Section 195 - Deduction of tax at source - Payment to non-resident

Last updated: 24 September 2007

Court :
in the itat delhi bench ‘C’

Brief :
Section 195 read with sections 9 and 44D of the Income-tax Act, 1961 - Deduction of tax at source - Payment to non-resident - Assessment year 1998-99 - Whether obligation to deduct tax under section 195 is only with reference to income element embedded in remittance - Held, yes - Whether where under a bona fide arrangement there is a provision for reimbursement of expenses to parties, which they incur in furtherance of a common objective, such reimbursement cannot be considered as bearing character of income - Held, yes - Three companies viz., M (a company incorporated in India), HK (a company incorporated in Hongkong) and MI (a company incorporated in USA) formed a consortium for purpose of bidding for operation GSM-based cellular services in 18 circles in India in 1995 - Respective consortium members undertook to bear their own pre-bid expenses till such time bid was successful - For this purpose, assessee-company was created as a joint venture vehicle - understanding was that as soon as joint venture vehicle was created, respective members of consortium would become entitled to get their share of pre-bid expenses reimbursed out of capital of assessee-company - Since HK company lacked expertise to draw up pre-bid documents, it engaged services of another consultancy firm - Consultancy firm, therefore, rendered services to assessee-company - HK company, therefore, paid certain amount to consultancy agency and raised an invoice for amount on assessee-company, under terms of consortium arrangement, to get reimbursed - Whether since there was no income element in remittance made by assessee to HK company, lower authorities were wrong in permitting assessee to remit amount to HK company after deducting tax at source under section 195 - Held, yes - Whether provisions of section 44D had also no relevance to instant case - Held, yes FACTS Three companies viz., M (a company incorporated in India), HK (a company incorporated in Hongkong), and MI (a company incorporated in the USA) formed a consortium for the purpose of bidding for operation GSM-based cellular services in 18 circles in India in 1995. the respective consortium members undertook to bear their own pre-bid expenses till such time the bid was successful. For this purpose, the assessee-company was created as a joint venture vehicle. The understanding was that as soon as the joint venture vehicle was created, the respective members of the consortium would become entitled to get their share of the pre-bid expenses reimbursed out of the capital of the assessee-company. Since the HK company lacked the expertise to draw up the pre-bid documents, it had engaged the services of another consultancy firm. The consultancy firm, therefore, rendered services to the assessee-company. The HK company, therefore, paid certain amount to the consultancy agency and raised an invoice for the amount on the assessee-company, under the terms of the consortium arrangement, to get reimbursed. The invoice ws also supported by a certificate from the charted accountants duly verifying the expenses. The assessee, therefore, wrote to the exchange control department of the RBI seeking approval for remitting the aforesaid amount to the HK company. By communication dated 18-8-1997, the RBI advised that the assessee-company was permitted to make a remittance of US $ 1.5 million to the HK company. The assessee thereafter made an application under section 195(1) to the Assessing Officer seeking permission to remit the amount without deduction of income-tax and also submitted before the Assessing Officer that since the amount was being remitted only towards reimbursement of pre-bid expenses, there was no income element imbedded therein and that the remittance could not also be considered as ‘fees for technical services’ (‘FTS’) because no technical services of any kind were rendered by the HK company. A letter dated 16-9-1997 from the HK company was also addressed to the Assessing Officer to the same effect. The Assessing Officer having noted that according to the letter of the HK company, the HK company had engaged another agency for consultancy services for preparation of the bid documents and had paid them for their services and had raised an invoice on the assessee-company for reimbursement of the expenses and no income element was imbedded therein, and that they had not rendered any technical services to the assessee-company so as to enable the payment to be called FTS, refused to accept the claim of the assessee on the grounds that the provisions of section 9(1)(vii) read with Explanation 2 thereto, defining the expression ‘fees for technical services’ were applicable to the instant case, and that the assessee-company was getting the technical services through the HK company which was acting as its agent in Hongkong and had made the payment on behalf of the assessee-company. The Assessing Officer, however, exempted the expenses incurred on trips to India and held that no tax needed be deducted on that part of the remittance. As regards the balance, he accepted the assessee's claim only with regard to pro-rata reduction having regard to the fact that the actual remittance would be less than the maximum permitted by the RBI. He, therefore, held that the payments made by the assessee to the HK company towards professional and consultancy fees to the consultancy agency would be treated as income and tax would be charged at the rate of 30 per cent as per section 115A. On appeal, the Commissioner (Appeals) upheld the action of the Assessing Officer. He, however, held that the assessee was liable to deduct tax under section 195(1) only on the income embedded in the remittance and that the Assessing Officer was not right in directing the assessee to deduct tax at 30 per cent on the entire amount remitted. He estimated the income element embedded in the remittance at 20 per cent of the same and directed tax to be deducted at 30 per cent on 20 per cent of the amount remitted. On revenue’s appeal to the Tribunal and cross objection by the assessee:

Citation :
Assistant Commissioner of Income-tax, Circle 23(92), New Delhi v. Modicon Network (P.) Ltd. r.v. easwar, vice-president and rajendra singh, accountant member It appeal no. 3449 (Delhi) of 2002 And c. o. no. 92 (delhi) of 2006 [Assessment year 1998-99]

Under section 195(1) any person responsible for paying to a non-resident any interest or any other sum chargeable under the provisions of the Act (except salaries) shall, at the time of credit of such income to the account of the payee or at the time of payment thereof, whichever is earlier, deduct income-tax thereon at the rates in force. Under sub-section (2), the person paying the amount, if he considers that the whole of the amount would not be income chargeable to tax in the hands of the recipient, may make an application to the Assessing Officer to determine the appropriate proportion of such sum so chargeable and upon such determination, the tax shall be deducted only on the chargeable proportion of the amount. Therefore, the obligation to deduct tax is only with reference to the income element embedded in the remittance. [Para 12] The main question for consideration in the instant case was as to whether the amount remitted by the assessee to the HK company contained any income element so as to fasten liability upon the assessee to deduct tax thereon at the appropriate rate. The Assessing Officer had taken the view that the amount represented FTS in terms of Explanation 2 below section 9(1)(vii) and, therefore, the assessee was liable to deduct the tax. A look at the above Explanation shows that it contains a definition of FTS and says that FTS means any consideration for the rendering of any managerial, technical or consultancy services including the provision of services of technical or other personnel, but does not include consideration for any construction, assembly, mining or like project undertaken by the recipient or consideration which would be income of the recipient chargeable under the head ‘Salaries’. The content of the Explanation unmistakably is that the payment must be made as quid pro quo for such services rendered as have been enumerated therein. It postulates that the remitter of the amount has received the benefit of the technical services and that the technical services have been rendered by the recipient of the amount. In the instant case, the HK company had not rendered any services, let alone technical services, to the assessee company for which the amount was remitted. The services were rendered by a consultancy firm engaged by the HK company. The HK company paid the consultancy agency and sought reimbursement of the same from the assessee company in terms of the consortium arrangement. Thus, the amount remitted by the assessee company was only by way of reimbursement of the expenses incurred by the HK company and not by way of consideration for rendering any services which were technical services. Further there was no evidence on record to show that the HK company and the agency firm engaged by it were connected in any manner or that the entire transaction was a pre-planned or pre-meditated arrangement devised in order to avoid the provisions of tax deduction at source. Therefore, it could not be said that the remittance was in truth and reality consideration for technical services disguised as reimbursement of the expenses. [Para 13] It is well settled that if under a bona fide arrangement there is a provision for reimbursement of expenses to the parties, which they incur in furtherance of a common objective, such reimbursement cannot be considered as bearing the character of income. In the instant case, there was no dispute about the genuineness or bona fide of the terms of arrangement between the partners of the consortium. Since the HK company lacked the expertise to draw up the pre-bid documents, it had to engage the services of another consultancy firm. It paid the consultancy firm and raised an invoice for the amount on the assessee company, under the terms of the consortium arrangement, to get reimbursed. The argument of the department was that the nature of the remittance as FTS did not change merely because the HK company had to engage another agency to prepare the pre-bid documents. The argument could not be accepted having regard to the objective of the consortium and the agreement between the partners of the consortium to the effect that the pre-bid expenses incurred by them would be reimbursed by the joint venture vehicle. Thus, the preliminary question, namely, whether the amount remitted would in its entirety or partly be considered as income of the HK company had to be resolved in favour of the view that it being a mere reimbursement it could not be so considered. [Para 14] Further section 44D had no relevance to the instant case, as it is concerned with the computation of income by way of royalties, etc. in the case of foreign companies. It is relevant at the assessment stage and not at the stage of remittance. The reference made by the revenue in the course of arguments to the fact that the investment by the HK company in the assessee-company was routed through a Mauritian subsidiary did not turn the case in any manner in favour of the revenue. [Para 16] Since there was no income element in the remittance made by the assessee to the HK company, the orders of the lower authorities permitting the assessee to remit the amount to HK company after deducting tax at source were liable to be set aside. [Para 17]