Court: The Bombay High Court
Citation: Mc Kinsey & Company Inc, United States Vs. Union of India [2010-TII-09-HC-MUM-INTL]
Brief- The Bombay High Court (“High Court”) has, in a recent ruling’ in the case of Mc Kinsey & Company Inc, United States v. Union of India [2010-TII-09-HC-MUM-INTL], held that there must be a valid and acceptable basis for making a departure from the order passed by a superior official and that the hierarchical discipline should be observed while implementing the fiscal legislation. In the absence of that, the exercise of the powers by the Assessing Officer (“AO”) would be arbitrary and open to challenge.
• The assessee is a non-resident company incorporated in the United States. The assessee forms a part of the Mc Kinsey Group and provides international management consultancy services. The parent company of the assessee has a branch office in India (“Mc Kinsey India”). The assessee provides two kinds of services to Mc Kinsey India:-
-Borrowed services which are the services rendered by the assessee to Mc Kinsey India as a part of consultancy, which the latter provides to its clients;
-Firm function services which include administrative and support services provided to the worldwide offices of the Group including to the McKinsey India.
• As regards borrowed services, the Income-tax Appellate Tribunal held that the services would have to be regarded as business income relying upon the Memorandum of Understanding (“MoU”) between the governments of India and United States of America (“USA”), and not as fees for included services.
• The firm function services are charged on the basis of cost allocation together with an agreed mark up of 3% in accordance with the MoU entered into by the assessee and McKinsey India with effect from 1 April, 2005. The question involved is in respect of imposition of withholding tax in the case of such firm function services.
• In this regard, the assessee made an application to the Deputy Director of Income-tax (International Taxation) (“DDIT”) under section 197 of the Income-tax Act, 1961 (“Act”) for AY 2010-11 seeking a nil withholding tax certificate in respect of payments received from McKinsey India for firm function services.
• The assessee also referred to the orders passed by the Director of Income-tax (International Taxation) (“DIT”) under section 264 of the Act and by the AO under section 197 of the Act for the AY 2007- 08 to 2009- 10, which specifies the withholding tax rate of 1.5% and 1.3%, respectively, on similar gross payments.
• The AO, however, rejected the application on the grounds that the schedules to the preparation of the consolidated accounts were not made available for AY 2006-07 and hence the assessee’s claim that the receipt is in the nature of business income was not verifiable. Consequently, the AO held that the payments made were in the nature of fees for included services covered under Article 12 of India-USA Tax Treaty (“Tax Treaty”) and were subject to withholding tax at the rate of 15% on gross basis.
Is the AO’s order directing the withholding tax at 15% on the gross amount without following the hierarchical discipline founded on logical or cogent grounds?
• The payments received from Mckinsey India are not subject to tax in India because they are not fees received for technical services;
• Receipt in respect of administrative and support services forms part of normal business income under Article 7 of the Tax Treaty and is not taxable in India in absence of a permanent establishment in India;
• In light of the MoU entered into between the payer and the recipient, the income relating to the firm function services cannot be higher than 3%. Consequently, without prejudice to its submissions, the assessee was willing to submit itself to a deduction of tax at source to the extent of the income element involved in the payment received, which can be no higher than 3% of the total payment;
• The Transfer Pricing Officer, for AY 2006 – 2007 had accepted the consideration involved in the transaction as being reflective of an arm’s length price and that determination would be binding on the AO;
• The DIT, in exercise of powers under section 264 had directed that tax for AY 2008-09 should be deducted at 1.5 % of the gross receipts. Furthermore, the AO for AY 2009¬10 had also passed an order under section 197 determining the withholding tax rate at the rate of 1.3%.
• There was no justification for the AO not to follow the order passed by the DIT for AY 2008-2009.
• Reliance was placed by the AO on the draft assessment order for AY 2006-07, wherein it was held that the amount received by the assessee for firm function services would be taxable in India as fees for technical services within the meaning of section 9(i)(vii) of the Act and would be taxable as fees for included services under Article 12 of the Tax Treaty. In doing so the AO showed consistency in his approach by following the approach taken in the draft assessment order;
• An alternative remedy was available to the assessee under section 264 of the Act and hence the writ petition should not be entertained.
High Court ruling
• The AO’s order directing that the withholding of tax computed at 15% on the gross amount for AY 2010-2011 is not founded on any logical or cogent basis;
• Reliance by the AO on his order for AY 2006-07 cannot prima facie be accepted since that order is a draft assessment order, pending the conclusion of the Dispute Resolution Procedure;
• Unless there was a valid and acceptable basis for making a departure from the order passed by the DIT and cogent material was available before the AO to do so, the exercise of discretion would become arbitrary and vulnerable to challenge;
• The fact that the assessee had alternative remedies available, does not bar the exercise of the writ jurisdiction in cases where the AO has chosen to act in complete departure from a duly considered determination made by the superior officer.
• Unless a sense of hierarchical discipline is observed; while implementing fiscal legislation, the exercise of powers by AO would be rendered arbitrary. This would be impermissible and contrary to the norms of fairness which are otherwise embodied in Article 14 of the Constitution of India;
• The prescriptions of Article 14 must at all times influence statutory interpretation and must be rigorously applied to the exercise of statutory discretion;
• In the absence of material on record to justify the departure, the Court set aside the order of the AO and directed him to issue a certificate under section 197(1) of the Act in accordance with the order passed by the DIT for AY 2008-2009
Conclusion:- This is a very important judgment upholding the hierarchical discipline while implementing fiscal legislation. It provides relief to all taxpayers who are often subjected to arbitrary changes in opinion by the tax authorities without logical or valid grounds. The judgment would ensure consistency to be followed by tax officers as regards the approach of their superiors.