Millennium
Infocom Technologies Ltd.
v.
Assistant
Commissioner of Income-tax, Circle - 6(1),
N.K. KARHAIL,
JUDICIAL MEMBER
AND K.D.
RANJAN, ACCOUNTANT MEMBER
I.T. APPEAL
NO. 4465 (
[Assessment
year 2001-02]
January 31,
2008
Section
40(a)(i) read with sections 195 and 90 of the Income-tax Act, 1961 and
Article 26(3) of the DTAA between India and USA - Business disallowance -
Interest, etc., payable outside India - Assessment year 2001-02 - Assessee-company
was engaged in business of setting up of websites for purposes of E Commerce -
For hosting of websites, assessee required servers, which were not available in
India at relevant time - For this purpose, it took servers on lease and paid
rentals through credit card to four non-resident foreign companies for
launching of different websites on their servers located in USA - It claimed
deduction of payments in question as a revenue expenditure - Assessing Officer
disallowed said amount under section 40(a)(i) on ground that assessee did not
deduct any tax at source under section 195 at time of remittance to non
resident - Whether since payments made to non-residents on account of rentals
for hosting of websites on servers being were not in nature of interest or
royalties or fee for technical services or other sum chargeable to tax in
India, assessee was not required to deduct tax at source under section 195
while making payments outside India - Held, yes - Whether further in view of provisions
of article 26(3) of DTAA between India and USA which neutralizes rigour of
provisions of section 40(a)(i), Assessing Officer could not seek to invoke
provisions of section 40(a)(i) for deduction while computing profits and gains
of business or profession - Held yes
-
Circular No. 759, dated 18-11-1997
-
Circular No. 10/2002, dated 9-10-2002
-
Circular No. 767/22-5-1998
The
assessee was engaged in the business of setting up of websites for the purposes
of E. Commerce. For hosting of the websites, the assessee required
servers, which were not available in
On
appeal, the Commissioner (Appeals) upheld the action of the Assessing Officer.
On
second appeal:
Under
section 40(a)(i), relevant to the assessment year 2001-02, in the case
of any assessee, any interest (not being interest on a loan issued for public
subscription before 1-4-1938, royalty, fees for technical services or other sum
chargeable under this Act, which is payable outside India, on which tax has not been paid or
deducted under Chapter XVII-B, shall not be deducted
in computing the income chargeable under the head ‘profits and gains of business or profession’. Proviso to
sub-clause (i) further says that where in respect of such sum tax has
been paid or deducted under Chapter XVII-B in
any subsequent year, such sum shall be allowed as deduction in computing the
income of the previous year in which such tax has been paid or deducted. Sub-
clause (ia) which contains identical provisions in respect of payments
made to a resident, has been inserted by the Finance (No. 2) Act, 2004, with
effect from 1-4-2005. In this sub-clause words ‘rent, royalty’ have been inserted with effect from 1-4-2006.
Provisions of sub-clause (i) deals with the payments made outside
The
definition of ‘Fees for technical services’ as defined in Explanation 2 to
section 9(1)(vii) shows that consideration
paid for rendering of any managerial, technical or consultancy services, as
also the consideration paid for the provision of services of technical or other
personnel, would be regarded as fees paid for ‘Technical services’ The
definition excludes from its ambit the consideration paid for construction,
assembly, or mining or like project undertaken by the recipient, as also
consideration which would constitute income of the recipient chargeable under
the head ‘Salaries’. The Madras High Court in the case of Skycell
Communication Ltd. v. Dy. CIT [2001]/19 Taxman 496/251 ITR 53 had examined the scope of term
technical services. It was held in said case that installation and operation of
sophisticated equipments with a view to earn income by allowing customers to
avail of the benefits of the user of such equipments does not result in the
provision for technical service to the customer for a fee. On applying the above stated reasoning to the
facts of the instant case, it could be safely concluded that. Therefore, providing of space on the servers
by the non residents for the purpose of hosting of the website would not result
in the provision for technical service to the assessee for a fee. Therefore,
the payments were not made for fees for technical services liable to be taxed
in
Now
the question for consideration arose as to whether payment of rentals for
hosting of websites on the servers amounted to royalty. Explanation to section 40(a)(i) states that for the purposes
of sub-clause (i) ‘royalty’ shall
have the same meaning as in Explanation 2 to clause (vi) of sub-section (1) of section
9. From the definition of royalty as
mentioned in Explanation 2 to clause (vi) of section 9(1) for and upto the assessment year
2001-02 it is clear that none of the clauses of Explanation take into its ambit
the consideration paid for renting of space for hosting of websites on servers.
However, clause (iva) to Explanation 2, which was inserted by the
Finance Act, 2001, with effect from 1-4-2002, reads as. The use or right to use
any industrial, commercial or scientific equipment but not including the
amounts referred to in section 44BB.
Thus
with effect from 1-4-2002, the consideration for use or right to use industrial
commercial or a scientific equipment is royalty. [Paras 8.3 and 8.4]
The
legislative intention for insertion of clause (iva) in Explanation 2 to
section 9(1)(vi) can be traced from the memorandum explaining the
provisions of the Finance Bill, 2001. From plain reading of the memorandum
explaining the provisions of the Finance Bill, 2001, it is clear that prior to
the amendment, the consideration for the use of, or the right to use,
industrial, commercial or scientific equipment was not included in the
definition of ‘royalty’ in Explanation 2 and consequently the income
from the leasing of industrial, commercial or scientific equipment became
taxable in the source country as business income from the assessment year
2002-03 and onwards. [
As per paragraph 1 of article
12, the DTAA between India and USA, dated 20-12-1990, royalties and fees for
included services arising in a Contracting State and paid to a resident of
other Contracting State may be taxed in that other State. However, as per
paragraph 2 of article 12 such royalties and fees for included services may
also be taxed in the Contracting State in which they arise and according to the
laws of that State; but if the beneficial owner of the royalties or fees for
included services is a resident of other Contracting State, the tax so charged
shall not exceed the specified percentage mentioned in this article. Also
paragraph 3(b) of article 12 takes into its ambit the payments of any kind
received as consideration for the use of, or the right to use any industrial,
commercial or scientific , equipment other than equipments relating to Shipping
and Air Transport described in paragraph 2(c) or 3 of article 8. Though the
DTAA between India and USA provides for taxing of royalties for the use of, or
the right to use any industrial, commercial or scientific equipment in the
Contracting State in which they arise and according to the laws of that State
but the same could not be taxed in India upto assessment year 2001-02 as clause
(iva) of Explanation 2 to section 9(l)(vi) was inserted
with effect from 1-4-2002. [
The Central Board of Direct Taxes in
the Circular No. 759, dated 18-11-1997 in F. No.500/152/96-FTD dispensed with
the requirement of no objection certificate to be obtained from the Assessing
Officer at the time of remittance outside
However,
under section 195(2) the person responsible for paying any such sum, other than
salary, chargeable under the Act to a non resident considers that the whole of
such sum would not be income chargeable in the case of the recipient, he may
make application to the Assessing Officer to determine, by general or special
order, the appropriate portion of such sum so chargeable, and upon such
determination, tax shall be deducted under sub-section (1) only on that
proportion of the sum which is chargeable. The Supreme Court in the case of Transmission Corporation of Andhra
Pradesh Ltd. v CIT [1999] 239
ITR587/105 Taxman 742 has
clearly laid down the principle that the obligation of the assessee to deduct tax under section 195 is limited only to
the appropriate proportion of income chargeable under the Act. This leaves no
doubt that at the time of making payments of
any sums to non-residents, the nature of the remittance has to be determined
for the purposes of deduction of tax at source. The CBDT in three circulars i.e.
Circular Nos. 759, dated
18-11-1997; 767, dated 22-05-1998;
and 10 of 2002, dated 9-10-2002 have entrusted this task to the chartered
accountant. Only in the cases where the person responsible for paying any such
sum, other than salary, chargeable under the Act to a non resident considers
that the whole of such sum would not be income chargeable in the case of the
recipient, he is obliged to make application to the Assessing Officer under
section 195(2) to determine the appropriate portion of such sum so chargeable
and tax shall be deducted under sub section (1) only on that proportion of the
sum which is chargeable. Even in the cases where lower tax has been deducted or
no tax deducted, the assessee by filing an undertaking before the RBI
(addressed to the Assessing Officer) has made himself liable not only for
payment of tax on such remittances but also for penalty and prosecution for the
defaults committed by him for non deduction or lower deduction of tax at
source. [
Thus, the
payments made to non-residents were neither in the nature of interest nor fee for technical services or royalty. Since the payment for use of space in servers was not in nature
of royalty and income arising on use of, or the right to use, industrial,
commercial or scientific equipment was not royalty prior to the amendment of
section 9(1) by the Finance Act, 2001 with effect from 1-4-2002, within the
meaning of provisions of Explanation 2 to section 9(vi) of the
Act, the same was to assessed in other Contracting State i.e. USA as per
paragraph 1 of Article 12 of DTAA and not in India. [
The assessee
also submitted that it was protected under article 26(3) of India-US DTAA. Article 26(3) is a general clause providing for indirect
discrimination against a non resident. It reads as except where the provisions
of paragraph 1 of Article 9 (Associated Enterprises), paragraph 7 of article 11
(Interest), or paragraph 8 of article l2 (Royalties and Fees for Included
Services) apply , interest, royalties, and other disbursements paid by a
resident of a Contracting State to a resident of a other Contracting state
shall, for the purposes of determining the taxable profits of the first
mentioned resident , be deductible under the same conditions as if they had
been paid to a resident of the first mentioned State. Apparently the provisions
of paragraph 1 of article 9 (Associated Enterprises) and paragraph 7 of article
11 (Interest) of DTAA were not applicable to facts of the instant case. Paragraph 8 of article 12 (Royalties and Fees for Included
Services) deals with a situation where, by reason of a special relationship
between the payer and the beneficial owner or between them and some other
person, an excess payment is made on account of royalties and fees for included
services, such excess payment will be taxed according to laws of each
Contracting State having due regard to the other provisions of the
Convention. In the instant case, the
parties were neither related; nor was the issue relating to excess payment
involved. Thus assessee’s case also did not fall under paragraph 8 of article 12 (Royalties and Fees for Included
Services). [Paras 8.13 and 8.14]
The
provisions of section 40(a)(i), as it stood prior to its amendment by
the Finance (No 2) Act, 2004 with effect from 1-4-2005, applied to the payments
by an assessee outside
Now the question for
consideration was as to whether the resident assessee could take advantage of
provisions of article 26(3) of DTAA. The provisions of section 40(a)(i), as it existed prior to its
amendment by the Finance (No 2) Act, 2004, with effect from 1-4-2005 and
subsequent amendment by the Taxation laws (Amendment) Act, 2006 with
retrospective effect from 1-4-2006, provided for disallowance of payments
made to a non resident only where tax is not deducted
at source at the time of remittance. However, a similar payment to a resident
does not result in disallowance in the event of non deduction of tax at source.
Thus a non resident left with a choice of dealing with a resident or a non
resident in business would opt to deal with a resident owing to the provisions
of section 40(a)(i). To this extent the non resident is discriminated.
Article 26(3) of Indo-US DTAA seeks to provide relief against such
discrimination by saying that deduction should be allowed on the same condition
as if the payment is made to a resident. Thus, this clause in DTAA neutralizes
the rigour of the provisions of section 40(a)(i) of the Act. In this
regard it would be relevant to refer to the provisions of section 90(2). Hence,
by virtue of the provisions of section 90(2), the law which is beneficial to
the assessee to whom DTAA applies, should be followed. [
Therefore, in view of the provision of article 26(3) of
DTAA, the Assessing Officer could not seek to invoke the provisions of section
40(a)(i) for deduction while computing the profits and gains of business
or profession. Therefore, it was to be held that the payments made on account of
rentals for hosting of websites on servers are not in nature of interest or
royalties or fee for technical services or other sum chargeable to tax in
EDITOR’S NOTE
(i) Where the
assessee had an independent investment division and had earned exempted income viz
dividend from investments made in the companies, the Assessing Officer was
required to ascertain the actual expenditure incurred out of expenditure made
on investment division which could be related for earning of exempted income
and only such expenditure could be disallowed under section 14A.
(ii) Where the
assessee in earlier years had given certain amount to its employees by way of
loan and in the relevant previous year had written off the same in the books of
account on the request of the employees and had claimed deduction of the said
amount as business expenditure, since no material had been brought on record to
prove the business expediency, the loan given to various employees in earlier
years and writing of the same would not constitute the expenditure incurred for
the purpose of business and therefore, the Assessing Officer was justified in
disallowing assessee’s claim.
- Skycell Communications Ltd. v.
Dy, CIT [2001] 251 ITR 53/119
Taxman 496 [