA income of the permanent establishment is to be computed in accordance with domestic law and therefore as tax was not deducted on such interest payment the same was an ineligible deduction u/s40(a)(ia) of the Income-tax Act .”

12. “Whether, on the facts and in the circumstances of the case and in law, the Ld. CIT(A) has erred in not making the disallowance u/s. 14A read with Rule 8D for earning of the exempt income on the basis of principles of mutuality by the HO by following the special Bench case in Sumitomo Mitsui Banking Corporation, when the HO & BO are fungible entities?”

13. “The Appellant prays that the order of the Ld. CIT (A) on the above ground(s) be set aside and that of the Assessing Officer be restored.”

3. The issues raised in this appeal are admittedly covered by the decision of coordinate bench dated 28^th March, 2019 in ITA No 678 &679/Mum/2018 for the assessment years 2013-14 and 2014-15. We therefore see no reasons to take any view of the matter then the view taken by the coordinate bench in the aforesaid decision wherein the coordinate bench has inter alia observed as follows:-

5. The first issue that came up for consideration from ground No.1 to 4 of revenue appeal is disallowance of data processing cost u/s.40(a)(ia) of the IT Act, 1961. The ld. AR for the assessee, at the time of hearing submitted that the issue is squarely covered in favour of the assessee by the decision of ITAT, Mumbai ‘I’ Bench in assessee’s own case for the Y.2012-13 in ITA No.6423/Mum/2016 where under identical set of facts, the Tribunal has deleted additions made by the AO towards data processing cost paid to its head office u/s.40(a)(i) of the Act for failure to deduct tax at source u/s.194J of the Income Tax Act, 1961.

6. The ld. DR, on the other hand fairly accepted that the issue is covered in favour of the assessee by the decision of ITAT for earlier years.

7. We have heard both the parties, perused the materials available on record and gone through the orders of the authorities below. The issue involved in this ground of appeal i.e., data processing cost paid to head office is in the nature of royalty as per Clause-3, Explanation 1 to Section 9(1)(vi) of the Income Tax Act, 1961 which is liable for withholding tax u/s.194J of the Income Tax Act, 1961 has been the subject matter of discussions by the Co-ordinate Benches of ITAT in assessee’s own case for the A.Y.2012-13. The Co-ordinate Bench, after considering relevant provisions of the Act, and also scope of Article 12(3)(a) of DTAA between India and Netherlands held that data processing cost did not constitute royalty and is merely reimbursement of expenses not liable for withholding tax and therefore, no disallowance could be made u/s.40(a)(i) of the Income Tax Act, 1961. Relevant paragraphs of the Tribunal order are as under:-

“2.1. The facts in brief are that – assessee paid Data Processing Cost of Rs. 88,26,181/- to its HO, which according to the AO is a copy right protected intellectual property, known as ICT Infrastructure, which is IT Hardware imbedded with software and accordingly, the AO came to the conclusion that the it is a Royalty as per Clause-(iii), Explanation-2 to Section 9(1)(vi) of the Act. Since the assessee has not deducted any tax at source, the AO disallowed the same under the provisions of Section 40(a)(ia) of the Act and added to the income of the assessee. 2.2. At the outset, Ld. Counsel for the assessee pointed out that the issue is squarely covered in favour of assessee in assessee’s own case by the decision of the Co-ordinate Bench in earlier years i.e., AYs. 2004-05, 2006-07 & 2007-08, wherein the Co-ordinate Bench has held that ‘Royalty’ cannot be held to be covered under the scope of Article 12(3)(a) of DTAA (Double Taxation Avoidance Agreement) between India and Netherlands. Ld. CIT(A) following the order of ITAT in these years held that Data Processing Cost did not constitute ‘Royalty’ and is merely a reimbursement of expenses not liable for TDS and therefore, the deduction has to be allowed for reimbursement of cost of data processing charges.

2.2. The ld DR on the other hand relied on the grounds of appeal and order of AO.

2.3. Since the facts in the instant year are identical to ones as in the earlier years and accordingly we respectfully following the decision of the Coordinate Benches hold that assessee is entitled for deduction of data processing cost of Rs. 88,26,181/- as the same is not royalty but reimbursement of Data Processing Charges and therefore there is no requirement of deduction of tax at source from the said reimbursement. This ground of Revenue is dismissed.”

8. In this view of the matter and consistent with view taken by the Coordinate Bench, we are of the considered view that there is no error in the order of the ld. CIT(A) in deleting additions made by the AO towards disallowance of data processing cost, hence, we are inclined to uphold the findings of ld. CIT(A) and reject the ground taken by the revenue.

9. The next issue that came up for consideration from ground No.5 to 9 is disallowance of interest paid to head office and taxability of the same in the hands of the head office.

10. The ld. AR for the assessee submitted that this issue is also covered in favour of the assessee by the decision of ITAT Mumbai in assessee’s own case for the Y.2012-13, wherein the Tribunal under identical set of facts, held that interest paid by the PE to GE is not liable to tax in the hand of head office, since branch is separate and distinguishable from head office for the purpose of assessment under the Income Tax Act and also held that interest earned by the head office from branch office is not chargeable to tax in view of the specific provisions of Article 11 of DTAA between India and Netherlands.

11. The ld. DR, on the other hand fairly accepted that issue is covered in favour of the assessee by the decision of ITAT Mumbai ‘I’ Bench in assessee’s own case for the A.Y.2012-13.

12. We have heard both the parties and perused the materials available on record. The issue of deductibility of interest paid to head office is a subject matter of consideration by the Co-ordinate Bench in assessee’s own case for earlier years. The Tribunal after considering relevant facts in the light of the provisions of Article 11 of DTAA between India and Netherlands hold that interest paid by the branch office to head office is not chargeable to tax in view of the specific provisions of Article 11 of DTAA between India and Netherlands. The relevant findings of the Tribunal are as under:-

“3. As far as the Ground No. 2 is concerned, the facts in brief are that assessee-branch in India during the year has paid interest of Rs. 11,94,79,875/- to its HO which is not taxable in the hand of H.O. under the Income Tax Act and therefore not offered to tax as income of the H.O. The AO disallowed the same on the ground that the decision of the ITAT in the case of Mitsui Bank [35 TTJ 426] and ITAT, Calcutta in the case of ABN AMRO Bank [97 ITD 89] and also that the DRP has disallowed the same in AYs. 2006-07 & 2007-08 though the credit of TDS deducted of Rs. 1,21,04,206/- u/s. 195 of the Act was allowed which was deducted in terms of Circular No. 740, dt. 17-04-1996 @ 10% under Article 11(2) of Tax Treaty between India and Belgium.

3.1. At the outset, Ld. Counsel for the assessee submitted that the issue is squarely covered in favour of assessee in assessee’s own case in AYs. 2002­03 to 2011-12 and Ld. AR submitted that CIT(A) while deciding the issue, has also followed the decision of the Co-ordinate Bench in assessee’s own case for the AYs. 2003-04 to 2007-08. Therefore, the CIT(A) has passed well reasoned and speaking order which is in accordance with the ratio as laid by the tribunal in the earlier year and should be followed in the instant year also.

3.2. After hearing both the sides and perusing the material on record, including the decisions relied upon, we find that the issue has been decided by the Co-ordinate Benches in the earlier years from AYs. 2002- 03 to 2011­12, wherein the Co-ordinate Benches have allowed the claim for deduction of interest paid by the branch office to its HO considering the fact that the assessee a banking company. The Calcutta High Court has held in the case of ABN Amro Bank 198 taxman 376 where an assessee is an branch (PE) of non resident entity i.e its Head Office(G.E.) and the interest paid by the P.E. to G.E. allowable since branch (P.E.) is separate and distinct from head office(G.E.)for the purpose of assessment under the I.T.Act and also held that interest earned by the head office (G.E.) from branch office(P.E.) is not chargeable to tax in view of the specific provisions of Article 11 of DTAA between India and Netherland. Therefore, respectfully following the decisions of the Co-ordinate Benches, we dismiss the ground raised by Revenue.”

13. In this view of the matter and consistent with view taken by the Coordinate Bench, we are of the considered view that the CIT(A) was right in deleting the addition made by the AO towards disallowance of interest paid to head office. Hence, we are inclined to uphold the findings of the ld. CIT(A) and reject the ground taken by the revenue.

14. The next issue that came up for consideration from ground No.10 is disallowance u/s.14A of the Income Tax Act, 1961. The ld. AR for the assessee submitted that this issue is also covered in favour of the assessee by the decision of ITAT, Mumbai in assessee’s own case for the A.Y.2012-13 in ITA No.6423/Mum/2016.

15. DR, on the other hand fairly accepted that the issue is covered in favour of the assessee.

16. We have heard both the parties, perused the materials available on record and gone through the orders of the authorities below. The issue involved in the present appeal i.e., disallowance of expenditure incurred in relation to exempt income u/s.14A r.w.r. 8D is no longer res integra. The Co­ordinate Bench of ITAT, Mumbai ‘I’ Bench, in assessee own case considered similar issue in light of provisions of Section 14A r.w.r. 8D and by following the decision of ITAT Delhi Bench in the case of Sumitomo Corporation vs. DCIT 114 ITD 61 held that when the assessee has not claimed reduction towards interest paid to head office as its expenditure, the question of apportionment interest for exempt income and taxable income does not arise, consequently no disallowance could be made u/s.14A of the Income Tax Act, 1961. The relevant findings of the Tribunal are as under:-

“4.1. The facts in brief are that the assessee during the course of assessment proceedings made disallowance u/s. 14A r.w. Rule 8D to the tune of Rs. 2,15,61,865/-, comprising proportionate disallowance of interest of Rs. 1,34,59,230/- under rule 8D(2)(ii) and Rs. 81,02,635/- under Rule 8D(2)(iii). The said disallowance was made by the AO on the ground that the assessment of both HO and branch in India are done together. According to the AO, the branch has borrowed money from the HO, utilized and had paid back the interest on such debt and thus, the branch has claimed expenses in connection with payment of interest to the HO and the HO is claiming the said interest income as exempt. Therefore, the disallowance u/s. 14A r.w. Rule 8D has to be made on the basis of Principles of Mutuality following the Special Bench decision in the case of Sumitomo Corpn. Vs. Dy.CIT [114 ITD 61]/[17 SOT 197] (Delhi) when the HO and branch office are fungible entities.

4.2. Ld. CIT(A) deleted the disallowance on the ground that if there is any exempt income earned by the branch which is exempt under the Income Tax Act, only then the provisions of Section 14A could be applied. According to the CIT(A) the assessee has not claimed any exempt income under theIncome Tax Act as is clear from the computation of total income and as regards the interest of Rs. 11,94,79,875/-, interest earned by the HO from the branch, the HO has not incurred any expenditure in India to earn it even though the interest earned by it is held to be not chargeable to tax under DTAA and therefore, the provisions of Section 14A of the Act would not apply. 4.3. Ld. AR at the outset pointed out that the issue involved in this case has been decided by the Co-ordinate Bench in assessee’s own case in ITA Nos. 7481/Mum/2014 & 7482/Mum/2014, dt. 28-02-2017 for the AYs. 2010-11 & 2011-12 decided the issue in favour of assessee by observing and holding as under:

“6. Next issue relates to disallowance u/s. 14A for earning exempt income. We have considered rival contentions and found from record that the issue has been decided in assessee’s favour by the Mumbai ITAT, in assessee’s own case for Assessment Years 2004-05, 2005­06, 2007-08 and 2009-10. The Indian Branch has not received/earned any interest income from its Head Office or other foreign branches and hence there can be no question of the interest expense in question being incurred to earn any exempt income and hence the same cannot be disallowed u/s. 14A. The proposition that no disallowance can be made u/s.14Aof the Income-tax Act, 1961 in case there is no exempt income is now well settled and one can refer to the following cases wherein the said proposition has been upheld:

• • • • ClT v/s. Delile Enterprises (ITA No 110 of 2009) (Born)
      •  Cheminvest Ltd., v/s. CIT (2015) 378 ITR 33 (Delhi)
      •  ACIT vs. Lafarge India Holding (P) Ltd., (2008)-(19 SOT 121) (Mum Trib)
      • CIT v/s Shivam Motors Pvt Ltd., (2015) 230 Taxman 63 (Allahabad)
      • CIT v/s. Corrtech Energy Pvt. Ltd.. (233 Taxman 130) (Gujarat)
      • ACIT v/s. Mr. M. Baskaran (ITA No.1717/Mds/2013)
      • CIT v/s. Lakhani Marketing Inc (2015) 226 Taxman 45 (P & H)
      • Huntsman International (India) P. Ltd., v/s DCIT (2016] 66 com 325 (Mum, Trib)

6. Contention of assessee before us was that no expenditure has been incurred or claimed by the Indian Branch in respect of interest earned by the Head Office (which is not taxable). Accordingly, it was pleaded that provisions of Section 14A are not applicable to the said case.

7. We found substantial merit in the contention of learned AR, however, in the interest of justice, we restore the matter back to the file of the AO to find out if assessee was in receipt of any exempt income vis-a-vis interest paid to head office. If the AO found that assessee was not in receipt of any exempt income, no disallowance is to be made. Accordingly AO is directed to decide afresh after verification.

8. Learned DR fairly conceded that similar grounds have been taken by Revenue In the assessment year 2011-012.

9. We have gone through the orders of the authorities below following the reasoning given in the Assessment Year 2010-11. We do not find any infirmity in the order of CIT(A) for the A.Y 2011-012.

10. In the result, appeals filed by the Revenue are dismissed in terms indicated hereinabove”.

4.4. Since the facts of the present case before us are similar to the facts of the case as decided by the Co-ordinate Bench in the AYs. 2010-11 & 2011­12 (supra) in assessee’s own case, we , therefore , respectfully following the decision of the Co-ordinate Bench, uphold the order of CIT(A) and the grounds raised by Revenue is dismissed.”

17. In this view of the matter and consistent with view taken by the Coordinate Bench in assessee’s own case for earlier years, we are of the considered view that there is no error in the findings of the ld. CIT(A) in deleting additions made towards disallowance of expenditure incurred in relation to exempt income u/s. 14A of the Act. Hence, we are inclined to upheld the findings of ld. CIT(A) and reject the ground taken by the revenue.

18. In the result appeal filed by the revenue is dismissed

ITA  No. 679/Mum/2018 (A.Y.2014-15)

19. The facts and issues involved in this appeal are identical to the facts and issues which we have already considered in ITA No. 678/Mum/2018. The reasons given by us in the preceding paragraphs shall mutatis mutandis apply to this appeal also. Therefore, for the reasons given in the preceding paragraph in ITA No. 678/Mum/2018, the appeal filed by the revenue is dismissed.

20. In the result, both the appeals of the revenue are dismissed.

5. Learned Departmental Representative has also fairly agreed that all the issues raised in this appeal are squarely covered by the aforesaid decision. We see no reasons to take any other view of the matter then the view so taken by the coordinate bench. Respectfully following the coordinate bench order, we confirm action of the CIT(A) and decline to interfere in the matter.

6. In the result, the appeal filed by the revenue is dismissed. Pronounced in the open court today on the 1^st day of December, 2020.