Case Law Details
Interest on fixed deposits effectively connected with PE – Business Income; Direct expenses incurred by a head office for Indian projects – not Head office expense; Fees for procurement services – not taxable as ‘fees for technical services’
In brief :-In a recent ruling in the case of DDIT Vs. Samsung Engineering Co. Ltd. [2010-T11-169-ITAT¬MUM-INTL], the Mumbai Income-tax Appellate Tribunal (the “Tribunal”), held that (i) interest on a fixed deposit kept as margin with banks, which is effectively connected with a permanent establishment (“PE”) would be taxable as business income; (ii) Salary and welfare expenses of staff working for projects in India cannot be considered as head office expenditure under section 44C of the Income-tax Act, 1961 (“the Act”); (iii) Payment for procurement services requiring industrial and scientific experience, but which do not involve imparting any information concerning industrial, commercial, or scientific experience, do not constitute ‘fees for technical services’.
Issue No.1 – Interest on fixed deposits kept as margin with banks is effectively connected with the PE and would be taxable as business income
Facts
• The assessee, a tax resident of Korea, was engaged in turnkey projects relating to procurement, engineering and construction. It was awarded two contracts by an Indian company.
• The assessee earned interest on fixed deposits kept as margin with banks.
• The assessee filed its return by claiming interest income taxable as business income.
• The assessing officer (“AO”), though accepting that interest income was effectively connected to the PE, held that the interest income was to be assessed as “income from other sources” until and unless the assessee was engaged in the business of money lending.
• On appeal before the Commissioner of Income-tax (“CIT(A)”), the CIT(A) held that interest income is part of the business of the assessee’s PE in India and has to be treated as business income as it was directly connected with the PE.
Assessee’s contentions
• The assessee had to maintain fixed deposits for keeping them as margin towards obtaining letter of credit and other guarantees for the various projects.
• Hence, the interest income was directly related to the business of the assessee and should be treated as business income.
• The Reserve Bank of India (“RBI”) had permitted the opening of a project office and a site office for the purpose of executing the contract with an Indian company. The approval of the RBI for operation in India was restricted exclusively for the execution of the contract with the Indian company. Hence, the income was inextricably connected to the project office in India.
• While contending as such, the assessee placed reliance on the decisions in the cases of CIT v. Indo Swiss Jewels Ltd. [2005] 284 ITR 389 (Born), CIT v. Koshika Telecom Ltd. [2006] 287 ITR 479 (Delhi) and CIT v. Lok Holdings [2008] 308 ITR 356 (Born).
Tribunal Ruling
The assessee had to invest funds in fixed deposits, to reserve as margin towards obtaining the letters of credit and other guarantees for various projects. After considering the decisions in the cases of Indo Swiss Jewels Ltd., Koshika Telecom Ltd., Lok Holdings, (above) the Tribunal upheld the CIT(A)’s order holding that the interest income earned on the deposit had arisen from business activity, and therefore, it would be treated as business income.
Issue No. 2 – Salary and welfare expenses of staff working for projects in India cannot be considered as head office expenditure under section 44C of the Act
Facts
• The assessee claimed deduction for salary and staff welfare expenses for its Korean staff, while working out the profit/loss of the project carried out in India.
• The assessee had various teams in Korea which rendered services to all projects including India. The employees submit their time sheets on a daily basis, which were ultimately recorded while working out the profit/loss for each of the projects.
• The man hours segregated to various projects were verified by a certified public accountant of Korea and allocated to the projects accordingly.
• The assessee submitted that the auditor has confirmed in its audit report that all the expenses were accounted on accrual basis and only direct cost and expenses relating to the project were considered for preparing these statements.
• According to the AO, in the absence of adequate details, one-fourth of the expenses for assessment year (“AY”) 2001-02 and one-sixth of the expenses for AY 2002-03 were in the nature of general and administrative overheads which were to be treated as head office expenses under section 44C of the Act.
• On appeal to the CIT(A), the assessee contended that:
– It had offered the entire global income of the contract as taxable in India. Hence, no PE concept was followed.
– The expenses were directly related to the Indian project and not in the nature of overheads, since proper time sheets were maintained for each department.
– Section 44C of the Act was not applicable since it had not claimed any Head Office expenses in the rupee portion.
– The Bombay High Court in the case of CIT v. Emirates Commercial Bank Ltd. [2003] 262 ITR 55 (Bom) had held that section 44C of the Act was applicable only in cases of non-residents who conducted business in India through their branches. However, where expenditure is exclusively incurred for the branch, the restrictions contained in section 44C of the Act had no application.
• The CIT(A) held that the direct expenses incurred by the head office for the Indian projects were not covered by section 44C of the Act.
Tribunal ruling
• Any expenses incurred wholly and exclusively for the purposes of Indian business would not fall within the ambit of section 44C of the Act.
• The restrictions contained in section 44C of the Act would be applicable only where there were common expenses which were incurred by the head office for various branches.
• The assessee had filed the time sheet on a daily basis for each employee in the organisation and had recorded the man hours on a daily basis through Enterprise Resource Planning software. The time spent on the Indian projects was properly segregated and was verified and certified by the auditors.
• Hence, the Tribunal upheld the CIT(A)’s order and held that the expenses were incurred exclusively for the Indian projects and were not in the nature of overheads. Thus, once it was held that the expenses were directly related to the Indian projects, the provisions of section 44C of the Act would not be operative.
Issue No. 3 – Fees for procurement services requiring industrial and scientific experience, but which do not involve imparting any information concerning industrial, commercial, or scientific experience, do not constitute ‘fees for technical services’
Facts
• The assessee had made payments to Samsung Corporation in AYs 2001-02 and 2002-03 for providing services for identification and procurement of critical imported material, arranging coordination between foreign vendors and the assessee, monitoring all other activities which were incidental and essential to maintain activities.
• The AO held that the fees for the services rendered were in the nature of ‘fees for technical services’ on which the assessee had not withheld any tax, and hence, the AO disallowed the expenses under the provisions of section 40(a)(i) of the Act.
• On appeal to the CIT(A), the assessee contended that:
– Payment for all the material was made by the head office and was not made by the project office in India, so was not debited in the books of account of the project office in India.
– The expenses were debited to the project account maintained by the head office, for determining profit or loss from the project.
– The provisions of section 195 of the Act were not applicable as payment was made by a non-resident from outside India to another non-resident for the services which are rendered outside India.
– Hence, no income accrued or arose in India, and thus, withholding tax was not deductible on the payments.
– Reliance was placed on the CBDT Circular no. 786 dated 7 February, 2000 where it was clarified that in the case of a non-resident agent operating outside the country, no part of the income arises in India and therefore, no withholding tax is deductible under section 195 of the Act.
– Reliance was also placed on the Mumbai Tribunal decision in the case of Linde AG v. ITO [1997] 62 ITD 330 (Mumbai) where it was held that though procurement services required industrial and scientific experience, this did not mean imparting any information concerning industrial, commercial or scientific experience.
• The CIT(A), by relying the decision in the case of Linde AG (above), held that payment towards procurement charges can be termed as commission and not as ‘fees for technical services’. Furthermore, Samsung Corporation did not have a PE in India and the procurement service fees cannot be brought to tax in India. Hence, the provisions of section 40(a)(i) of the Act would not be applicable.
Tribunal Ruling
The Tribunal held that:
• Though the procurement services required industrial and scientific experience, they did not involve imparting of any information concerning industrial, commercial, or scientific experience.
• The services were purely commercial and had nothing to do with rendering of any technical, managerial or consultancy services. Hence the payment would not be said to be towards fees for technical services.
• Further, the payment was made by the assessee to Samsung Engineers through its head office outside India and since the services were also rendered outside India, no income had accrued or arisen in India, and therefore the payments were not chargeable to tax in India. Therefore, the assessee was not required to withhold tax. Consequently, the provisions of section 40(a)(i) of the Act would not be applicable.
Conclusion :- The Tribunal has once again reiterated the principle that interest on fixed deposits kept as margin with banks is effectively connected with the business and would be taxable as business income. Furthermore, the Tribunal held that the direct expenses incurred by a head office for Indian projects, would not form part of “Head office expenses” and hence, would not be liable for dis allowance under section 44C of the Act. The Tribunal also held that procurement services requiring industrial and scientific experience, which do not constitute imparting of any information concerning industrial, commercial, or scientific experience, are not covered within the definition of ‘fees for technical services’.
