ITAT held that tax withholding provisions under section 195 of the Income-tax Act, 1961 (the Act) are not applicable to payments made by the Indian head office to its foreign branch, as both are ‘residents’ according to the Indian Income-tax Act, 1961 and the relevant Double taxation avoidance agreement (the tax treaty) between India and the US. Furthermore, sales made by the Indian HO to its foreign branch are eligible for deduction under section 10A of the Act and are therefore to be included in the ‘export turnover’ when calculating deduction under section 10A of the Act of the Act.
It is interesting to note that while both the issues discussed above deal with transactions between HO and the branch, on one issue the branch is treated as part and parcel of the HO and hence withholding provisions were not to be applied on transactions between them, but on the other issue, transactions between the branch and the HO have been treated as if between two different entities so as to be eligible to claim deduction under section IDA of the Act. This ruling is important for Indian companies with foreign branches who have been required to withhold tax when making remittances to their branches.
INCOME TAX APPELLATE TRIBUNAL, HYDERABAD
ITA No.824/Hyd/2010 – Assessment Year 2006-07)
M/s. Semantic Space Technologies Ltd., Hyderabad
Dy. Commissioner of Income-tax
ITA No.915/Hyd/2010 – (Assessment Year 2006-07)
Asst. Commissioner of Income- tax
M/s. Semantic Space Technologies Ltd., Hyderabad
Date of Pronouncement – 7.3.2012
Per D.Karunakara Rao, Accountant Member:
These cross-appeals for the assessment year 2006-07 are directed against the order of the Commissioner of Income-tax(Appeals)- IV, Hyderabad dated 31.3.2010.
2. First effective ground of the Revenue reads as follows
“2. The CIT(A) erred in inclusion of (i) misc. income (ii)credit Balance written back and notice period salary for the purpose of arriving deduction u/s. 10A.”
3. At the outset, the learned counsel for the assessee mentioned that the issues relating to inclusion of (i) miscellaneous income (ii) credit balance written back; and (iii)notice period salary for the purposes of arriving at the deduction under S.10A of the Act, are covered by the order of this Tribunal dated 19th August, 2009 in assessee’s own case in the cross-appeals for the assessment year 2005-06, viz. in ITA Nos.397 and 536/Hyd/20008.. In this regard, the learned counsel took us through para 8 of the said order dated 19th August, 2009 for the proposition that miscellaneous income and the credit balance written back should be included in the profit eligible for computation of exemption under S.10A of the Act. We find that the said direction was given by the Tribunal, following the decision of the Mumbai Bench of the Tribunal in the case of Extrusion Processes (P)Ltd V/s. ITO (2007) 106 ITD 336. The Tribunal also noted that there is no decision to the contrary brought to its notice and finally decided the issue in favour of the assessee. We have considered the facts of the present case in relation to this issue and find that they are analogous to those considered by the Tribunal in the above decision for the preceding year. Therefore, we are of the opinion that the CIT(A) was justified in deciding this issue in favour of the assessee. We accordingly confirm the order of the CIT(A) on this issue.
4. Further, on the aspect of notice period salary, the learned counsel for the assessee drew our attention to para 7 of the said order of the Tribunal and mentioned that the said issue was also decided by the Tribunal in favour of the assessee. In that regard, the Tribunal relied on the decision of the Supreme Court in the case of Lakshmi Machine Works (290 ITR 667). We have perused the facts of the case on this issue, and find that the issue involved in this appeal is identical to the one already adjudicated by the Tribunal. Relevant portion of the order of the Tribunal in this regard reads as follows
“7. We have considered the rival submissions and perused the material available on record. As for the notice period salary recovered from employees of Rs.1,4O,548, we are of the view that the lower authorities are not justified in excluding the same from the eligible profits of the business while calculating the deduction under S.1OA of the Act. Since the said amount represents recovery of the business expenses earlier incurred by the assessee in recruiting and training of the employees concerned, the income arising on account of such recovery also represents the business income of the assessee……”
Considering the above reasoning given by the Tribunal, we find no infirmity in the impugned order of the CIT(A) on this aspect. We accordingly uphold the same, rejecting the ground of the Revenue in this appeal.
5. Next effective ground of the Revenue, being ground No.3, relates to inclusion of gain on account of foreign exchange fluctuation of Rs.36,20,165, for the purpose of computing eligible income under S.10A of the Act.
6. At the very outset, it has been brought to our notice that the CIT(A) has decided this issue relying on the Bombay bench of the Tribunal in the case of Renaissance Jewellery P. Ltd. V/s. ITO(101 ITD 380). During the proceedings before us, no decision to the contrary, has been brought to our notice. In the circumstances, we are of the opinion that there is no infirmity in the order of the CIT(A) on this issue. The same is accordingly confirmed and this ground of the Revenue is rejected.
7. Ground No.4 of the Revenue relates to the disallowance made by the assessing officer under S. 40(a)(ia) of the Act.
8. At the outset, the learned counsel for the assessee mentioned that this ground has been erroneously raised by the Revenue for the reason that the CIT(A) confirmed the disallowance made by the assessing officer, which can be seen from para 12.1 of the impugned order of the CIT(A). In fact, it is submitted, assessee raised grounds in its appeal against disallowance sustained by the CIT(A). The Learned Departmental Representative fairly agreed to the occurrence fo the mistake in raising this ground. We have perused the discussion in paras 12 and 12.1 of the impugned order and find that the CIT(A) has in fact, did not find any infirmity in the disallowance made by the assessing officer and accordingly confirmed the disallowance of Rs. made for contravention of the provision of S.195 of the Act. In such factual circumstance, we find that the Commissioner of Income-tax has erroneously authorized the Department to raise this ground. This ground is accordingly rejected as misconceived.
9. In the result, appeal of the Revenue is dismissed.
10. Summarised grounds of the assessee in this appeal are as under
“1. The order of the learned Commissioner of Income-tax(Appeals) is erroneous in law and on the facts of the case.
2. The learned Commissioner of Income-tax(Appeals) erred in directing the exclusion of the interest income of Rs.1,09,0987 for purposes of computing eligible income u/s. 10A.
3. The learned Commissioner of Income-tax(Appeals) erred in upholding the exclusion of the sum of Rs.2,58,24,051 received from the US branch of the assessee from “export turnover” for purposes of Sec.10A though these are covered by notification issued by CNBDT and approved by STPI.
4. Even if it is assumed that the impugned aggregate receipt of Rs.2,58,24,051 did not represent export turnover, the learned Commissioner of Income-tax(Appeals) erred in upholding the action of the Assessing officer in excluding the entire turnover from the export income while computing the “income from export of software”.
5. The learned Commissioner of Income-tax(Appeals) erred in confirming disallowance of Rs.2,46,50,958 u/s. 40(a)(ia) on the ground that the appellant made the said payment to a foreign entity and that accordingly the appellant ought to have deducted tax at source under Sec.1956 of the I.T. Act though the impugned payment represented movement of funds within the same Indian taxable entity.
6. The learned Commissioner of Income-tax(Appeals) failed to appreciate that in any case, foreign branch is not a non¬resident as per Sec.6(5) of the I.T. Act and therefore the impugned payment is not covered by Sec.195 of the IT Act and is also excluded from the purview of taxation even as per DTAA with USA.
7. The learned Commissioner of Income-tax(Appeals) failed to appreciate the submissions of the appellant that the impugned amount of Rs.2,46,50,958 has not been claimed as a deduction in computing total income on the basis of the consolidated P&L Account which formed the basis for computation of taxable income and accordingly the provisions of sec.40(a)(ia) are not attracted at all to the impugned amount.
8. The learned Commissioner of Income-tax(Appeals) relied on the decision of Karnataka High Court in the case of Samsung Electronics which facts and circumstances are entirely different from the facts of the case of the appellant.
9. For the above grounds and such other ground that may be urged at the time of hearing, the appellant prays that the appeal be allowed. “
11. Before issue-wise adjudication is taken up, the learned counsel for the assessee submitted that there are three issues involved in these grounds, which are as follows
(i) Exclusion of interest income of Rs.1,09,087 for the purposes of computing the eligible income under S.10A of the Act.
(ii) Exclusion of a sum of Rs.2,58,24,051 being the amount received from branch office of the assessee at US. The assessing officer is of the opinion that this amount is not to be included in the export turnover of the assessee for the purposes of S.10A of the Act.
(iii) Disallowance of Rs.2,46,50,958 invoking the provisions of S.40(a)(ia) when these payments are made by the branch office of the assessee and when such branch office of the assessee is not non-resident.
Now, we shall proceed with the issue-wise adjudication of this appeal filed by the assessee.
12. As for the first issue relating to interest income of Rs.1,09,087, mentioned in ground No.2 of the summarized grounds of appeal, the facts in brief are that the assessee received interest amount of Rs.1,09,087 and pleaded for inclusion of the same as profits of the business eligible for exemption under S.10A of the Act. The assessing officer held that this income is outside the operational income, and accordingly excluded the same from the scope of S.10A and taxed the same as income under the head ‘other sources’. In the process, the assessing officer relied on the decision of the Apex Court in Sterling Foods (1999)237 ITR 579. Before the CIT(A), the assessee pleaded that the interest derived on account of temporary parking of business funds constitutes income derived from its export activity. The CIT(A) relying on the Mumbai Bench decision of the Tribunal in the case of Renaissance Jewellery P. Ltd. V/s.ITO(101 ITD 380), confirmed the disallowance made by the assessing officer. Aggrieved by the same, assessee is in appeal before us on this issue.
13. Learned counsel for the assessee, reiterating the contentions urged before the lower authorities, submitted that the interest income derived by temporary parking of funds constitutes export income of the assessee, and hence is eligible for deduction under S.1OA of the Act.
14. On the contrary, the Learned Departmental Representative strongly supported the orders of the CIT(A) and relied on the decisions cited by him in the impugned order.
15. On hearing both sides, we find that the issue of granting deduction on interest received, has now reached finality at the levels of the High Court, say by the decision of the Chattisgarh High Court in the case of Nav Bharat Explosives Co. Pvt. Ltd. (337 ITR 0515), wherein it was held that the income by way of interest on fixed deposits is not eligible for special deduction under S.1OA. Therefore, we uphold the impugned order of the CIT(A) on this issue. This issue is accordingly decided against the assessee, rejecting ground No.2 of the assessee in this appeal.
16. The second issue, covered by grounds No.3 and 4 of the summarized grounds of appeal of the assessee, relates to the treatment to be given to the sales made to the branch office located in US. The said sales were included by the assessee in the export turnover of the assessee for the purposes of computing deduction under S.1OA. Per contra, the assessing officer is of the view that the said inclusion is not proper, considering the fact that sale by head office to the branch itself does not constitute sale per Se. It is merely a case of transfer. Therefore, the assessing officer excluded such sales to its branch office from the export turnover of the assessee, before allowing the said deduction. At the end of the first appellate proceedings, the CIT(A) not only confirmed the said exclusion of the sales from the export turnover of the assessee, but also proceeded to exclude the said amount from the total turnover of the assessee, to maintain the ‘principle of parity’.
17. Relevant facts of the issue are given in paras 8 to 10 of the impugned order. Briefly, the relevant facts are that the head office sales include Rs.61,77,900 received from the branch office on account of ‘software development charges’ and another sum of Rs.1,96,46,151 on account of ‘HR and marketing services’. The assessee included them as part of the export of software services, which was not entertained by the assessing officer as discussed earlier. During the first appellate proceedings,, the assessee submitted that the said receipts from the branch office constitutes export of software services by the assessee, considering the fact that the said export was done with due approval of STPI, Hyderabad. In this regard, he relied on the Board’s Notification No.0890E/F No.142/49200-TPL dated 26.9.2000 to support its case. Further, the assessee included the relevant income in the eligible profits of the assessee. However, to maintain harmony of exclusion from the export turnover, he also reduced the said amount from the eligible profit of the business. Considering the fact that the assessee failed to produce segregation of the profit relatable to the said sales of the head office and the branch office, the assessing officer proceeded to exclude both the sums of Rs.61,77,900 and Rs.1,96,46,151 from the ‘profits of the business’ before deduction under S.10A was determined. Considering the above submissions of the assessee, the CIT(A) analysed and held that the above sums do not constitute the eligible sums for inclusion. He held it so on the reasoning that there cannot be sales between the head office and the branch office, as sales imply the transfer of goods and the change of hands of different entities/persons. He accordingly confirmed the exclusion made by the assessing officer from the export turnover. To bring parity, the CIT(A) proceeded to make similar exclusion from the total turnover also, as discussed in para 10.2 of the impugned order. For this proposition, he relied on the decision of the Hyderabad Bench of the Tribunal in the case of ITO Vs. De Block India Software Pvt. Ltd. (citation not given) and Special Bench (Chennai) of the Tribunal in the case of ITO V/s. SAK Soft Ltd. (313 ITR (AT)353).
18. So far as the issue of exclusion of the above sums from the profits of business is concerned, the CIT(A) simply confirmed the decision of the assessing officer, in the absence of any segregation of profits relatable to the above mentioned sums.
19. Aggrieved with the above decision of the CIT(A), assessee is in appeal before us on this issue.
20. Learned counsel for the assessee filed written submissions, out of which para 3 is relevant in this regard. Essentially, it contains narration of the facts and reiterated the stand against exclusion from the export turnover as well as total turnover. He emphasized the fact of exporting the goods to the branch office in US, with the approval of the STPI Hyderabad. Further, he questioned the validity of exclusion of the entire receipt from the export income instead of reducing only the profit segment of the said sales to the branch office in US by adopting some estimated profit, if any. Regarding the exclusion of the said sales to branch office in US from the total turnover, the learned counsel was of the view that the same is not in accordance with the said principle that the total turnover of the assessee should exclude the transfers, if any , made to be branch office. Further, the learned counsel for the assessee made a reference to the Delhi Bench of the Tribunal in the case of Virage Logic International V/s. Dy. Director of Income-tax (2007)13 SOT 270, for the proposition that transfers by the head office constitutes export sales for the purposes of computing deduction under S.10A of the Act. The Tribunal held that the assessing officer’s approach of treating the sales between the assessee and the head office does not constitutes transfers was not approved for the purpose of completion of the sale, it is not necessary that there must be any third party. For arriving at the above proposition, the approval given by the STPI assumed importance as discussed in para 3 of the said order of the Tribunal. The Tribunal was supported by the provision of S.1OA (7) read with S.80IA(8) of the IT Act in this regard.
21. On the other hand, the learned Departmental Representative for the Revenue relied heavily on the orders of the lower authorities.
22. We heard both the parties, perused the orders of the Revenue authorities and the written submissions and citations filed before us. As discussed in the preceding paras, the crux of the issue relates to the transfers between the head office and the branch office located in US, and whether it constitutes exports for the purpose of S.1OA of the Act. In this regard, in our opinion, the Delhi Bench order in the case of Virage Logic International (supra) helps to arrive at a conclusion and in favour of the assessee. In that case, the head office has sent goods to the assessee in India and the said export was included in the export turnover for the purposes of determining the deduction under S.1OA of the Act. On these factual matrix of that case, the Delhi Bench of the Tribunal has come to the conclusion that the said exports constitutes sales. The order of the assessing officer in that case was set aside. Relevant portion of the said decision of the Tribunal is reproduced below
“13. In the present case there is no dispute that the assessee developed ‘Computer Software’ and transmitted electronically to its head office. The assessee is an approved 100 per cent export oriented unit for development of computer software duly approved by the STP of India. The export of software during the previous year is evidenced by the Softex form duly certified by the competent officer of STPI. The consideration has been received by the assessee in the form of convertible foreign exchange. The only reason assigned by the Revenue authorities for denying exemption under section 10A of the Act is that there has been no export sale by the assessee, since the computer software was transmitted to head office and since the assessee and the head office were one entity, there was no sale to any third party. This approach of the Revenue authorities were not correct in view of the provisions of section 1OA(7) of the Act. The legal fiction of treating an assessee as a separate entity vis-à-vis sale by it or transfer by it from an eligible business or to an eligible business has been recognised under section 1OA(7) of the Act. A plain reading of the provisions of section 1OA(7) together with the provisions of section SO-IA(S) of the Act, which reads as follows reveals the statutory recognition of such legal fiction
14. In the present case, there cannot be any doubt about the market price also since the transfer pricing officer has already held that the price at which the assessee transmitted the computer software to the head office was at arm’s length price. On this basis, the claim of the assessee deserves to be accepted.”
The above extract demonstrates that the transfers between the Head Office and the Branch Office and vice versa with the approval of the STPI clubbed with satisfaction of other conditions like realization of proceeds in foreign exchange, constitutes exports for the purpose of the deduction under S.1OA of the Act. Thus, without going into the other arguments raised by the learned counsel for the assessee, we find that the assessee must be given relief on this issue. Accordingly the decision of the CIT(A) to exclude the said sales by the assessee to the branch in US from the total turnover and the other changes made by the assessing officer are reversed. Accordingly, summarized grounds at Sl. No.3 and 4 of the assessee are allowed.
23. The third issue, covered by grounds No.5 to 8 of the summarized grounds of the assessee, relates to the disallowance made invoking the provisions of S.195 read with S.9 of the Income-tax Act and Double Taxation Avoidance Agreement(DTAA) with USA in respect of remittances made by the head office to Branch Office in US.
24. Brief facts of this issue are that the assessee made payment of Rs.2,46,50,958 to the US Branch on account of work sub-contracted to them. The assessee did not furnish details of TDS made in respect of such payments. The assessing officer is of the opinion that the said payments to the branch office attracts the TDS provisions under S.194C/195 of the Act, as the Branch is a non-resident, and consequently the assessing officer invoked the provisions of Section 195 read with S.40(a)(ia) of the Act and denied the benefit of deduction under S.10A in respect of such payments.
25. During the first appellate proceedings, the assessee argued stating that the branch office in USA is not a non-resident, as it is part and parcel of the assessee. The provisions of S.194/195 are attracted only if the payee is non-resident. In this regard, learned counsel mentioned that the payee is resident for all legal purposes. The assessee argued that the status of a branch office is the same as that of the head office, viz. assessee, considering the very nature of the branch. He further mentioned that the Permanent Establishment for the said branch office is in India, which is undisputed and the clubbed income of the assessee is taxable in India only. The learned counsel for the assessee not only explained the provisions of S.195 of the Act, but also Article 4(1) of the DTAA with USA dealing with ‘resident’. It was submitted that the provisions of DTAA read harmoniously with the provisions of the Indian Income-tax Act, clearly indicate that the status of US Branch is ‘resident’ in India only, and therefore, the provisions of S.195 have no application. The assessee also made other submissions, without prejudice to the above. He also brought to our notice the reversal of the judgment of the Hon’ble Karnataka High Court in the case of CIT V/s. Samsung Electronics Ltd. (195 Taxman 313 = 320 ITR 209). Considering the other submissions narrated in para 11 of the impugned order as well, the CIT(A) upheld the views adopted by the assessing officer. In the process, he relied on the decision of the Karnataka High Court in the case of CIT V/s. Samsung Electronics Ltd. (320 ITR 209), which is popular at that time for the proposition that tax has to be deducted ‘on any payment’ made abroad. Thus, the CIT(A) confirmed the views of the assessing officer.
26. Aggrieved by the aforesaid decision of the CIT(A), assessee raised this issue before us, vide grounds No.5 to 8 of the summarised grounds of appeal.
27. On this issue, arguments of the learned counsel for the assessee in the written submissions are briefly as follows
(a) Branch office in USA is part and parcel of the assessee company and therefore, the payment is nothing but payment to itself. Therefore the provisions of S.195 of the Act, where the payer and payee are not separate, are not applicable.
(b) For the foreign branch of the assessee shares the same status as that of the assessee, considering the relevant provisions of DTAA as well as the Income-tax Act. When the payee is a branch of Indian company, such branch cannot be non¬resident in status. Therefore, the impugned payment is outside the scope of S.195 of the Act.
(c) Residential status of the assessee is ‘resident’ because S.3 of the Indian Companies Act defines that ‘company said to be a resident’ is an ‘Indian company’ or ‘… the control and management of its affairs is situated wholly in India’. Same is the case with the assessee. Therefore, the branch office of the assessee cannot be treated as non-resident in the circumstances. The provisions of DTAA also support the above views.
28. The written submissions also mention that the payments/remittances in question do not attract the provisions of S.195 of the Act, as they represent neither interest nor dividend under DTAA. At the maximum, these payments constitute ‘fee for included services’. In that case, the provisions of Article 12 of the DTAA with US do not apply. Applying the ratio of the Mumbai Bench decision of the Tribunal in the case of Raymond Limited V/s. DCIT (86 ITD 791), it is submitted that such payments are outside the provisions of S.195 of the Act. Further, the learned counsel mentioned that the CIT(A) has emphasised and substantially relied on the decision of the Karnataka High Court in the case of Samsung Electronics Ltd. (supra), but the fact is that the said judgment of the Karnataka High Court has been reversed by the Supreme Court vide its judgment dated 9.9.2010 in the case of GE India Technologies Pt. Ltd. V/s. CIT and Others (327 ITR 456). The Supreme Court explained in the said judgment that expression ‘chargeable under the provisions of the Act’ in S.195(1) shows that the remittances have got to be trading receipt whole or part of which is liable to tax in India. If the tax is not so assessable, there is no question of tax at source being deducted. The ratio laid down by the Karnataka High Court judgment in the cited case (320 ITR 209) has been set aside in that case.
29. On the other hand, the learned Departmental Representative has relied on the orders of the assessing officer and the CIT(A).
30. We heard both the parties on this issue. The issue in short is the remittance made by the assessee to its branch office abroad should be subjected to TDS provision, as made out by the Revenue authorities. The crucial arguments of the assessee in this regard include- (a) these payments are outside the scope of S.195 of the Act for the reason that the branch office abroad is part and parcel of the assessee and it is a ‘resident’ in status and ‘not non-resident’, as made out by the Revenue. The provisions of S.195(1) mention clearly that only the payments to non-residents attract provisions of s.195 of the Act. The other argument is the misplaced reliance of the CIT(A) on the decision of the Karnataka High Court in the case of Samsung Electronics Ltd. (Supra), in view of the subsequent decision of the Apex Court in the case of GE India Technologies Pt. Ltd. V/s. CIT and Others (supra). In so far as the first argument is concerned, it is a decided issue that the status of the branch office of the assessee abroad is not ‘non-resident’. In such situation, the provisions of S. 195 are inapplicable. Coming to the applicability of the decision of the Karnataka High Court, it is the argument of the learned counsel for the assessee that the Supreme Court has set aside the operation of the judgment of the Karnataka High Court in the cited case, vide judgment reported at 327 ITR 456. For these reasons, in our opinion, the impugned payment of Rs.2,46,50,958 made by the assessee to the branch office in USA, is outside the scope of S.195 of the Act. Accordingly, this issue is decided in favour of the assessee, allowing grounds No.5 to 8 of the summarized grounds of appeal raised by the assessee.
31. In the result, assessee’s appeal is partly allowed.
32. To sum up, while the Revenue’s appeal, being ITA No.915/Hyd/2010, is dismissed, assessee’s appeal, being ITA No.824/Hyd/2010, is partly allowed.
Order pronounced in the court on 7.3.2012