TDS Obligations: Reimbursement of Expenses vs. Fee for Technical Services

PCIT vs M/s Jas Forwarding Pvt. Ltd (Delhi High Court)

The issue of tax deduction at source (TDS) under Section 195 of the Income Tax Act, 1961 (Act), particularly in the context of payments made to non-resident associated enterprises (NRAE), has been a subject of judicial scrutiny. One such area of contention is whether the reimbursement of expenses to foreign entities can be classified as “fee for technical services” under Section 9(1)(vii) of the Act, which would consequently trigger the requirement to deduct TDS. In a recent case decided by the High Court of Delhi, the appellants sought to impose this obligation on the respondent, arguing that the reimbursements made were within the purview of technical or managerial services. However, upon examining the contractual terms, the court found that the remittances did not qualify as fee for technical services, thereby negating the necessity for tax deduction under Section 195. This decision brings clarity to the distinction between reimbursement of expenses and payments for technical services, underscoring the importance of examining the nature of services rendered in determining TDS liability.

The case involves an appeal filed by the Principal Commissioner of Income Tax, Delhi against the judgment of the Income Tax Appellate Tribunal (ITAT) in favor of the respondent, M/s JAS Forwarding Pvt. Ltd (Assessee). The key issues in the case relate to the disallowance of expenses under Section 40(a)(i) of the Act on account of reimbursement of expenses made to NRAE and payment made to NRAE for freight and forwarding services.

Procedural History and Factual Background

The matter was initially brought before the Assessing Officer (AO), who made additions under Section 40(a)(i) of the Act on the grounds that the reimbursement of expenses to the NRAE would fall within the ambit of “fees for technical services” under Section 9(1)(vii) of the Act, and therefore, the respondent was required to deduct tax at source under Section 195. The respondent challenged the AO’s order before the Commissioner of Income Tax (Appeals) [CIT(A)], who agreed that the reimbursement of expenses did not fall within the scope of “fees for technical services” but held that in the absence of the respondent establishing the nature of the expenses, they would be liable to be disallowed under Section 37 of the Act. The matter then reached the ITAT, which upheld the CIT(A)’s decision in favor of the respondent. The Principal Commissioner of Income Tax, Delhi has now appealed against the ITAT’s judgment before the High Court. The key facts leading to the dispute are:

1. The relationship between the Indian respondent and its NRAE was governed by an agreement dated December 12, 2005, which outlined the duties and responsibilities of the parties.

2. The reimbursement of expenses to the NRAE included items such as server maintenance costs, netting charges, management expenses, travel costs, insurance expenses, and Non-Vessel Operating Common Carrier (NVOCC) tariff filing expenses.

3. The AO had disallowed the reimbursement of these expenses under Section 40(a)(i) of the Act, contending that they fell within the ambit of “fees for technical services” under Section 9(1)(vii).

4. The CIT(A) and ITAT, however, disagreed with the AO’s view and held that the reimbursement of expenses did not constitute “fees for technical services.”

The issues addressed in the judgment are as follows:

• Whether the reimbursement of expenses made by the Assessee to its NRAEs would fall within the ambit of “fees for technical services” under Section 9(1)(vii) of the Act, and thus be subject to TDS under Section 195 of the Act.
• Whether the Assessee was required to deduct TDS on the reimbursement of expenses made to the NRAEs, and if the failure to do so would attract disallowance of the expenses under Section 40(a)(i) of the Act.
• Whether the reimbursement of expenses, such as server maintenance costs, netting charges, management expenses, travel costs, insurance expenses, and NVOCC tariff filing expenses, can be considered as mere reimbursements without any income embedded in them, and thus not subject to TDS.

The appellant made the following arguments:

• The appellant argued that the reimbursement of expenses made to the non-resident association enterprises would fall within the ambit of Section 9(1)(vii) of the Act, and thus constitute “fee for technical services”.
• The appellant argued that the nature of functions performed by the foreign principals in favor of the respondent/Assessee would clearly amount to and fall within the ambit of Section 9(1)(vii) of the Act and thus constitute “fee for technical services”.
• The appellant argued that the obligation to deduct tax under Section 195 of the Act would arise provided it were established that the reimbursement of remittances made would fall within the scope of Section 9 of the Act and to the extent that it introduces legal fictions in respect of income which could be said to have accrued in India.

• Whether the nature of the functions performed by the NRAEs for the Assessee would fall within the ambit of Section 9(1)(vii) and constitute “fees for technical services”.

The respondent made the following arguments:

• The reimbursement of expenses, such as server maintenance cost, netting charges, management expenses, travelling cost, and insurance expenses, are in the nature of day-to-day expenses of the business activities of the Assessee and do not fall within the ambit of “fees for technical services” under Section 9(1)(vii) of the Act.
• The expenses reimbursed are regular business expenses, and the genuineness of the expenses has not been doubted by the AO or the CIT(A).
• The services rendered by the non-resident associate enterprises do not involve the “making available” of any technical knowledge, experience, skill, know-how, or processes, nor do they consist of the development and transfer of a technical plan or technical design. The services are merely rendered, and the Assessee does not have the ability to make use of the technical knowledge, etc., by itself in its business or for its own benefit without recourse to the performer of the services in the future.
• The reimbursement of expenses, such as netting charges and management expenses, are for administrative and business development activities performed by the non-resident associate enterprises for the common interest of the JAS Group, which directly or indirectly benefit the Assessee. These expenses are merely cross-charged to the Assessee and do not involve the transfer of any technical knowledge or skills.
• The reimbursement of travelling costs for foreign delegates coming to India was inadvertently included in the list of payments made to non-residents, but the amounts were actually receivable by the Assessee from the non-residents and not payable to them. Therefore, no disallowance can be made under Section 195 of the Act.
• The reimbursement of NVOCC insurance expenses and NVOCC tariff filing expenses are merely cross-charges of group insurance and tariff filing costs, which are an integral part of the Assessee’s business operations and do not constitute “fees for technical services.”

Court’s analysis:

The key issues in this case are:

1. Whether the reimbursement of expenses made by the Assessee to its NRAEs would fall within the ambit of “fees for technical services” under Section 9(1)(vii) of the Act, and therefore be subject to TDS under Section 195 of the Act.

2. Whether the disallowance of the reimbursement expenses under Section 40(a)(i) of the Act for failure to deduct TDS was justified. The court’s analysis on these issues is as follows:

3. On the issue of “fees for technical services”:

• The High Court noted that it was incumbent upon the revenue authorities (the appellants) to establish that the reimbursements made by the Assessee would fall within the ambit of any technical, managerial or consultative service rendered by the NRAEs.
• After perusing the relevant clauses of the agreement between the Assessee and its NRAEs, the High Court found itself unable to sustain the revenue’s submission that the reimbursements would constitute “fees for technical services” under Section 9(1)(vii) of the Act.
• The High Court agreed with the findings of the lower appellate authorities (CIT(A) and ITAT) that the nature of the reimbursements was of regular business expenses, such as server maintenance, netting charges, management expenses, travel costs, insurance, etc., which are an integral part of running the business.
• The High Court held that the revenue authorities had not made any finding regarding the nature of the services rendered by the NRAEs, whether managerial, technical or consultancy in nature.

1. On the issue of disallowance under Section 40(a)(i):

• The High Court noted that the additions were made by the AO under Section 40(a)(i) of the Act, which disallows expenses where the assessee has failed to deduct TDS as required under Section 195 of the Act.
• However, the High Court agreed with the lower appellate authorities that since the reimbursements did not constitute “fees for technical services”, the obligation to deduct TDS under Section 195 of the Act did not arise.
• The High Court held that in the absence of the reimbursements falling under Section 9(1)(vii) of the Act, the disallowance under Section 40(a)(i) of the Act was not justified. In conclusion, the High Court dismissed the revenue’s appeals, holding that no substantial question of law arose in this case. The court upheld the findings of the lower appellate authorities that the reimbursements made by the Assessee to its NRAEs were in the nature of regular business expenses and did not constitute “fees for technical services” under the Act.

Judgement

The key points from the final decision in this case are:

1. The court found that the nature of the reimbursements made by the Assessee to the NRAE were for regular business expenses such as server maintenance, netting charges, management expenses, travel costs, and insurance, and did not constitute “fees for technical services” under Section 9(1)(vii) of the Income Tax Act.

2. The court held that the Assessee had provided sufficient evidence to establish that the reimbursements were for genuine business expenses, and the commercial expediency of such expenses could not be questioned.

3. The court dismissed the appeals filed by the Principal Commissioner of Income Tax, concluding that no substantial question of law arose in this case.

Cases highlighted in the judgement

1. SA Builders Ltd. v. Commissioner of Income-Tax – 2006 (12) TMI 82 – Supreme Court: This case was cited to support the principle that the domain of commercial expediency cannot be entered into when the expenses are regular business expenses.

2. Cochin Refineries Limited v. Commissioner of Income-Tax – 1996 (3) TMI 104 – Kerala High Court: This case was cited to support the position that reimbursement of payments made to the personnel of a consultant would be part and parcel of the process of advice of a technical character and would fall within the meaning of the Explanation to Section 9(1)(vii) of the Income Tax Act, 1961.

3. Timken India Limited, In re – 2004 (12) TMI 12 – Authority for Advance Rulings: This case was cited to support the position that payments made pursuant to an agreement would be subject to tax irrespective of there being a profit or income in the hands of the recipient.

4. Danfoss Industries Pvt. Ltd., In re – 2004 (5) TMI 58 – Authority for Advance Rulings: This case was cited to support the position that payments cannot be considered as reimbursement of actual expenditure, and that tax has to be withheld under Section 195 of the Act.

5. Steffen, Robertson and Kirsten Consulting Engineers and Scientists v. Commissioner of Income-Tax – 1997 (10) TMI 393 – Authority for Advance Rulings: This case was cited to support the position that living allowance paid to foreign technicians would form an integral part of the fees payable and would be taxable in India.