Praveen Boda

Service tax on construction services - Circular 151/2/2012_CBEC

2012-02-11T09:35:00.002+05:30

CIRCULAR NO 151/2/2012-ST Dated: February 10, 2012

Subject: Service tax on construction services - regarding

Many issues have been referred by the field formations, in the recent past, seeking clarification regarding the levy and collection of service tax on construction services [clauses (zzq),(zzzh) of section 65(105) of the Finance Act, 1994], in the light of varying business models. Across the country, divergent business models and practices are being followed in the construction sector. Some of these business models and practices could be region specific.

2. From the issues referred by the field formations, important ones have been identified model wise, examined and clarified as follows:

2.1. Tripartite Business Model (Parties in the model: (i) landowner; (ii) builder or developer; and (iii) contractor who undertakes construction): Issue involved is regarding the liability to pay service tax on flats/houses agreed to be given by builder/developer to the land owner towards the land /development rights and to other buyers.

Clarification: Here two important transactions are identifiable: (a) sale of land by the landowner which is not a taxable service; and (b) construction service provided by the builder/developer. The builder/developer receives consideration for the construction service provided by him, from two categories of service receivers: (a) from landowner: in the form of land/development rights; and (b) from other buyers: normally in cash.

(A) Taxability of the construction service:

(i) For the period prior to 01/07/2010: construction service provided by the builder/developer will not be taxable, in terms of Board’s Circular No.108/02/2009-ST dated 29.01.2009.

(ii) For the period after 01/07/2010, construction service provided by the builder/developer is taxable in case any part of the payment/development rights of the land was received by the builder/ developer before the issuance of completion certificate and the service tax would be required to be paid by builder/developers even for the flats given to the land owner.

(B) Valuation:

(i )Value, in the case of flats given to first category of service receiver, is determinable in terms of section 67(1)(iii) read with rule 3(a) of Service Tax (Determination of Value) Rules, 2006, as the consideration for these flats i.e., value of land / development rights in the land may not be ascertainable ordinarily. Accordingly, the value of these flats would be equal to the value of similar flats charged by the builder/developer from the second category of service receivers. In case the prices of flats/houses undergo a change over the period of sale (from the first sale of flat/house in the residential complex to the last sale of the flat/house), the value of similar flats as are sold nearer to the date on which land is being made available for construction should be used for arriving at the value for the purpose of tax. Service tax is liable to be paid by the builder/developer on the ‘construction service’ involved in the flats to be given to the land owner, at the time when the possession or right in the property of the said flats are transferred to the land owner by entering into a conveyance deed or similar instrument(eg. allotment letter).

(ii) Value, in the case of flats given to the second category of service receivers, shall be determined in terms of section 67 of the Finance Act, 1994.

2.2 Redevelopment including slum rehabilitation projects: Generally in this model, land is owned by a society, comprising members of the society with each member entitled to his share by way of an apartment. When it becomes necessary after the lapse of a certain period, society or its flat owners may engage a builder/developer for undertaking re-construction. Society /individual flat owners give ‘No Objection Certificate’ (NOC) or permission to the builder/developer, for re-construction. The builder/developer makes new flats with same or different carpet area for original owners of flats and additionally may also be involved in one or more of the following:

(i) construct some additional flats for sale to others;

(ii) arrange for rental accommodation or rent payments for society members/original owners for stay during the period of re-construction;

(iii) pay an additional amount to the original owners of flats in the society.

Clarification: Under this model, the builder/developer receives consideration for the construction service provided by him, from two categories of service receivers. First category is the society/members of the society, who transfer development rights over the land (including the permission for additional number of flats), to the builder/developer. The second category of service receivers consist of buyers of flats other than the society/members. Generally, they pay by cash.

(A) Taxability:

(i) Re-construction undertaken by a building society by directly engaging a builder/developer will not be chargeable to service tax as it is meant for the personal use of the society/its members. Construction of additional flats undertaken as part of the reconstruction, for sale to the second category of service receivers, will also not be a taxable service, during the period prior to 01/07/2010;

(ii) For the period after 01/07/2010, construction service provided by the builder/developer to second category of service receivers is taxable in case any payment is made to the builder/ developer before the issuance of completion certificate.

(B) Valuation:

Value, in the case of flats given to second category of service receivers, shall be determined in terms of section 67(1)(i) of the Finance Act, 1994.

2.3 Investment model: In this model, before the commencement of the project, the same is on offer to investors. Either a specified area of construction is earmarked or a flat of a specified area is allotted to the investors and as it happens in some places, additionally the investor may also be promised a fixed rate of interest. After a certain specified period an investor has the option either to exit from the project on receipt of the amount invested alongwith interest or he can re-sell the said allotment to another buyer or retain the flat for his own use.

Clarification: In this model, after 01/07/2010, investment amount shall be treated as consideration paid in advance for the construction service to be provided by the builder/developer to the investor and the said amount would be subject to service tax. If the investor decides to exit from the project at a later date, either before or after the issuance of completion certificate, the builder/developer would be entitled to take credit under rule 6(3) of the Service Tax Rules, 1994( to the extent he has refunded the original amount). If the builder/developer resells the flat before the issuance of completion certificate, again tax liability would arise.

2.4 Conversion Model: Conversion of any hitherto untaxed construction /complex or part thereof into a building or civil structure to be used for commerce or industry, after lapse of a period of time.

Clarification: Mere change in use of the building does not involve any taxable service, unless conversion falls within the meaning of commercial or industrial construction service.

2.5 Non requirement of completion certificate / where completion certificate is waived or not prescribed: In certain states, completion certificates have been waived or are considered as not required for certain specified types of buildings. Doubts have been raised, regarding levy of service tax on the construction service provided, in such situations.

Clarification: Where completion certificate is waived or is not prescribed for a specified type of building, the equivalent of completion certificate by whatever name called should be used as the dividing line between service and sale. In terms of the Service Tax (Removal of Difficulty) Order, 2010, dated 22/06/2010, authority competent to issue completion certificate includes an architect or chartered engineer or licensed surveyor.

2.6 Build- Operate - Transfer (BOT) Projects: Many variants of this model are being followed in different regions of the country, depending on the nature of the project. Build-Own-Operate-Transfer (BOOT) is a popular variant. Generally under BOT model, Government or its agency, concessionaire (who may be a developer/builder himself or may be independent) and the users are the parties. Risk taking and sharing ability of the parties concerned is the essence of a BOT project. Government or its agency by an agreement transfers the ‘right to use’ and/or ‘right to develop’ for a period specified, usually thirty years or near about, to the concessionaire.

Clarification: Transactions involving taxable service take place usually at three different levels: firstly, between Government or its agency and the concessionaire; secondly, between concessionaire and the contractor and thirdly, between concessionaire and users, all in terms of specific agreements.

At the first level, Government or its agency transfers the right to use and/or develop the land, to the concessionaire, for a specific period, for construction of a building for furtherance of business or commerce (partly or wholly). Consideration for this taxable service may be in the nature of upfront lease amount or annual charges paid by the concessionaire to the Government or its agency. Here the Government or its agency is providing ‘renting of immovable property service’ (renting of vacant land to be used for furtherance of business or commerce) and in such cases the concessionaire becomes the service receiver.

In this model, though the concessionaire is undertaking construction of a building to be used wholly or partly for furtherance of business or commerce, on the land provided by the government or its agency for temporary use, he will not be treated as a service provider since such construction has been undertaken by him on his own account and he remains the owner of the building during the concession period.

At the second level, transaction can take place between a concessionaire and the contractor. Where the concessionaire himself does not have exposure to construction sector, he may engage a contractor for undertaking construction of a building on the land, in respect of which right to use has been obtained in his favour, from the Government or its agency. If the concessionaire is himself a builder/developer, this level of transaction may not arise. Where an independent contractor is engaged by a concessionaire for undertaking construction for him, then service tax is payable on the construction service provided by the contractor to the concessionaire.

At the third level, the concessionaire enters into agreement with several users for commercially exploiting the building developed/constructed by him, during the lease period. For example, the user may be paying a rent or premium on the sub-lease for temporary use of immovable property or part thereof, to the concessionaire. At this third level, concessionaire is the service provider and user of the building is the service receiver. The concessionaire may provide to the users, taxable services such as ‘renting of immovable property service’, ‘business support service’, ‘management, maintenance or repair service’, ‘sale of space for advertisement’, etc. Service tax is leviable on the taxable services provided by the concessionaire to the users.

There could be many variants of the BOT model explained above and implications of tax may differ. For example, at times it is possible that the concessionaire may outsource the management or commercial exploitation of the building developed/constructed by him, to another person and may receive a pre-determined amount as commission. Taxable service here will be business auxiliary service and service tax is leviable on the commission.

(A) Taxability:

(i) the service provided by the Government or its agency to the concessionaire is liable to service tax;

(ii) the construction services provided by the contractor to the concessionaire would be examined from the point of taxability as to whether the activity is not otherwise excluded;

(iii) the services provided by the concessionaire to the user of the facility are liable to service tax;

(B) Persons liable to pay tax:

Government or its agency and concessionaire are liable to pay tax on the services being provided by them. There could be several other persons liable to pay service tax, depending on the variant of the BOT model followed.

2.7 Joint Development Agreement Model: Under this model, land owner and builder/developer join hands and may either create a new entity or otherwise operate as an unincorporated association, on partnership /joint / collaboration basis, with mutuality of interest and to share common risk/profit together. The new entity undertakes construction on behalf of landowner and builder/developer.

Clarification: Circular 148/17/2011-ST dated 13/12/2011, particularly paragraphs 7, 8, 9 apply mutandis mutandis in this regard.

3. This Circular may be communicated to the field formations and service tax assessees, through Trade Notice/ Public Notice. Hindi version to follow.

F.No.332/13 /2011-TRU

(Samar Nanda)

Under Secretary, TRU

Taxation of Keyman Insurance Policy

2012-02-09T21:02:00.001+05:30

In "Commissioner of Income-tax v. Rajan Nanda [2012] 18 taxmann.com 98 (Delhi)" the Delhi High Court (HC) decided on tax treatment of keyman insurance policy under the Indian Tax Laws in a batch of appeals in the cases of Escorts Heart Institute & Research Centre Ltd. and its executive directors.

Keyman insurance policy is an insurance policy taken out by a business entity on the life of its employees or key personnel (employees) to safeguard itself against financial loss in the event of death of such employees.

The HC held that premiums paid on such policy are allowable as revenue deduction in the hands of the employer. It further held that, on assignment of such policy to the employees at surrender value, the difference between the value of premiums paid by the employer till the date of assignment and the surrender value is not taxable as salary or income from other sources in the hands of the employees. It also held that, on such assignment, the keyman policy gets converted into an ordinary life insurance policy and the maturity proceeds on such policy is exempt from tax in the hands of the employees in terms of the exemption available for proceeds of ordinary life insurance policy under the Income Tax Law.

Facts:

A.K. Sikri, Actg. CJ. - All these appeals relate to the same episode, which is re-enacted year after year and therefore, various assessment years are involved. Even the characters in the said episode are the same, who are three assessees, though for the purpose of taxability qua each of them, separate cases have originated. However, the disputes which have arisen flow from the same set of facts, although nature of dispute in respect of one assessee is little different from the disputes in respect of other two.

2. One assessee, viz., Escorts Heart Institute & Research Centre Ltd. is the company which had taken "key man" policy for the other two assessees, who were employees/Directors of the assessee company. After nursing these policies for sometime by paying premium thereupon, they were assigned to other two assessees, i.e., employees/Directors receiving surrender value from them. Whereafter, for the remaining period of all those policies, the insurance premium were paid by the assignees. Insofar as the assessee company is concerned, the question is as to whether premium paid by it, after adjusting the surrender value, is to be treated as business expenditure or not as claimed by the assessee. Insofar as other two assessees are concerned in whose favour the 'key man' policies were assigned, the question is as to whether the difference between the actual premium paid and surrender value given by them is to be treated as 'salary' in their hands and is to be taxed accordingly. Another issue qua these two Directors is as to whether the maturity value received by them on the said policy is to be taxed or not.

3. With this little indication of the nature of issues which arise in three sets of appeal, we advert to the facts in detail, which would be common to all the cases. Thereafter, we will refer to specific issues.

FACTS:

4. As pointed out above, the assessee company has been taking 'key man' insurance policies on the lives of two employees/Directors in different years. For the sake of brevity and clarity, we shall give facts in respect of such 'key man' policy taken by the assessee company on the life of Mr. Rajan Nanda, its Chairman and Director.

5. The assessee company had been taking the 'key man' insurance policies in its name covering Mr. Rajan Nanda and these policies were assigned in favour of Mr. Nanda in the subsequent year. The details of the policies are as under:

A.Y. in which policy is assigned Policy No. A.Y. in which policy is taken Date of maturity Amount paid by the assessee before assignment Amount paid by the keymnas for assignment

6. Insofar as the assessee company is concerned, the Assessing Officer (AO) took the view that since the expenditure incurred on the premia paid on the said keyman insurance policies was much more than the amount realized by the assessee company on the assignment of these policies to the employees/Directors, i.e., the surrender value only was received, the amount paid by the assessee company as premia on the said policies could not be treated as expenditure incurred wholly and exclusively for the business purpose of the assessee company. Therefore, the AO disallowed the premium paid, in different years which was claimed as business expenditure, holding that it was a colourable device adopted by the assessee company to claim a business expenditure, which was not wholly and exclusively for the business of the assessee company.

7. The assessee company preferred appeal against the assessment orders and succeeded before the CIT (A), who held it to be the business expenditure.

8. The view of the CIT (A) was upheld by the Income Tax Appellate Tribunal (hereinafter referred to as 'the Tribunal').

9. Insofar as Mr. Nanda is concerned, in his case, the AO took the view that he had taken substantial benefit by paying only surrender value as against much higher amount of premium paid by the company. The difference between the premium paid by the company and the surrender value paid by Mr. Nanda was treated as the benefit to be taxed in his hands. In appeal preferred by Mr. Nanda before the CIT (A), the first appellate authority held that as the Director, he was receiving commission income and was having the status of 'employee' and the aforesaid benefit derived by him was to be treated as 'salary' within the meaning of Section 17 of the Income Tax Act (hereinafter referred to as 'the Act'). However, the Tribunal has reversed the decision of the CIT (A) holding that merely by assignment in a particular year when the policy was still continuing, no taxable event had taken place and therefore, no tax could be charged. It has also held that the amount in question cannot be treated as 'perquisite' so as to fall within the scope of Section 17(3) of the Act. This decision in the case of Mr. Nanda is followed in the case of other Director-assessee, viz. Dr. Naresh Trehan.

10. Challenging the orders of the Tribunal, Revenue has preferred appeals in the case of the company as well as in respect of both the said Directors. With these background facts, we revert to each set of appeal.

Appeals qua Assessee Company:

11. Basic facts and events in this behalf have already been noted above. The appeals of the Revenue were admitted on the following substantial question of law, which is common to all these appeals filed by the Revenue against the assessee company:

"Whether the ITAT was correct in law in deleting the addition made by the Assessing Officer by disallowing the business expenditure claimed in respect of keyman insurance premium?"

12. Mr. N.P. Sahni, learned counsel who appeared for the Revenue submitted that the admitted facts would show that the assessee had been taking keyman insurance policy year after year in the name of its employees/Directors paying huge premia and thereafter assigning the same in the very next year to the said keyman at a very nominal value, said to be the surrender value, though the policies were for a period of five years each. This modus operandi adopted by the assessee was a clear colourable device to benefit the said keymen who were, in fact at the helm of affairs and managing the company. Such an expenditure could not be treated as expenditure wholly or exclusively for the purposes of business. The difference between the premium paid and the surrender value received on assignment is substantial in respect of each policy. The assessee has not been able to justify assigning the policies at a nominal value when the same could be continued for another four years and then acquiring fresh policies again in that year by paying heavy premium.

13. Mr. Sahni also invited our attention to the scheme of keyman insurance policy as introduced by the Life Insurance Corporation of India. He argued that it is clearly stated therein that 'the object of kayman insurance is to indemnify the company for the loss of earning resulting from the date of valuable employee and replacement of any trained person to perform his functions. Clause (3) of the Scheme states that "Assignment not allowed except absolute assignment in favour of kayman in case of his leaving the job of the company". Clause 4(e) on the same page reads as under:

"The following endorsement shall be placed on the policy for which prior consent from the employer should be obtained before the completion of the proposal. It is hereby agreed and declared that in the event of the employee life assured leaving employment of the employer, the within mentioned policy will be, (i) either surrendered to corporation for its cash value or (ii) assigned absolutely in favour of the employee life assured. It is further agreed and declared that the within mentioned policy shall not be allowed to be assigned to anyone except life assured himself absolutely."

14. After pointing out the aforesaid clause of the scheme, argument of Mr. Sahni was that the assessee had acted in contravention of various clauses of the LIC's scheme of keyman insurance policy and had been assigning the policies year after year when they were still continuing with the company and had not left it.

15. His other submission was that the surrender value relates and is applicable only to the LIC when a policy is paid up by the insurer (in this case, the assessee company) and not to keyman or any third person. If a company does not wish to continue the policy, it can surrender the same to the LIC for its cash value or assign it absolutely in favour of employee, as per the scheme. The surrender value is not relevant insofar as the value of the benefit passed on to the keyman is concerned; nor can it be treated as full and true value of the consideration for assigning the policy before its maturity. The position is akin to various schemes of statutory authorities like DDA, HUDCO, etc. where plots/flats are allotted and if the same are surrendered, only the amount as per allotment scheme is paid even, if the market value is much higher. In some such schemes, even unearned increase has to be shared with the concerned authority. The assessee company is, thus, not justified in asserting that it has shown the surrender value received from kayman as its income and the huge premium paid cannot be tinkered with or disallowed under Section 37(1) of the Act.

16. Mr. Sahni further argued that the Tribunal placed reliance upon Circular No.762 dated 18th February, 1998 explaining the tax aspect relating to keyman insurance policy was not appropriate and the Tribunal neither appreciated the import of the said Circular in a proper manner, nor it examined the effect of Sections 2(24)(xi), 10(10D) and 37(1) of the Act in a proper perspective. He argued that as per the aforesaid Circular, the object of a keyman insurance policy is to enable business organizations to insure the life of a keyman in order to protect the business against the financial loss which may occur in the likely eventuality of premature death. It was submitted that the main thrust of argument of the respondent before the CIT (A) as well as the Tribunal was that the payment of keyman insurance premium is allowable as revenue expenditure in view of the aforesaid Circular dated 18th February, 1998. While not disputing that the payment of keyman insurance policy premium paid by the company was allowable in view of the said Circular, he argued that the Tribunal failed to appreciate the true spirit of this Circular as the purpose was to cover the risk of premature death of the key persons of the organization and it could not be applicable in the instant case where the assessee company was assigning these keyman policies in the subsequent years, though the term of the policy was 5 years. According to Mr. Sahni, in such eventuality, payment of excess premium could not be treated as 'business expenditure' under Section 37(1) of the Act, as there was no commercial expediency on the part of the assessee to make such exorbitant payment. He argued that the test of commercial expediency could not be reduced to the shape of a ritualistic formula, nor could it be put in a water-tight compartment so as to be confined in a straitjacket formula. All that the law requires is that the expenditure should not be in the nature of capital expenditure or personal expenditure of the assessee and it should be wholly and exclusively laid out for the purpose of the business. It is well settled that the items of expenditure are to be considered from the point of view of a normal, prudent businessman. The test would merely mean that the Court would place itself in the position of a businessman and find whether the expenses incurred could be said to have been laid out for the purposes of the business. The ultimate analysis of the transaction would depend on the status of the parties as spelt out and nature or character of the trade or the venture, the purpose for which the expenses were incurred and the object which was sought to be achieved in incurring those expenses. Such an expenditure, however, must not suffer from the vice of collusiveness or colourable device. It was submitted that the instant case is a clear case of colourable transactions which are executed by the assessee at behest of its Directors/employees managing the assessee company.

17. It was further submitted that colourable devices cannot be part of tax planning and it would be wrong to encourage or entertain the belief that it is honourable to avoid the payment of tax by resort to dubious methods as held in the case of McDowell & Co. Ltd. v. CTO [154 ITR 148 (SC)]. Reliance was also placed on the decisions of Supreme Court in the case of CIT v. Durga Prasad More [82 ITR 540 (SC)]. In the latter case, the Apex Court in arriving at its conclusion has laid emphasis on the surrounding circumstances and test of human probabilities.

18. Per contra, the submission of Mr. V.P. Gupta, learned counsel appearing for the assessee company that the CIT (A) as well as the Tribunal had followed its earlier orders in the case of group companies. It was pointed out in the impugned order dated 29th August, 2008 (which is the subject matter in ITA No.398 of 2009), the Tribunal had referred to the orders for Assessment Years 1991-92, 1992-93, 1993-94 and 1997-98. In fact, the claim of the assessee company was also accepted for the Assessment Years 2001-02 and 2002-03. On this premise, it was argued that premium paid by the assessee company on keyman insurance policy had been held to be allowable as business expenditure under Section 37(1) of the Act for number of years and the order of the Tribunal had been accepted by the Department. Therefore, principle of consistency should be followed and the Department should not be allowed to rake up this issue.

19. On merits, it was argued that the scheme of the Act was quite clear in this behalf, which was amply clarified vide CBDT's Circular dated 18th February, 1998 that the premium paid to the keyman insurance policy is allowable as business expenditure. This Circular was binding on the Department.

20. Mr. Gupta also referred to the judgment of the Bombay High Court in the case of Commissioner of Income Tax v. B.N. Exports [2010] 323 ITR 178 (Bom.), wherein the insurance premium on keyman insurance policy had been considered to be allowable.

21. Mr. Gupta also argued that the allowability of the deduction is being disputed only for the reason that the concerned individuals have raised claim in their cases regarding non-taxability of the maturity value received by them pursuant to assignment of policies in their favour. Claim made regarding exemption of amount in the hands of individuals cannot determine or impact allowability of the expenditure in the case of the respondent company. In this regard, he placed reliance on the decision of the Supreme Court in the case of Empire Jute Company Limited v. Commissioner of Income Tax [124 ITR 1 (SC)], wherein it has been observed that a certain payment constitutes income or capital receipt in the hands of recipient is not material in determining whether the payment is revenue or capital disbursement qua the payer.

22. His further submission was that no such case of colourable device could be projected by the Department when assignment of such policies was envisaged in the CBDT's Circular dated 18th February, 1998 itself. It was further argued that the ingredients under Section 37 were duly met and satisfied as the expenditure incurred by the company was only on business considerations and the assignment of policy was also in the larger interest of business. It was, inter alia, submitted in this behalf that the assessee company was able to earn substantial profit by availing services of these individuals (keyman) by incurring the expenditure under reference and it is a fact duly recorded by the Tribunal in the impugned order that these persons were very important in the assessee organization and when they left their assignments, its profit were drastically reduced. Accordingly, the expenditure was incurred only with business consideration and is, therefore, an allowable deduction.

23. Another dimension, which was given by the learned counsel for the assessee company was that the Department could not sit on the armchair of the assessee and decide as to whether it was appropriate, as a business expediency, for the assessee to incur certain expenditure or not. It was for the assessee company to arrange its affairs in a manner which reduce its tax liability. There was no provision in the Act, which had been violated by assigning the policies in favour of the individuals. Reference in this regard was made to the decisions of Punjab & Haryana High Court in the case of Commissioner of Income Tax v. Pivete Finance Ltd. [2010] 192 Taxman 21 (P & H), wherein it was alleged by the Department that the assessee has been consistently resorting to colourable device with the object for reducing the tax liability by transferring shares to another group of companies with a view to reduce the table income. The Court reiterated its holding in earlier decision in the case of Porrits & Spencer (Asia) Ltd. v. Commissioner of Income Tax [2010] 190 Taxman 174 to the effect that if the transaction was otherwise valid in law and a part of tax planning then merely because it has resulted in reduction of tax, it cannot be ignored on the ground that the underlying motive of entering into such a transaction by the assessee was to reduce its tax liability to the State. He also drew our attention to the judgment of this Court in the case of Commissioner of Income Tax v. Panacea Biotech Ltd. [2010] 324 ITR 311 (Delhi) wherein this Court has observed in connection with the claim of the assessee for allowability of depreciation on purchase of a flat towards the end of the previous year that obviously, the assessee must have purchased this flat within the relevant financial year to take benefit of depreciation as tax planning.

24. Rebutting the arguments of Mr. Sahni, predicated on the alleged violation of terms of scheme of keyman insurance policy by assigning the same to the kayman, it was argued that no such contention was ever raised before the Authorities below. Even otherwise, the insurance company had accepted the assignment. So much so, even the Department had accepted the assignment and had taxed surrender value of the assignment and therefore, such an argument could not be raised.

25. After giving our due and thoughtful consideration to the submissions of the parties of both sides, we feel that the assessee has been able to make out a case in its favour and order of the Tribunal does not call for any interference. We are persuaded by the following reasons in support of this view of ours:

(i) The Department has itself allowed the expenditure incurred on the premium paid for keyman insurance policies in previous years as business expenditure under Section 37 of the Act. Right from 1991-92 upto 1993-94 and thereafter even in respect of Assessment Year 1997-98, the expenditure was allowed. Though thereafter, the expenditure was disallowed, but again the claim was accepted for the Assessment Years 2001-02 and 2002-03. Principle of consistency would, therefore, by applicable in such a case.

(ii) The Tribunal has rightly referred to and relied upon the CBDT's Circular dated 18.2.1998. This Circular is binding on the Income Tax Department, which categorically stipulates that premium on keyman policy should be allowed as business expenses. The assessee would, naturally, take into consideration such clarifications issued by the CBDT and would act on the basis thereof. When the assessee was given the impression, by means of the aforesaid Circular, that if expenditure is incurred on the keyman policy, it would be treated as business expenditure. There is no reason for the Department to deviate therefrom when it comes to the assessment.

(iii) The nature of expenditure incurred on keyman insurance policy has even been judicially considered and Bombay High Court has held in B.N. Exports (supra) that this expenditure is to be allowed as business expenditure, in the following words:

"The effect of Section 10(10D) is that monies which are received under a life insurance policy are not included in the computation of the total income of a person for a previous year. However, any sum received under a Keyman insurance policy is to be reckoned while computing the total income. For that purpose, a Keyman insurance policy means a life insurance policy taken by a person on the life of another person who is or was in employment as well as on a person on who is or was connected in any manner whatsoever with the business of the subscriber. The words "is or was connected in any manner whatsoever with the business of the subscriber" are wider than what would be subsumed under a contract of employment. The latter part makes it clear that a Keyman insurance policy for the purposes of Clause (10D) is not confined to a situation where there is a contract of employment. Clause (10D) relates to the treatment for the purpose of taxation of moneys received under an insurance policy. In this appeal, the court has to determine the question of expenditure incurred towards the payment of insurance premium on a Keyman insurance policy. The circular which has been issued by the Central Board of Direct Taxes clarifies the position by stipulating that the premium paid for a Keyman insurance policy is allowable as business expenditure. In the present case, on the question whether the premium which was paid by the firm could have been allowed as business expenditure, there is a finding of fact by the Tribunal that the firm had not taken insurance for the personal benefit of the partner, but for the benefit of the firm, in order to protect itself against the set back that may be caused on account of the death of a partner. The object and purpose of a Keyman insurance policy is to protect the business against a financial set back which may occur, as a result of a premature death, to the business or professional organization. There is no rational basis to confine the allowability of the expenditure incurred on the premium paid towards such a policy only to a situation where the policy is in respect of the life of an employee. A Keyman insurance policy is obtained on the life of a partner to safeguard the firm against a disruption of the business that may result due to the premature death of a partner. Therefore, the expenditure which is laid out for the payment of premium on such a policy is incurred wholly and exclusively for the purposes of business."

(iv) The argument of Mr. N.P. Sahni, learned counsel for the Revenue that taking such keyman insurance policy every year and thereafter assigning the same to the beneficiaries may be treated as colourable device, may not be correct. Though this argument appears to be attractive when we look into the fact that the assessee had been taking the policies and thereafter assigning the same year after year in favour of the beneficiaries, what cannot be ignored that this course of action is permitted by the Department itself as stated in CBDT's Circular dated 18.2.1998.

(v) The expenditure incurred has to be tested on the touchstone of Section 37 of the Act and to see as to whether such expenditure is permissible or not. No doubt, the object of a keyman insurance policy is to enable business organizations to insure the life of a keyman in order to protect the business against the financial loss which may occur in the likely eventuality of premature death. Such an expenditure is treated as business expenditure by the Department itself and recognized as such in Circular dated 18.2.1998. The expenditure is to be seen at the time it is incurred. Merely because the policy was assigned after sometime would not mean that the expenditure incurred in the first instance would lose the flavour of it being 'business expenditure'.

(vi) Once the legal provisions and the outlook of Department itself based on such legal provisions permit the assessee to have the tax planning of this nature, and the course of action taken by the assessee is permissible under law, the argument of colourable device cannot be advanced by the Revenue. When expenditure of this nature is treated 'business expenditure' per se by the Department itself, there cannot be any question of raising the issue of want of business expediency. The learned counsel for the respondent is right in his submission that the Department could not sit on the armchair of the assessee and decide as to whether it was appropriate on business expediency for the assessee to incur such an expenditure or not. If the transaction is otherwise valid in law and is a part of tax planning, merely because it has resulted in reduction of tax, such expenditure cannot be ignored raising the issue of underlying motive of entering into this type of transaction. Various judgments cited by the learned counsel for the respondents clearly get attracted to this Court.

26. The question of law is, thus, decided against the Revenue. As a result, appeals filed by the Revenue against the assessee company are dismissed.

Appeals qua Directors Assessee:

27. These appeals were admitted on the following questions of law:

(i) Whether on the facts and circumstances of the case, there was any justification to tax the difference between the premium paid by the employer and the surrender value paid by the employee to the employer at the time of assignment of the policy and whether it could be taxed in the year of assignment?

(ii) Whether on the facts and circumstances of the case, the Income Tax Appellate Tribunal was justified in restoring back the matter to the AO to ascertain whether the keyman insurance policy on assignment by the employer to the employee was converted into an ordinary policy so as to determine the question of taxability of the amount received by the employee on the maturity of such a policy; and if answer to the preceding part to this question is in the affirmative, then, whether the insurance money received on maturity by the employee is exempt in full under Section 10(10D) of the Income Tax Act?

(iii) Whether the Tribunal in spite of being of the view that the keyman insurance policy after its assignment to the keyman assumed the character of an ordinary insurance policy erred in law in holding that out of the sum received on maturity of the said policy, a sum equivalent to the surrender value of the policy at the time of assignment in favour of the assessee be subjected to tax?

(iv) Whether the Tribunal erred in directing the surrender value of Rs. 35,28,815/- to be taxed in spite of the fact that at the time of assignment the assessee had made a payment of the said amount to the assignor, i.e., the employer company?

(v) Whether the Tribunal was justified in law in rejecting the alternative the alternative claim of the assessee that in the eventuality that the amount received on maturity becomes liable to tax then deduction be allowed in respect of the premiums paid by the assessee after assignment to him of the policies in question as also the surrender value paid by him to the employer at the time of assignment and which was embedded in the figure of Rs. 2,85,00,000/-?

28. Ms. Rashmi Chpora, learned counsel appeared for the Department in these appeals. She reiterated and highlighted the modus adopted by the company in taking Keyman Insurance Policy year after year in the name of the two Directors and then assigning the same in favour of these Director assessees at a value much less than the amount paid by the companies in the very next year of taking the policy. Her submission was that in this manner, by assigning the policy and receiving only surrender value as against the actual premia paid, which was much higher, the difference between two amounts was the benefit received by the Director assessees, which would be treated as income assessable to tax. Taxability was sought to be covered by the provisions of Section 17 of the Act treating the same as profits in lieu of salary, i.e., perquisite in the hands of employee.

29. She further submitted that the maturity amount received by the assessee on the export of premium of policies, which is generally five years, was also taxable income as per Section 2(24) of the Act. Her submission was that the letter from LIC on surrender the Keyman Insurance Policy turns into an ordinary policy is of no consequence as the treatment by the LIC under the Rules and Regulations therein and for such purpose cannot govern the taxability of income is governed by the provisions of Act, which is self-contained stature. Original terms and conditions of the Keyman Insurance Policy cannot change on surrender as the quantum of premium and maturity amount remains as per the original terms and conditions. The Legislature has specifically brought in provisions to tax the maturity value alongwith bonus, etc. as income under salary, business and profession and income from other sources, etc. by incorporating various provisions such as 2(24)(xi), 17(3)(ii), 28(vi) and 56(iv) of the Act, which govern the taxability of amount received towards Keyman Insurance Policies including the sum allocated by way of bonus, etc.

30. She also hammered the issue of colourable device adopted by the company and echoed the same sentiments as expressed by Mr. N.P. Sahni while arguing the appeals of the Department qua the assessee company and submitted that by this device, company was benefitted by treating the expenditure as business expenditure under Section 37(1) of the Act and Director assessees were benefitted on the ground that the same was exempt under Section 10(10D) of the Act. According to her, such a device was impermissible. She concluded her arguments by submitting that the LIC is a commercial organisation, which formulates its own terms and policies and/or allows conversion of one policy to another, but the same cannot govern the taxability of income, but the same cannot cover the taxability of income which has to be determined on the basis of specific provisions of the Act.

31. The aforesaid submissions were refuted by Mr. R.M. Mehta and Mr. Bajpai who appeared for the assessee. Mr. Mehta argued that the case had to be examined having regard to the specific provision incorporated under the Act relating to the Keyman Insurance Policy with effect from 01.10.1996. On that basis, it was to be found as to whether the difference between the premium paid by the company prior to the date of assignment and the surrender value of the policy as computed by the LIC could be treated as income at the hands of the assessee, viz., whether such a difference was 'perquisite' within the meaning of Section 17(3)(ii) of the Act as done by the AO. His submission, in this behalf, was that the Tribunal rightly came to the conclusion that Section 10(10D) of the Act as well as other consequential Amendments read with CBDT's Circular No.762 dated 18.2.1998 would clearly demonstrate that it is only "sum received" under the Keyman Insurance Policy, that would be treated as "profits in lieu of salary" in terms of Section 17(3) of Act. CBDT Circular dated 18.2.1998 clearly postulates that only the surrender value of the policy at the time of assignment or the sum received by an individual at the time f retirement was taxable.

32. On the second issue, viz., taxability of the amount at the time of maturity of the insurance policy was untenable inasmuch as after the assignment of the policy, at the hands of the assessee, it became an ordinary policy and no one assignment Keyman Policy for the balanced terms of the policy insurance premium was paid by the assessee as payable in an ordinary policy. Therefore, as per CBDT Circular itself, which was rightly relied upon by the Tribunal, such an amount received on maturity could not be added as income of the assessee.

33. Mr. O.S. Bajpai specifically refuted the arguments of learned counsel for the Revenue by giving his own analysis to the various provisions of the Act. His submission, in this behalf, was that the concept of assignment is embedded in the very scheme of Keyman Insurance Policy. He submitted that the provisions of Section 10(10D) of the Act were to be read conjointly with Section 17(3)(ii) of the Act.

34. He first sought to highlight distinction between the Keyman Insurance Policy and ordinary policy by submitting that in case of keyman policy there have to be two players, viz., (i) one who pays premium to secure the life of the other and (ii) the other whose life is secures. In contrast, there is only a single player in an ordinary policy, who gets his life secured and pays the premium himself. In the present case, this person happens to be an employee after policy is assigned to him. In this scenario, learned Senior Counsel argued that Section 17(3)(ii) comes into picture when the recipient is to be taxed for the amount of insurance received by him on maturity or he is taxed on surrender value as profit in lieu of salary. In other words, if there is no assignment of Keyman Insurance Policy, there is no question of invoking Section 17(3)(ii) as an employer cannot be taxed under this Section, but only an employee can be taxed. When there is no assignment, Section 37 and Section 28 or Section 56 of the Act will operate. The employer will seek deduction under Section 37 and pay tax under Section 28 or 56 of the Act. Section 17(3)(ii) of the Act comes into play only if an employee is to be taxed and an employee does not come into picture if there is no assignment. If employer does not continue the policy and surrenders it midway, he too would get only surrender value. But when there is assignment, the employee comes into picture and Section 17(3)(ii) of the Act becomes operative. Thus, in the case of an employee, Section 17(3)(ii) of the Act can co-exist only with assignment to the employee. This makes assignment a part of the scheme of the Act itself. He, thus, argued that the assignment leads to conversion and changes the character of keyman insurance policy into an ordinary policy. Further, assignment is a followed transaction between the LIC's employer and employee. With this assignment, LIC not only agrees to convert the policy from keyman insurance policy to general insurance policy, it also agrees to receive the premium from the employee. When such a course is legally permissible, there is no question of adoption of colourable device, was the submission of Mr. Bajpai for which he referred to the judgment of the Supreme Court in the case of Union of India v. Azadi Bachao Andolan, [2003] 263 ITR 706 (SC) followed in Walfort Share & Stock Brokers (P.) Ltd. v. CIT [2010] 326 ITR 1 (SC).

35. On the aforesaid premise, his submission was that when the amount received by the employee on maturity of the policy is the amount received in respect of ordinary policy; it was exempt from taxation by the statutes itself and, therefore, such an amount could not be taxed at all.

36. Insofar as taxability of difference between the premium paid by the employer and the surrender value paid by the employee (assessee) is concerned, the same was to be examined only if it was (perquisites within the meaning of Section 17(3)(ii) of the Act. His submission, in this behalf, was that the keyman insurance is taxable under Section 17(3)(ii) of the Act as a 'profit in lieu of salary' only when it is actually received. If it is not actually received, the condition of taxability is not satisfied and it cannot be taxed under Section 17(3)(ii) of the Act. He highlighted the fact that Section 28(iv), Section 56(2)(iv) as well as Sections 2(24)(xi) and Section 17(3)(ii) of the Act used the word "received" and therefore, unless the amount is received under Keyman Insurance Policy, it could not be taxed under any other provision.

37. While dealing with the case of the assessee company, we have already referred to the provisions of Section 10(10D) of the Act, which defines the insurance policy. The scheme of purpose of Keyman Insurance Policy has also been adverted to at that stage. Since two kinds of additions were made by the AO, which are the subject matter of the present appeals, we now take these two aspects for discussion:

(i) Difference between the premium paid by the company and the surrender value paid by the assessee at the time of assignment: Whether it is 'profit in lieu of salary' within the meaning of Section 17(3)(ii) read with Section 2(24)(xi) of the Act:

Section 2(24) gives the definition of income which is inclusive as it starts with "income includes………" Thereafter, various heads are specified, which would be treated as income. We are concerned with Clause (xi), which relates to Keyman Insurance Policy which is worded as under:

"any sum received under a Keyman insurance policy including the sum allocated by way of bonus on such policy.

Explanation. - For the purposes of this clause, the expression "Keyman insurance policy" shall have the meaning assigned to it in the Explanation to clause (10D) of section 28;"

38. For the purpose of this Clause, expression "Keyman Insurance Policy" shall have the meaning assigned to Clause (10D) of Section 10 of the Act, which reads as under:

"Keyman insurance policy" means a life insurance policy taken by a person on the life of another person who is or was the employee of the first-mentioned person or is or was connected if any manner whatsoever with the business of the first mentioned person."

39. Section 10 is the first Section in Chapter III entitled 'Incomes which do not form part of total income'. In Section 10 of the Act, various kinds of incomes are stipulated, which are not to be included in total income. This Section excludes those sums from income, which are received under a Life Insurance Policy, including the sum allocated by way of bonus of such policy. However, there are certain sums, which are specifically excluded meaning thereby those sums are not excluded from income. Sub-clause (b) of Clause (10D) mentions any sum received under a Keyman insurance policy. It would follow that sum received under a Keyman insurance policy under an Insurance policy is not to be excluded from total income and it would be treated as income. That is provided by Clause (xi) of Section 2(24) of the Act. Since Explanation to Clause (xi) states that Keyman insurance policy shall have the same meaning as assigned to it in Explanation to clause (10D) of Section 10 of the Act, we merely reproduce the said Explanation:

"Explanation - For the purposes of this clause, "Keyman insurance policy" means a life insurance policy taken by a person on the life of another person, who is or was the employee of the first-mentioned person or is or was connected in any manner whatsoever with the business of the first-mentioned person."

40. This Explanation, thus, gives the meaning to "Keyman insurance policy" and only that sum received under this policy would be treated as income. As per this Explanation, Keyman insurance policy is the one which is taken by a person on the life of another person who is or was the employee of the first mentioned person, etc. It means, in our context, the person who has taken the policy is the company/employer and the person on whose life the policy taken is the Director assessee. It is not a case where the employer kept the policy with itself till end and on maturity, the amount received was given to the employee. In that case, the provision would have attracted.

41. The moot question here is as to whether any such tax event has occurred within the meaning of Section 17(3)(ii) of the Act. Section 17 defines "salary", "perquisite" and "profits in lieu of salary". The amount in question admittedly is not "salary". However, this provides "in lieu of salary" as defined in Section 17(3) of the Act, then also it would be chargeable to tax under the head "salary". Clause (ii) of Sub-section (3) of Section 17 reads as under:

"(ii) Any payment other than any payment referred to in clause (10), clause (10A), clause (10B), clause (11), clause (12), clause (13) or clause (13A) of section (10), due to or received by an assessee from an employer or a former employer or from a provident or other fund, to the extent to which it does not consist of contributions by the assessee or interest on such contributions or any sum received under a Keyman insurance policy including the sum allocated by way of bonus on such policy.

Explanation : For the purposes of this sub-clause, the expression "Keyman insurance policy" shall have the meaning assigned to it in clause (10D) of section 10."

42. As noted above, the contention of the Department is that the amount in question is received in the form of difference between the amount paid by the employer to the insurance company and the amount received from the employee in the form of surrender value. The contention of the Director assessee, on the other hand, is that on the assignment of policy, no such amount is received. The contention of the assessee is predicated on the following expression in Clause (ii) of sub-section (3) of Section 17 of the Act:

"Any sum received under a Keyman insurance policy………….."

43. Obviously, Section 17(3)(ii) of the Act would come into pay only when the policy is assigned by the employer to the employment as employer cannot be taxed under this Section, which is applicable only to the employee. After assignment, there may be two situations, viz.,

(i) Employee does not continue the policy and does not pay further premiums, then he would get only surrender value; or

(ii) Employee continues the policy and pays subsequent premiums, then he would get full amount on maturity.

44. In the present case, second situation has occurred as on assignment, the Director assessee did not surrender the same to the LIC and chose to continue with the policy by making payment for remaining period of the policy. It is also to be borne in mind that the LIC has accepted the said assignment and from the date of assignment, it has become a policy between the LIC and the Director assessee, viz., the employees. However, no particular amount was received by these Director assessees on assignment. Clause (ii) of subsection (3) of Section 17 taxes "any sum received in a Keyman policy insurance". The word "received" assumes significance. The Legislature in its wisdom thought to tax only that payment, which is received by the employee assessee under Keyman insurance policy.

45. Once we find that for Keyman insurance policy, specific provision is made under clause (ii) of sub-section (3) of Section 17 of the Act and the case is not covered by that clause. Can it be treated as covered under Clause (iii)? Answer has to be in the negative for various reasons, which are underlined below:

(i) Section 17(3)(ii) was amended by incorporating the provision of Keyman insurance policy with effect from 01.10.1996 to take care of specific scheme of Keyman insurance policy added/introduced by the said amendment vide Finance (No. 2) Act, 1996. Clause (3) of Section 17 of the Act, on the other hand, was already in existence. When the Legislature intended to cover the amount received under Keyman insurance policy under Clause (ii), for the purpose of taxability of amounts received under a Keyman insurance policy, one has to look into this Clause and not Clause (iii).

(ii) Even clause (iii) uses expression "any amount due or received". Thus, it is also on receipt of this amount with this Clause gets triggered.

(iii) The purport of Clause (iii) is altogether different. Such an amount due or received by the assessee has to be:

(a) Before joining any employee; or

(b) After cessation of its employee.

No such contingency occurred when his Keyman insurance policy was assigned by the company in favour of the Director assessees.

(iv) Other provisions, which were introduced/amended while providing the Keyman insurance policy scheme under the Act by Finance (No. 2) Act, 1996 are Section 28(iv) and Section 56(2). Section 28 deals with profits and gains of business or profession and Clause (iv) thereof reads as under:

"(iv) The value of any benefit or perquisite, whether convertible into money or not, arising from business or the exercise of a profession;"

This Section would obviously apply when the assessee is assessed under for income under the head "profits and gains of business or profession" which is specific head provided under Section 28 of the Act. Even qua such an assessee, the amount is made taxable as income only when the sum is "received".

46. Section 56 deals with "income from other sources", which is income No. F of stipulated in Section 14 of the Act. Clause (iv) of sub-section (2) of Section 56 makes particular income referred to in Section 2(24)(xi) chargeable as tax if it is not taxed under the head "profit and gains of business or profession" or under the head "salary". Thus, we fall back on Section 2(24)(xi), which also uses the expression "received" and would imply that the amount should have been actually received. We, thus, agree with the opinion of the learned Tribunal that the tax event did not occur, as no such amount was received at the time of assignment of the policy by the company as employer to the Director assessee, as employee. It is trite that income can be charged only if it comes under the heads of Section 14. [See Nalnikant Ambalal Mody v. Commissioner of Income-Tax, Bombay, [1966] 61 ITR 428 (SC)].

47. The scheme of the Act by introducing Keyman insurance policy, clearly provides that such an amount can be taxed either as business profits or surrender value of the policy endorsed in favour of the employee (Keyman) or the sum received by him at the time of retirement and in all these cases, it would be profits in lieu of salary for tax purpose. In case there is no employee-employer relationship, then the surrender value of the policy or the business profits are to be taken from other sources. We are also supported our conclusion by CBDT's Circular No.762 dated 18.2.1998, which reads as under :

"Taxation of a sum received under the Keyman insurance policy.

14.1 A Keyman insurance policy of the Life Insurance corporation of India, etc. provides for an insurance policy taken by a business organization or a professional organization on the life of an employee, in order to protect the business against the financial loss, which may occur from the employee's premature death. The "Keyman" is an employee or a director, whose services are perceived to have a significant effect on the profitability of the business. The premium is paid by the employer.

14.2 There were some doubts on the taxability of the income including bonus, etc. from such policy and also regarding the treatment of the premium paid -whether it should be allowed as a capital expenditure or as a revenue expenditure. The Finance (No.2) Act, 1996, therefore, lays down the tax treatment f the Keyman Insurance Policy.

14.3 Clause (10D) of Section 10 of the Income Tax Act exempts certain income from tax. The Finance (No.2) Act, 1996 mends clause (10D) of Section 10 to exclude any sum received under a Keyman Insurance Policy including the sum allocated by way of bonus of such policy for this purpose.

14.4 The Finance (No.2) Act, 1996, also lays doen that the sums received by the said organization on such policies be taxed as business profits; the surrender value of the policy, endorsed in favour of the employee (Keyman); or the sum received by him at the time of retirement be taken as "profits in lieu of salary" for tax purposes; and in case other persons having no employer-employee relationship the surrender value of the policy or the sum received under the policy be taken as income from other sources and taxed accordingly. The premium paid on the Keyman Insurance Policy is allowed as business expenditure.

14.5 The amendments take effect from the 1st day of October, 1996."

48. It also follows from the aforesaid that it was only the surrender value of the policy at the time of assignment or the sum received by an individual at the time of retirement, which is taxable.

49. Insofar as assignment is concerned, at that time surrender value was paid by the Director and therefore, nothing could be taxed. Therefore, from any angle, matter is to be looked into, this component cannot be taxed at the hands of the Director assesses as mentioned.

Re: Whether the maturity value of the insurance policy received bv the assessee is taxable:

50. The Tribunal has taken the view that the Keyman insurance policy was taken in a particular year and assigned in the next year and both these events had taken place in the years preceding the assessment year in question. The Tribunal took note of the certificate obtained by the assessee from the LIC whereby it had certified that a Keyman insurance policy after assignment assumed the status of an ordinary insurance policy. The Tribunal also took note of the relevant provisions of the Act and the aforesaid CBDT Circular to hold as under:

"All this shows that from the time of taking out the policy upto its maturity, the Legislature has envisaged the treatment to be given with regard to sums involved in the hands of the players involved. The players involved obviously are two-one, the person on the life of whom the insurance policy is taken out and second he person who takes out such policy. The premium is borne by the second person. Where such a dual role comes to an end, the very essence of the Keyman Insurance Policy is lost. This is the reason why the LIC of India confirmed that after assignment of a Keyman Insurance Policy in the name of the individual and the premiums thereafter being paid by such individual, the hitherto Keyman Insurance Policy becomes an ordinary policy. In this case, on the date of maturity, the policy in question is rightly to be accepted as an ordinary insurance policy."

51. The Tribunal while giving requisite relief brought to tax the amount of surrender value at the time of assignment subject to verification by the AO. It also rejected the alternative argument of the assessee that in case the sum received on maturity was held to be taxable then deduction be allowed for the premia paid by the assessee after the assignment of the policy, which were embedded in the maturity amount and not claimed as a deduction in the tax assessments.

52. Thus, the issue depends on the question as to whether on assignment of the insurance policy to the assessee, it changes its character from Keyman insurance also to an ordinary policy. It is because of the reason that if it remains Keyman insurance policy, then the maturity value received is subjected to tax as per Section 10(10D) of the Act. On the other hand, if it had become ordinary policy, the premium received under this policy, in view of the aforesaid Section 10(10D) itself, the same would not be subjected to tax.

53. Once there is no assignment of company/employer in favour of the individual, the character of the insurance policy changes and it gets converted into an ordinary policy. Contracting parties also change inasmuch as after the assignment which is accepted by the insurance, the contract is now between the insurance company and the individual and not the company/employer which initially took the policy. Such company/employer no more remains the contracting parties. We have to bear in mind that law permits such an assignment even LIC accepted the assignment and the same is permissible. There is no prohibition as to the assignment or conversion under the Act. Once there is an assignment, it leads to conversion and the character of policy changes. The insurance company has itself clarified that on assignment, it does not remain a keyman policy and gets converted into an ordinary policy. In these circumstances, it is not open to the Revenue to still allege that the policy in question is keyman policy and when it matures, the advantage drawn therefrom is taxable. One has to keep in mind on maturity, it does not the company but who is an individual getting the matured value of the insurance.

54. No doubt, the parties here, viz., the company as well as the individual taken huge benefit of these provisions, but it cannot be treated as the case of tax evasion. It is a case of arranging the affairs in such a manner as to avail the state exemption as provided in Section 10(10D) of the Act. Law is clear. Every assessee has right to plan its affairs in such a manner which may result in payment of least tax possible, albeit, in conformity with the provisions of Act. It is also permissible to the assessee to take advantage of the gaping holes in the provisions of the Act. The job of the Court is to simply look at the provisions of the Act and to see whether these provisions allow the assessee to arrange their affairs to ensure lesser payment of tax. If that is permissible, no further scrutiny is required and this would not amount to tax evasion. Benefit inured owing to the combined effect of a prudent investment and statutory exemption provided under Section 10(10D) of the Act, the section does not envisage of any bifurcation in the amount received on maturity on any basis whatsoever. Nothing can be read in Section 10(10D) of the Act, which is not specifically provided because any attempt in that behalf as contended by Revenue would be tantamount to legislation and not interpretation.

55. Accordingly, we answer the questions of law as framed in favour of the assessees and against the Revenue. As a result, the appeals of the Revenue are dismissed and those of the assessees are hereby allowed.

"Lease equalization charge” as per ICAI Guidelines is allowable--In Finance Lease

2012-02-09T16:55:00.002+05:30

CIT vs. Virtual Soft Systems Ltd (Delhi High Court)

The assessee received lease charges and claimed a reduction towards “lease equalization charges” on the ground that reduction was in accordance with the Guidance Note dated 20.09.1995 issued by the ICAI in respect of Accounting for Leases and the Accounting Standard AS-1 notified u/s 145 which mandated that the accounting policy of the assessee should represent a true and fair view. The AO & CIT (A) rejected the claim on the ground that it was a “notional charge” and that the accounting guidelines could not override the Act. The Tribunal (38 SOT 412), however, allowed the claim. On appeal by the department, HELD dismissing the appeal:

(i) As the method for accounting for lease rentals was based on the Guidance Note “Accounting For Leases” issued by the ICAI, the AO was not entitled to disregard the same. The Guidance Note reflects the best practices adopted by accountants the world over and the fact that it was not mandatory is irrelevant. The ICAI is recognized as the body vested with the authority to recommend Accounting Standards for ultimate prescription by the Central Government u/s 211(3C) of the Companies Act. Also AS-1 pertaining to Disclosure of Accounting Policies has mandatory status for periods commencing on or after 01.04.1991. The change by the assessee in the policy of accounting for leases had the imprimatur of the ICAI and so the AO was not entitled to disregard the books of accounts or the method of accounting for leases;

(ii) The department’s contention that the “lease equalization charge” is a claim in the form of a deduction which cannot be allowed as there is no provision under the Act is based on a complete misappreciation of what constitutes a lease equalization charge. As the transaction was a finance lease, the charge had to be provided as per the ICAI Guidelines. As long as the method employed for accounting of income meets with the rudimentary principles of accountancy, one of which, includes offering only revenue income for tax, no fault can be found with the assessee debiting lease equalization charges in its profit and loss account. This represented the true and fair view of the accounts; a statutory requirement u/s 211(2) of the Companies Act, enabled determination of real income.

Link: http://itatonline.org/archives/index.php/cit-vs-virtual-soft-systems-ltd-delhi-high-court-in-a-finance-lease-claim-for-lease-equalization-charge-as-per-icai-guidelines-is-allowable/

Outsourcing of Manufacture attracts 194C--Nova Nordisk--Karnataka HC

2012-02-02T21:01:00.002+05:30

COMMISSIONER OF INCOME TAX Vs NOVA NORDISK PHARMA INDIA LTD--HC of Karnataka

Income tax - Sections 194C, 201(1A)

Where assessee outsources manufacturing of a pharma product for which raw materials are supplied by a foreign company having interest in the assessee company and trade mark of assessee to be labelled on such products, conversion charges attract provisions of Sec 194C

Assessee, an Indian Company, marketed pharmaceutical products. It had outsourced one of its products to M/s.Torrent Pharmaceuticals Limited. The raw materials were supplied for the jobwork by a foreign company NOVA Nordisk, Denmark. It also transpired that the assessee company was a subsidiary of M/s NOVA Nordisk Singapore but had no direct contract or relationship with the Indian manufacturer, but under another agreement between the Indian manufacturing company and the raw material supplying foreign company, the product produced by the use of raw material for manufacture of the product was stipulated to be exclusively supplied to the assessee company and the manufacturing company was under compulsion that the entire product or the output after the consumption of the raw material supplied to the manufacturing company was to be in turn sold only to assessee company in India.

One of the conditions in the agreement between the raw material supply foreign company and the Indian manufacturing company was that even if the agreement expired or the transaction came to an end and if some surplus product was left over with the manufacturing company, the product so left over was not to be sold outside in the market, but necessarily be sold to the assessee company.

In the agreement between the assessee company and its supplier a price fixation formula had been worked out and it was called as conversion charges. The assessee company was to pay the supplier/manufacturing company 19% of the landing cost of the raw material, consumed into the production of the product. This was the interrelation linking the three companies viz, the raw material supplying foreign company, the raw material receiving Indian manufacturing company and the product buying assessee company. The Indian manufacturing company manufactured the products making use of the raw material supplied by the foreign raw material supplier company.

There was another agreement between the assessee company and the manufacturer company also which provided for supply of technical know-how for the manufacture of the product, but at no cost and know-how to be exclusively utilised for converting the raw material received by the Indian manufacturing company from the raw material supplying foreign company. There was yet another agreement between the assessee and the supplier company known as trade mark licence agreement under which the product manufactured by the manufacturing company was to be labelled with the name of the assessee company for marketing and the entire manufactured product was to be restored to the buying company viz. the assessee company, in the even of termination of the contract.

Assessee paid 2% of total amounts paid to the supplying company to the manufacturing company in India. This amount was worked out to be at a sum of Rs.5,10,49,267/- by the assessing officer applying the formula of multiplying payments made by the assessing company to the supplier company using the multiplier 19/119 as being the value of conversion charges which alone was taken to be a payment by the assessing company towards the manufacturing cost or conversion charges paid by the assessee to the manufacturing company though the actual payments included the price of the raw materials, but that amount having been paid by the supplier directly to the foreign raw material supplier company, that was not included in the value of payments by the assessee company for the purpose of computing the amount that was required to be deducted under Section 194C of the Act.

But the price of the raw material having been paid by the supplier company to the raw material supplying foreign company, the income tax officer was of the view that a reading of the agreement between the assessing company and the supplier company and the agreement between the supplier company and the raw material supplying foreign company has linked one another and ultimately the manufacturing company being required to supply the entire product produced by utilising the raw material procured from abroad only to the assessee company, it cannot be held that it was a contract for sale of a product in the sense it was a sale of a product, but it was only a contract for manufacturing and therefore, was of the opinion that there was an obligation on the part of the assessee company to effect deduction of tax at source and there being a failure on the part of the assessee company while noticed that the tax liability had been met by the manufacturing company being an assessee under the Act and having independently filed its return, but at the same time the assessee company being not absolved of the liability of the provisions of Section 201(1A) of the Act proceed to compute the interest in terms of the statutory provisions and worked out to be 7,60,570/- starting from 1.4.1997 till the date of the order under the provisions of Section 201(1A) of the Act which was on 30.7.2001.

The CIT(A) opined that the assessee company not having supplied the raw material, the price paid by the assessee company was to be construed only as a price for the sale of the product and not a contract for manufacturing and therefore, Section 194C was not attracted. Tribunal agreed with the CIT(A).

On appeal, the HC held that,

++ we find that this is not simply a situation of a product manufactured to the specifications of the assessee, being sold to the assessee at the price fixed by the supplier but this is a situation where a product manufactured out of raw materials supplied by a foreign company who had direct interest in the assessee company so manufactured to the specification of the assessee company utilising the technical know-how supplied by it and also labelling the product with the brand name of the assessee and supplying the entire product only to the assessee company and not to anyone else and it is throughout to be held as a specific contract for manufacturing of a particular product notwithstanding the fact that the supplier had paid the price for the raw-material directly to the foreign company which supplied the raw material to the manufacturer, but had interest in the assessee company in India while bearing the trade mark of the foreign supplier, but having a definite communication and in such a situation one has to really look into the real nature of the transaction that emerges on the conjoint reading of the three agreements and the assessing officer in fact having undertaken this exercise and having arrived at the conclusion that the assessee company is one who fits into the definition and situation contemplated u/s.194C of the which on an examination is found is a proper reasoned approach and in consonance with the statutory provision.

++ we are also of the view that the situation contemplated u/s.194C of the Act i.e. the payment for carrying out any work which is to improve the situation of such nature and of course preceded between the contract between the assessee and the manufacturer company;

++ it was a situation where the provisions of Section 194C of the Act applied to the assessee and is clearly attracted to the present situation. The assessing authority has rightly applied the provisions of Section 194 of the Act to the present situation and has very correctly estimated the interest payable in terms of Section 201 (1A) and the Appellate Commissioner and the Tribunal are in error in taking the contrary view.

Revenue's appeal allowed

JUDGEMENT

The appeal by the Revenue u/s.260A of the Income Tax Act, 1961 (hereinafter referred to as 'the Act') against the order dated 22.3.2005 passed by the Income Tax Appellate Tribunal, Bangalore Bench in ITA No.688/Bang/02 and posing the following substantial questions of law for our answer:-

1. Whether Appellate Authorities were correct in holding that the transactions entered into between the assessee and the TPL is a contract for sale and not contract for work, when the entire transaction under the agreement were in the nature of work contract, and TDS was deductible?

2. Whether the Appellate Authorities committed and error in terming the transactions entered into between the assessee and the TPL as contract for sale of goods when on examination of the agreements and the transactions, work entrusted to TPL was only a work contract and not contract for sale of goods and consequently provisions of section 194C of the Act were applicable?

2. The appeal had been admitted on 10.9.2007 to examine these two questions.

3. The respondent had been put on notice and is represented by counsel M/s.Harish and Co., but unfortunately at the time of hearing of the appeal we had the benefit of hearing only Shri. Thirumalesh, learned Standing Counsel appearing for the appellant-Income Tax Department.

4. The assessee is an Indian Company and assessment year is 1997-98. The assessee company markets pharmaceutical products and one of its products had been got prepared from M/s.Torrent Pharmaceuticals Limited, a product which perhaps was being used as insulin in medically presentable form, raw material for the manufacture of this product was being supplied to M/s Torrent Pharmaceuticals Ltd. by a foreign company by name NOVA Nordisk, Denmark.

5. It also transpires that the assessee company was a subsidiary of M/s NOVA Nordisk Singapore but had no direct contract or relationship with the Indian manufacturer, but under another agreement between the Indian manufacturing company and the raw material supplying foreign company, the product produced by the use of raw material for manufacture of the product was stipulated to be exclusively supplied sold to the assessee company and the manufacturing company was under a compulsion that the entire product or the output of the consumption of the raw material supplied to the manufacturing company should be in turn sold only to assessee company in India.

6. One of the conditions in the agreement between the raw material supply foreign company and the Indian manufacturing company was that even if the agreement should expire or the transaction should come to an end and if some surplus product is left over with the manufacturing company, the product so left over should not be sold out side in the market, but necessarily be sold to the assessee company.

7. In the agreement between the assessee company and its supplier a price fixation formula had been worked out and it was stipulated therein and that was called as conversion charges. The assessee company was to pay the supplier/manufacturing company 19% of the landing cost of the raw material, consumed into the production of the product. This is the interrelation linking the three companies viz, the raw material supplying foreign company, the raw material receiving Indian manufacturing company and the product buying assessee company. The Indian manufacturing company manufactured the products making use of the raw material supplied by the foreign raw material supplier company.

8. There was another agreement between the assessee company and the manufacturer company also which provides for supply of technical know-how for the manufacture of the product, but at no cost and know-how to be exclusively utilised for converting the raw material received by the Indian manufacturing company from the raw material supplying foreign company.

9. There was yet another agreement between the assessee company and the manufacturer/supplier company known as trade mark licence agreement under which the product manufactured by the supplier/manufacturing company was to be labelled with the name of the assessee company for marketing and the entire manufactured product was to be restored to the buying company viz. the assessee company, in the even of termination of the contract.

10. While these are the relevant conditions for the purpose of resolving the dispute particularly, the question arising in the context of the provisions of Section 194C of the Act because of which proviso the respondent-Company is treated as an assessee, an assessee so deemed because of the default committed in not deducting the commensurate amount in respect of the payments mae by the assessee company in favour of the Indian Manufacturing company which was as per the provision at 2% of the total amounts paid by the assessee company to the supplying company.

11. This amount was worked out to be at a sum of Rs.5,10,49,267/- by the assessing officer applying the formula of multiplying payments made by the assessing company to the supplier company using the multiplier 19/119 as being the value of conversion charges which alone was taken to be a payment by the assessing company towards the manufacturing cost or conversion charges paid by the assessee to the manufacturing company though the actual payments include the price of the raw materials, but that amount having been paid by the supplier directly to the foreign raw material supplier company, that was not included in the value of payments by the assessee company for the purpose of computing the amount that was required to be deducted under Section 194C of the Act.

12. But the price of the raw material having been paid by the supplier company to the raw material supplying foreign company, the income tax officer was of the view that a reading of the agreement between the assessing company and the supplier company and the agreement between the supplier company and the raw material supplying foreign company has linked one another and ultimately the manufacturing company being required to supply the entire product produced by utilising the raw material procured from abroad only to the assessee company, it cannot be held that it was a contract for sale of a product in the sense it was a sale of a product, but it was only a contract for manufacturing and therefore, was of the opinion that there was an obligation on the part of the assessee company to effect deduction of tax at source and there being a failure on the part of the assessee company while noticed that the tax liability had been met by the manufacturing company being an assessee under the Act and having independently filed its return, but at the same time the assessee company being not absolved of the liability of the provisions of Section 201(1A) of the Act proceed to compute the interest in terms of the statutory provisions and worked out to be 7,60,570/- starting from 1.4.1997 till the date of the order under the provisions of Section 201(1A) of the Act which was on 30.7.2001.

13. It is aggrieved by this order the assessee carried the matter in appeal to the Appellate Commissioner. The Appellate Commissioner examining the agreement between the assessee and its supplier company and being of the view that in terms of the Board circular No.681 of 83/84 dated 8.3.1984 which is also applicable to the assessment year 1997-98, in terms of his order dated 8.2.2002 opined that the assessee company not having supplied the raw material, the price paid by the assessee company has to be construed only as a price for the sale of the product and not a contract for manufacturing and therefore, Section 194C is not attracted and in this view of the matter set aside the order of the assessing authority.

14. The revenue carried the matter further to the Tribunal, but without success as the Tribunal also affirmed the order of the Appellate Commissioner being of the view that, in terms of the Board circular the assessee being not the supplier of the raw material was not under any obligation to deduct any tax at source u/s/194C of the Act and therefore, dismissed the appeal in terms of the order dated 22.3.2005.

15. It is aggrieved by this order of the Tribunal, the present appeal by the Revenue posing the questions as indicated above for our consideration.

16. Appearing on behalf of the Revenue, Shri Thirumalesh, learned Standing counsel has drawn our attention to the orders, the relevant clauses in the agreement particularly, Articles 3 and 4 of the agreement between the assessee company and the supplier company which reads as under :-

ARTICLE 3: PURCHASE AND SALE OF INSULIN FORMULATIONS

3.1. During the terms, the supplier shall supply to the buyer and the buyer shall purchase from the Supplier, Formulations meeting the applicable requirements contained, and as more particularly specified in Appendix 2 on the following basis.

a) The supplier shall supply and the buyer shall purchase. Formulations manufactured from the Insulin Crystals strictly in accordance with the Know how licensed to the supplier by the buyer under the Know how License Agreement, and strictly in accordance with the Current Good Manufacturing practice(CGMP) as being defined by the relevant authorities in the territory from time to time.

b) The supplier's selling price to the Buyer for the Formulations shall be determined in accordance with conditions stipulated in Appendix-4.

ARTICLE-4 : PAYMENTS TERMS

4.1. Payment of the purchase price for each consignment of Formulations shall be made by the Buyer within thirty (30) days from the date of invoice, which should be issued simultaneously with the supply of formulations

4.2. Any amount due under this agreement from the Buyer that is not paid when due shall bear interest at a rate per year equal to eighteen (18) percent upto the date of final payment.

The terms of the agreement between the manufacturing company and the foreign raw material supplying company reading as under :-

That this agreement between TPL and NNAS would be co-terminus with the following separate agreements:-

i) "Insulin Formulation Supply Agreement" between the purchaser (i.e., TPL) and NNPL whereby TPL was to supply specified formulations to NNPIL which were formulated using crystals supplied by NNAS and know-how supplied by NNPIL.

ii) "Know-how Licence Agreement" between the purchaser and NNPIL whereby the "know-how" to manufacture such formulation was transferred from NNPIL to TPL for no apparent consideration.

iii) "Trade Mark Licence Agreement" between the purchaser and NNPIL.

17. Drawing our attention to the relevant terms of the three agreements Mr.Thirumalesh, learned counsel for the revenue submits that the Appellate Commissioner as well as the Tribunal have adopted a very simplistic approach in adopting the Board circular without even applying their mind as to applicability of the notification in a situation, of the present nature; that the present situation was not one of a simple agreement between the manufacturer and its buyer or, the seller of goods and buyer of manufactured goods by the very raw material supplied, but this was a rather complicated interlinking arrangement amongst the three parties viz. the assessee company, its supplier the manufacturing company and the foreign raw material supplier company and that the terms of agreement between the raw material supplying company virtually, dictating terms to the raw material receiving Indian manufacturing company to supply the entire product, manufactured by the utilisation of the raw materials and applying the technical know-how as supplied by the assessee company, this was not a case of the supplier or the manufacturer having produced an independent product out of its own ability or on its own but being guided, regulated and restricted in the marketing of the product only in favour of the assessee company and more so, the price fixation mechanism as stipulated under the agreement taking care of the value with reference to the quantity and quality of the product produced with the supplied raw material, the situation is not one governed by the Board circular and the Appellate Commissioner and the Tribunal ignoring the facts and circumstances of the case as had been discussed by the Income Tax Officer, have simply set aside the order passed by the Assessing Authority on the premise of the board circular. The situation does not fit into the board circular. It called for a proper view to be taken independent of the circular. This was a clear case where there was payment made by the assessee to the supplier in respect of a property supplied to it and on specifications and therefore, the orders passed by the Appellate Commissioner and the tribunal is to be set aside and the order passed by the Assessing Authority is to be restored.

18. We have bestowed our attention to the submission made at the bar and also perused the orders passed by the Assessing Authority as well as of the Appellate Commissioner, Income Tax Appellate Tribunal and also the provisions of Section 194C and Section 201 of the Act.

19. Section 194C of the Act is an enabling provision A provision introduced into the parent Act for the purpose of advance recovery of income tax and in certain circumstances in a situation where payment is made by a person for carrying out any work in pursuance of a contract between the contractor and the person then, an obligation is imposed on such person responsible for payment to deduct an amount equal to 2% and the consequence of failure to so deduct and remit to the account of the revenue are spelt out in Section 201 of the Act. We are particularly concerned with Section 201(1A) of the Act which provides for levy of simple interest at 15% p.a. during the relevant year on the ground not so deducted and it is this sum which is levied by way of interest, which is the bone of contention in this appeal.

20. Section 194C applies to all such situations where there is a contract of the nature as is indicated in this Section and in existence between a person and the company etc. Here the person is an assessee company and 'company' as indicated in Section 194C (1d) is the supplier company.

21. On a perusal of all the agreements which have a bearing on the transaction of sale of the product or sale or supply of the product by the supplier/manufacturer of the assessee company, we find this is not simply a situation of a product manufactured to the specifications of the assessee, being sold to the assessee at the price fixed by the supplier but this is a situation where a product manufactured out of raw materials supplied by a foreign company who had direct interest in the assessee company so manufactured to the specification of the assessee company utilising the technical know-how supplied by it also labelling the product with the brand name of the assessee and supplying the entire product only to the assessee company and not to anyone else and it is throughout to be held as a specific contract for manufacturing of a particular product notwithstanding the fact that the supplier had paid the price for the raw-material directly to the foreign company which supplied the raw material to the manufacturer, but had interest in the assessee company in India while bearing the trade mark of the foreign supplier, but having a definite communication and in such a situation one has to really look into the real nature of the transaction that emerges on the conjoint reading of the three agreements and the assessing officer in fact having undertaken this exercise and having arrived at the conclusion that the assessee company is one who fits into the definition and situation contemplated u/s.194C of the which on an examination is found is a proper reasoned approach and in consonance with the statutory provision. We answer the questions posed for our examination in the negative and in favour of the revenue.

22. We are also of the view that the situation contemplated u/s.194C of the Act i.e. the payment being carrying out any work which is to improve the situation of such nature and of course preceded between the contract between the assessee and the manufacturer company.

23. In the circumstance, we hold that it was a situation where the provisions of Section 194C of the Act applied to the assessee and is clearly attracted to the present situation. The assessing authority has rightly applied the provisions of Section 194 of the Act to the present situation and has very correctly estimated the interest payable in terms of Section 201 (A) and the Appellate Commissioner and the Tribunal are in error in taking the contrary view particularly, in the facts and circumstances of the case and therefore, the orders passed by the Appellate Tribunal and the Appellate Authority are both set aside and the order passed by the Assessing authority is restored.

The appeal is allowed. However, the parties to bear their own cost

Regards,

Praveen Boda

Taxability in respect of International Private Leased Circuit (IPLC)--Telegraph Authority u/s 65 (111) of the Finance Act, 1994 – reg

2012-01-03T06:59:00.000+05:30

F. No. 137/21/2011 – Service Tax

Government of India

Ministry of Finance

Department of Revenue

(Central Board of Excise & Customs)

New Delhi,

Dated: December 19, 2011

Subject: Taxability in respect of International Private Leased Circuit (IPLC) charges and amendment in the definition of Telegraph Authority u/s 65 (111) of the Finance Act, 1994 – reg.

Please refer to the clarifications issued vide Board's letter of even number dated 15.07.2011 on the subject mentioned above.

2. The matter has been re-examined and it is seen that the IPLC is specifically covered by the definition of the telecommunication service given in clause 65 [109a(iv)] of the Finance Act, 1994. As per the said section these services are taxable only when provided by a person who has been granted a licence under the first proviso to sub-section (1) of section 4 of the Indian Telegraph Act, 1985. It is only because the foreign telecom service provider cannot constitute a telegraph authority under an Indian law that they remain outside the taxability clause of the telecommunication service.

3. Therefore, the view taken in the said letter that what otherwise constitutes a “telecommunication service” would amount to “business support service” is erroneous.

4. The clarification issued vide the above mentioned letter stands corrected accordingly.

Deepankar Aron

Director (Service Tax)

CBEC, New Delhi

Clarification issued earlier in Julu 2011:

F.No.137/21/2011-Service Tax

Government of India

Ministry of Finance

Department of Revenue

Central Board of Excise & Customs

New Delhi

Dated: July 15, 2011

Subject: Taxability in respect of International Private Leased Circuit (IPLC)charges and amendment in the definition of Telegraph Authority u/s 65 (111) of the Finance Act, 1994-reg.

1.Representations have been received seeking clarification regarding taxability of IPCL charges incurred in foreign currency by BPO/MNCs against receipt of services from the service provider situated outside India/group companies under reverse charge mechanism [Section 66A of the Finance Act, 1994 read with Rule 2 (1) (d) (iv) of the Service Tax Rules 1994].

2. The matter has been examined. The activities are in the nature of Leased Circuit services presently covered under Telecommunication service. However, for getting classified under Telecommunication service, Section 65 (105 (zzzx) of the Finance Act, 1994 provides that the service should be provided by a Telegraph authority. Telecommunication service as defined under Section 65 (109a) covers services which are provided by a person who has been granted a licence under the first proviso to sub-section (I) of section 4 of the Indian Telegraph Act, 1885. In this situation in the instant case since the service provider is located abroad, he is not covered under the definition given in Section 65 (109a), Thus the service provided by foreign vendors cannot be taxed under Telecommunication service.

3. Section 65 (105) (zzzq) read with Section 65 (104c) of the Finance Act, 1994, defines Business Support Service as services provided in relation to business or commerce and includes evaluation of prospective customers, telemarketing, processing of purchase orders and fulfilment services, information and tracking of delivery schedules, managing distribution and logistics, customer relationship management services, accounting and processing of transactions, operational assistance for marketing, formulation of customer service and pricing policies, infrastructural support services and other transaction processing.

Explanation - For the purposes of this clause, the expression "infrastructural support services" includes providing office along with office utilities, lounge, reception with competent personnel to handle messages, secretarial services, internet and telecom facilities, pantry and security.

4. It is clarified that the above activity of receiving IPCL service from abroad is chargeable to Service Tax under Business Support Service [Section 65 (105)(zzzq) ibid] at the hands of recipients situated in India in terms of Section 66A of the Finance Act, 1994, read with Rule 2 (1) (d) (iv) of the Service Tax Rules. 1994 and provisions of Taxation of Services (Provided) From Outside India and Received in India, Rules 2006 apply.

All pending issues may be decided accordingly.

(R K Kapur)

OSD (Service Tax)

CBEC, New Delhi

S. 9: Profits from offshore supply of equipment & software not taxable in India--Delhi HC

2011-12-27T09:48:00.000+05:30

DIT vs. Ericsson AB (Delhi High Court)

The assessee, a Swedish company, entered into contracts with ten cellular operators for the supply of hardware equipment and software. The contracts were signed in India. The supply of the equipment was on CIF basis and the assessee took responsibility thereof till the goods reached India. The equipment was not to be accepted by the customer till the acceptance test was completed (in India). The assessee claimed that the income arising from the said activity was not chargeable to tax in India. The AO & CIT (A) held that the assessee had a “business connection” in India u/s 9(1)(i) & a “permanent establishment” under Article 5 of the DTAA. It was also held that the income from supply of software was assessable as “royalty” u/s 9(1)(vi) & Article 13. On appeal, the Special Bench of the Tribunal (Motorola Inc 95 ITD 269 (Del)) held that as the equipment had been transferred by the assessee offshore, the profits therefrom were not chargeable to tax. It was also held that the profits from the supply of software was not assessable to tax as “royalty”. On appeal by the department to the High Court, HELD dismissing the appeal:

(i) The profits from the supply of equipment were not chargeable to tax in India because the property and risk in goods passed to the buyer outside India. The assessee had not performed installation service in India. The fact that the contracts were signed in India could not by itself create a tax liability. The nomenclature of a “turnkey project” or “works contract” was not relevant. The fact that the assessee took “overall responsibility” was also not material. Though the supply of equipment was subject to the “acceptance test” performed in India, this was not material because the contract made it clear that the “acceptance test” was not a material event for passing of the title and risk in the equipment supplied. If the system did not conform to the specifications, the only consequence was that the assessee had to cure the defect. The position might have been different if the buyer had the right to reject the equipment on the failure of the acceptance test carried out in India. Consequently, the assessee did not have a “business connection” in India. The question whether the assessee had a “Permanent Establishment” was not required to be gone into (Ishikawajma Harima 288 ITR 408 (SC), Skoda 172 ITR 358 (AP) & Mahavir Commercial 86 ITR 147 followed);

(ii) The argument that the software component of the supply should be assessed as “royalty” is not acceptable because the software was an integral part of the GSM mobile telephone system and was used by the cellular operator for providing cellular services to its customers. It was embedded in the equipment and could not be independently used. It merely facilitated the functioning of the equipment and was an integral part thereof. The fact that in the supply contract, the lump sum price was bifurcated is not material. There is a distinction between the acquisition of a “copyright right” and a “copyrighted article” (Tata Consultancy Services 271 ITR 401 (SC) Sundwiger EMFG 266 ITR 110 & Dassault Systems 229 CTR 125 (AAR) followed).

Source: ITATOnline

Changes in e-furnishing form 15CA

2011-12-27T09:35:00.000+05:30

Procedure for furnishing information under sub-section (6) of section 195 of the Income-tax Act, 1961 read with rule 37BB of the Income-tax Rules, 1962.

General:

Form 15CA should be used for furnishing information of remittances in e-mode in accordance with the provisions of section 195 (6) of the Income-tax Act, 1961. The information should be furnished after obtaining a certificate in Form 15CB from an accountant as defined in the Explanation to section 288 of the Income-tax Act, 1961. The print out Form 15CA should be signed and submitted to the Reserve Bank of India/authorized dealer prior to remitting the payment.

Tin.nsdl has changed some guidelines for e-furnishing form 15CA. There are some changes in the form 15CA with which e-furnishing of the form 15CA will be completely different. The guidelines for e-furnishing form 15 CA are as follows.

Procedure for furnishing information under sub-section (6) of section 195 of the Income-tax Act, 1961 read with rule 37BB of the Income-tax Rules, 1962.

• The Form should be furnished at the website of the Tax Information Network www.tin-nsdl.com.

• Fields marked with (*) are mandatory.

• Select the values from the drop down wherever provided.

• Each transaction detail should be filled in separately.

Guidelines for Part A of Form 15CA:

Remitter:

• Permanent Account Number (PAN) and Tax Deduction and collection Account Number (TAN) allotted by the Income Tax Department should be mentioned. TAN is mandatory in cases where-

a)tax has been deducted or will be deducted at source;

b)the remitter has obtained an order under section 195 (2) of the Income-tax Act from the Assessing Officer.

• In case an invalid PAN and/or TAN is filled in by the remitter, the Form will not be generated.

• In case the remitter does not have a TAN, it is mandatory to quote PAN of the remitter.

• PAN of the remitter should invariably be given. However, the same is mandatory if status of entity is Company or Firm. If PAN is not given in such cases, the remitter will not be allowed to generate the Form.

• Details in at least two address fields for remitter should be mentioned.

• Name of the entity should be mentioned in the “Name of remitter” field.

• No value is to be provided in Area code, AO type, Range code & AO number. The fields will be entered by the system after validating the PAN and/or TAN.

• Email id and mobile no., if any, should be provided.

Recipient of remittance:

• Complete address of recipient of remittance, separated by coma, should be provided.

• PAN, allotted by the Indian Income Tax Department should be mentioned.

• If status of entity is “company”, then provide type of company i.e., “domestic” or “other than domestic”.

• In the field “ Principal Place of Business”, the country of tax residence of the recipient of the remittance should be mentioned.

Information for accountant:

• Enter name of the Chartered Accountant in the field “Name of the accountant”.

• Details in at least two address fields should be mentioned.

• Date of certificate should not be a future date.

• Registration no. should be numeric.

• Details of accountant are not required if point no. 15 is selected i.e. any order u/s 195 (2)/ 195 (3)/ 197 of the Income-tax Act has been obtained from Assessing Officer.

• Certificate number is an alphanumeric field.

Guidelines for PART B of the Form (Particulars of Remittance and TDS):

• Provide the values as per the accountant certificate obtained in Form 15CB.

• In case name of the country is not available in drop down list, select value “other” from the drop down and provide name of the country.

• In case currency name is not available in drop down then select value “other” from the drop down and provide name of the currency.

• Proposed date of remittance should be current date or a future date.

• Amount of TDS should be less than amount of remittance.

• Actual amount of remittance after TDS should be less than amount of remittance.

• Select type of the bank:

- Indian Bank (Bank of India, Dena Bank, Kotak Mahindra Bank Ltd. etc.)

- Foreign Bank (Standard Chartered Bank, HSBC, Citi Bank etc.)

• In case of “Indian Bank”, user will be required to provide “Name of the branch” and “BSR code”

• In case of “Foreign Bank”, user will be required to provide details of location of bank as below:

- Located in India

- Located outside India

• In case of foreign bank located in India, user will be further required to provide “Name of the branch” and “BSR code”

• In case of foreign bank located outside India, user will be further required to provide:

- Name of the branch

- BSR code (This will be optional)

- Code of branch (This will be mandatory)

• Rate of TDS as per DTAA (if applicable) should be mentioned upto two decimal places.

• Amount should be mentioned upto 2 decimal places.

• Select any one out of fields 12, 13, 14 and 16. One form is to be filled for one type of remittance.

• Details of “responsible person” should be mentioned for verification.

• If no tax has been deducted then value “0.00” should be mentioned in “Amount of TDS” field (foreign currency and Indian Rs.)

• Value for “rate of deduction as per the Income-tax Act” should be “0.00” if no tax has been deducted and “amount of TDS in Indian and foreign currency” should be “0.00”.

Generation of Form 15CA:

• After filling up the information, click “submit”. On submission of details if system shows any errors, rectify and re-submit the form

• A confirmation screen with all the data filled by the user will be displayed. The same can be either confirmed or edited.

• On confirmation, a filled up Form 15CA with an acknowledgement number will be displayed. Print out of the Form should be taken, signed and submitted prior to remitting the payment.

• Form 15CA can be re-printed by selecting the re-print option. For re-printing, please enter “acknowledgement no.”, “PAN” and/or “TAN” mentioned in the Form.

Set-off” of export receivables against import payables-Liberalization of Procedure

2011-11-18T17:50:00.001+05:30

RBI/2011-12/264

A.P. (DIR Series) Circular No. 47

November 17, 2011

To

All Category – I Authorized Dealer Banks

Madam/Sir,

“Set-off” of export receivables against import payables-Liberalization of Procedure

Attention of Authorized Dealer Category – I (AD Category – I) banks is invited to the fact that the requests received from the exporters through their AD branches for set-off of export receivables against import payables are considered by the Reserve Bank of India. As a measure of further liberalization, it has been decided to delegate power to AD Category – I banks to deal with the cases of “set-off” of export receivables against import payables, subject to following terms and conditions:

a.The import is as per the Foreign Trade Policy in force.

b.Invoices/Bills of Lading/Airway Bills and Exchange Control copies of Bills of Entry for home consumption have been submitted by the importer to the Authorized Dealer bank.

c.Payment for the import is still outstanding in the books of the importer.

d.Both the transactions of sale and purchase may be reported separately in ‘R’ Returns.

e.The relative GR forms will be released by the AD bank only after the entire export proceeds are adjusted / received.

f.The ” set-off” of export receivables against import payments should be in respect of the same overseas buyer and supplier and that consent for ”set-off” has been obtained from him.

g.The export / import transactions with ACU countries should be kept outside the arrangement.

h.All the relevant documents are submitted to the concerned AD bank who should comply with all the regulatory requirements relating to the transactions.

2. AD Category – I banks may bring the contents of this circular to the notice of their constituents and customers concerned.

3. The directions contained in this circular have been issued under Sections 10(4) and 11(1) of the Foreign Exchange Management Act, 1999 (42 of 1999) and are without prejudice to permissions / approvals, if any, required under any other law.

Yours faithfully,

(Dr. Sujatha Elizabeth Prasad)

Chief General Manager

Expenditure on ‘Application Software’ is revenue in nature

2011-11-06T22:43:00.000+05:30

CIT vs. Asahi India Safety Glass Ltd (Delhi High Court)

The assessee, engaged in manufacturing safety glass, entered into an agreement with Arthur Anderson for installation of the “Oracle” software application for financial accounting, inventory and purchase. A Master Software Licence and Services Agreement was also entered into with Oracle. The assessee incurred expenditure of Rs. 1.36 crores & Rs. 1.70 crores in AY 1997-98 & 1998-99. While in the books the expenditure for AY 1997-98 was capitalized, the expenditure for AY 1998-99 was treated as “deferred revenue expenditure”. The AO rejected the claim for deduction of the entire expenditure on the ground that it had resulted in “enduring benefit” and was “capital” in nature though the CIT (A) & Tribunal allowed the claim on the ground that the expenditure had not resulted in creation of new asset or a new source of income. On appeal by the department to the High Court, HELD dismissing the appeal:

(i) The test of enduring benefit is not a certain or a conclusive test which the courts can apply almost by rote. What is required to be seen is the real intent and purpose of the expenditure and whether the expenditure results in creation of fixed capital for the assessee. Expenditure incurred which enables the profit making structure to work more efficiently leaving the source of the profit making structure untouched is expense in the nature of revenue expenditure. Fine tuning business operations to enable the management to run its business effectively, efficiently and profitably; leaving the fixed assets untouched is of revenue expenditure even though the advantage may last for an indefinite period. Test of enduring benefit or advantage collapses in such like cases especially in cases which deal with technology and software application which do not in any manner supplant the source of income or added to the fixed capital of the assessee (Alembic Chemical Works 177 ITR 377 followed);

(ii) On facts, the expenditure was for overhauling the accountancy and to efficiently train the accounting staff. It was incurred under various sub-heads such as licence fee, annual technical support fee, professional charges, data entry operator charges, training charges and travelling expenses. None of these resulted in either creation of a new asset or brought forth a new source of income for the assessee. The software was “application software” which enabled it to execute tasks in the field of accounting, purchases and inventory maintenance more efficiently;

(iii) The fact that the expenditure was not written off in the books/ treated as ‘deferred revenue’ is irrelevant (Kedar Nath Jute vs CIT 82 ITR 363 (SC) followed)

Payment on shrink-wrapped software is royalty, rules High court of Karnataka

2011-10-17T20:01:00.003+05:30

Payment on shrink-wrapped software is royalty, rules High court of Karnataka

‘Firms have an obligation to deduct tax at source from the amount paid'

In a major setback to information technology companies, the Karnataka High Court on Saturday ruled that payments made by these firms in India to their foreign software suppliers would amount to “royalty” and the companies had an obligation to deduct tax at source from the amount that they paid .

This order enables the Income Tax Department to recover tax dues from major IT companies from 2000 onwards, which may run into crores of rupees.

A Division Bench, comprising Justice V.G. Sabhahit and Justice Ravi Malimath, passed the order while allowing an appeal by the I-T Department, challenging the 2005 order of the Income Tax Appellate Tribunal.

The tribunal, on appeals by major IT companies, including Wipro, Infosys, HP, Samsung, Sonata, GE India and others, had said that the payment did not attract tax in India as there was no permanent establishment of non-resident foreign suppliers here.

Purchase

The IT companies, which had purchased software from Microsoft and other foreign companies, claimed that the software imported by them were shrink-wrapped products and the same was not customised.

Hence no tax was deducted on the payment made to the foreign suppliers as it was not taxable in India.

However, the I-T Department contended that the payment amounted to “royalty” and hence IT companies had an obligation to deduct tax at source under Section 195(1) of the Income Tax Act. The IT companies argued that this transaction did not come under the purview of royalty.

The court found that what had been transferred through the shrink-wrapped software to the IT companies was only the licence to use the copyright belonging to the non-resident companies, subject to various terms and conditions , which ultimately authorised the end-users to make use of the copyright software.

Transfer

“This would amount to transfer of part of the copyright and transfer of right to use the copyright for internal use of the IT companies as per the terms and conditions,” the court said while refusing to accept the contention that there was no transfer or copyright or part of copyright.

Right

“We hold that the right to make a copy of the software and use it for internal business by making a copy, storing it in the hard disk of the designated computers and taking back-up would itself amount to copyright under Section 14 (1) of the I-T Act and licence is granted to use the software by making copies, which work, but for licence granted would have constituted infringement of copyright and having obtained licence, the companies are in possession of legal copy of the software.

The price of this software is not the price of the compact disc alone or software alone nor the price of licence granted. This is a combination of all in substance. Unless the licence is granted permitting the end-users to copy and download the software, the dumb CD containing software would not have any help to the end users (IT companies) as software would be operative only if it is downloaded to a designated computer as per terms and conditions,” the court said while pointing out that this aspect make out the difference between the computer software and the copyright.

Ruling

Based on this observation, the court held that payments made by IT companies to non-resident foreign companies for supply of shrink-wrapped software would amount to “royalty” within the meaning of the Article 12 of the Double Taxation Avoidance Agreement with the respective foreign countries and that the payment made by way of royalty attracted income tax under Section 9(1) of the I-T Act.

________________________________________

• Order enables I-T Department to recover tax dues from major IT companies

• The tax dues from 2000 will run into crores of rupees

Source: THE HINDU

Accreditation Fee Paid to UK Co--Not a 'Royalty' Income

2011-09-22T19:56:00.000+05:30

Assistant Commissioner of Income-tax, Central Circle 41, Mumbai v. Anchor Health and Beauty Care (P.) Ltd

Facts:

The assessee was engaged in the business of manufacturing and trading of tooth powder, tooth paste, tooth brush and other health care products. During the impugned assessment year it had made payment to a British Dental Foundation 'B' towards accreditation panel fees. The Foundation was a UK based registered charitable institution. The foundation was stated to, inter alia, evaluate consumer oral health care products to ensure that manufacturers' product claim were clinically proven and not exaggerated. As a result of the accreditation granted by the Foundation, the assessee was allowed to use that fact of approval in the marketing of its products. Assessing Officer observed that the payment made by assessee to the Foundation, was in nature of royalty and assessee was obliged to deduct the tax at source from the same, which was not deducted by the assessee.

He further observed that 'the assessee had not submitted any certificate in proof that the amount was not taxable in India', and that 'in view of the above, the expenditure was disallowed under section 40(a)(i), and, was accordingly added to the income of the assessee. On appeal, Commissioner (Appeals) deleted the addition made by Assessing Officer holding that the Foundation, did not had any permanent establishment in India and the amount paid to them could not be treated as royalty.

On revenue's appeal:

CASES REFERRED TO

GE India Technology Centre (P.) Ltd. v. CIT [2010] 327 ITR 456/193 Taxman 234 (SC) (para 5).

Pramod Kumar, Accountant Member. - The short issue that we are required to adjudicate in this appeal is whether or not the CIT(A) was justified in deleting the impugned disallowance of Rs. 11,71,826 under section 40(a)(i) of the Income-tax Act, 1961. The assessment year involved is 2004-05, and the impugned assessment was framed under section 143(3) of the Act.

2. It is a recalled matter. Originally, this appeal was disposed of ex parte, though by an elaborate and reasoned order, by the learned Vice President in SMC bench, but, upon the matter having been recalled at the instance of the assessee respondent, the appeal has been transferred to this division bench. That is how we have come to be in seisin of the matter, and that is how the appeal has once again come up for hearing on merits.

3. Let us first take a look at the developments leading to this litigation before us. The assessee before us is engaged in the business of manufacturing and trading of tooth powder, tooth paste, tooth brush and other health care products. During the course of scrutiny assessment proceedings, the Assessing Officer noticed that the assessee has paid a sum of Rs. 11,71,826 as accreditation panel fees to British Dental Health Foundation UK, but has not deducted tax at source from the same. On these facts, when the assessee was required to show cause as to why disallowance not be made under section 40(a)(i) in respect of the said payment having been made without deduction of tax at source, it was submitted by the assessee that as the recipient of income was not liable to be taxed, in respect of this income in India, no tax was required to be deducted at source by the assessee. It was in effect contended that disallowance under section 40(a)(i) can only be made when taxes are deductible but not deducted. However, this submission did not find any favour from the Assessing Officer. He was of the view that the aforesaid contention of the assessee "is not correct because, as per section 195 of the Income-tax Act, 1961, tax has to be deducted at source while remitting the monies outside India" . He further observed that "the assessee has not submitted any certificate in proof that the amount is not taxable in India", and that "in view of the above, the expenditure of Rs. 11,71,826 is disallowed under section 40(a)(i), and, is accordingly added to the income of the assessee". Aggrieved by the disallowance so made, assessee carried the matter in appeal before the CIT(A). Learned CIT(A) was of the view that as the British Dental Health Foundation did not have any permanent establishment and as the amounts paid to them could also not be treated as 'royalties' , the payment so made to the BDHF could not indeed be taxed in India. Learned CIT(A) further noted that since the BDHF did not have any tax liability in respect of these payments, and the assessee did not , therefore, have any obligation to deduct tax at source from this payment, disallowance under section 40(a)(i) was not sustainable in law. The impugned disallowance was thus deleted. The Assessing Officer is aggrieved of the relief so granted by the CIT(A) and is in appeal before us.

4. We have heard the rival contentions, perused the material on record and duly considered facts of the case in the light of applicable legal position.

5. We find that, as held by Hon'ble Supreme Court in the case of GE India Technology Centre (P.) Ltd. v. CIT [2010] 327 ITR 456/193 Taxman 234, tax deduction at source obligations under section 195(1) arise only if the payment is chargeable to tax in the hands of non-resident recipient. Therefore, merely because a person has not deducted tax at source from a remittance abroad, it cannot be inferred that the person making the remittance has committed a failure in discharging his tax withholding obligations because such obligations come into existence only when recipient has a tax liability in India. The underlying principle is this. Tax withholding liability of the payee is inherently a vicarious liability, on behalf of the recipient, and, therefore, when recipient does not have the primary liability to be taxable in respect of income embedded in the receipt, the vicarious liability of the payer cannot but be ineffectual. This vicarious tax withholding liability cannot be invoked unless primary tax liability of the recipient is established. Just because the payer has not obtained a specific declaration from the revenue authorities to the effect that the recipient is not liable to be taxed in India in respect of income embedded in particular payment, howsoever desirable be that practice, the Assessing Officer cannot proceed on the basis that the payer had an obligation to deduct tax at source. He still has to demonstrate and establish that the payee has a tax liability in respect of the income embedded in the impugned payment. That exercise was not carried out by the Assessing Officer on the facts of this case. The Assessing Officer was thus clearly in error in proceeding to invoke disallowance under section 40(a)(i) on the short ground that the assessee did not deduct tax at source from the foreign remittance. To that extent, CIT(A) was justified in deleting the impugned disallowance.

6. However, while on this issue, it is also necessary to consider is whether the assessee indeed had an obligation to deduct tax at source from the remittance of Rs. 11,71,826 to British Dental Health Association UK.

7. The assessee had made the payment of Rs. 11,71,826 to British Dental Health Association towards accreditation panel fees. BDHF is a UK based registered charitable institution. This Foundation is stated to, inter alia, "evaluate consumer oral health care products to ensure that manufacturers' product claims are clinically proven and not exaggerated" and "an independent panel of internationally recognised dental experts" is stated to "study all the claims carefully to make sure they are true, and backed up by reliable scientific evidence". As a result of the accreditation granted by the BDHF, the assessee is allowed to use this fact of BDHF approval in the marketing of its products. The question that we actually need to decide is whether the amount so received by BDHF, in consideration of the accreditation, can be brought to tax in India?

8. It is not even in dispute that BDHF does not have any permanent establishment in India, and the assessee has also filed a certificate to that effect as issued by the BDHF. It is also not in dispute that the provisions of the India United Kingdom Double Taxation Avoidance Agreement (206 ITR Stat 235; 'India UK tax treaty', in short) apply to the facts of this case, and that, these provisions being beneficial to the assessee vis-à-vis the provisions of the Income-tax Act, the treaty provisions will apply. Considering the fact that the payee does not have any PE in India, within meanings of that expression under Article 5 of Indo UK tax treaty, and this assertion has not been challenged by the revenue authorities, the income embedded in the accreditation fees cannot be brought to tax in India as business profits under Article 7. Learned Departmental Representative also does not dispute this. His only defence is that even if it is not taxed as business profits, it is at least taxable as 'royalties', since the assessee derives valuable advantage from the accreditation by BDHF and use the same as a marketing tool. However, we find that the scope of expression 'royalty', for the purposes of India UK tax treaty, is quite restricted as scope as evident from the provisions of Article 13(3) as reproduced below:

"(3) For the purposes of this Article, the term 'royalties' means:

(a) payments of any kind received as a consideration for the use of, or the right to use, any copyright of a literary, artistic or scientific work, including cinematograph films or work on films, tape or other means of reproduction for use in connection with radio or television broadcasting, any patent, trademark, design or model, plan, secret formula or process, or for information concerning industrial, commercial or scientific experience; and

(b) payments of any kind received as consideration for the use of, or the right to use, any industrial, commercial or scientific equipment, other than income derived by an enterprise of a Contracting State from the operation of ships or aircraft in international traffic.

9. While clause (b) of the definition of clearly inapplicable on the facts of this case as this clause deals with the equipment leasing only, clause (a) also does not deal with a situation in which the accreditation or approval granted by a resident is used, in another country, for promoting the sales. This accreditation does not allow the accredited product to use, or have a right to use, a trademark, nor any information concerning industrial, commercial or scientific experience - or, for that purpose, use or right to use of anything falling in any other category of clause (a). An accreditation or approval by a reputed body may give certain comfort level to the end users of the product, and thus may constitute a USP (i.e. unique selling proposition) to that extent, but it may also be, therefore, used for the purposes of marketing of the products, but, legally speaking, the payment made for such an accreditation is not covered the definition of 'royalty' as set out in Article 13(3) of India UK tax treaty. Learned Departmental Representative's argument is that in substance the payment for BDHS accreditation is nothing but a royalty to use their name for marketing, and, therefore, this payment should be treated as a payment of royalty. We see no substance in this simplistic plea. When an expression has been defined in law, and the impugned payment is not covered by such a specific definition, it cannot be open to us to look at normal connotations of this expression in business parlance. Simply because assessee is benefited by this accreditation, and the assessee uses the same for its marketing purposes, the character of payment cannot be classified as 'royalty'. The expression 'royalty' is neatly defined under Article 13(3) of Indo UK tax treaty, and unless the payment fits into the description set out in Article 13(3), it cannot be termed as 'royalty' for the purposes of examining its taxability under the tax treaty. In our considered view, on the facts of the case, the impugned remittance is in the nature of business profits in the hands of the UK based recipient, and since the recipient admittedly did not have any permanent establishment in India, the same is not taxable in India. In our considered view, therefore, the recipient did not have any primary tax liability in India, as a corollary thereto, the assessee did not have tax withholding obligations from this remittance.

10. For the foregoing reasons, we approve the conclusions arrived at by the learned CIT(A) and decline to interfere in the matter.

11. In the result, the appeal is dismissed.

Taxability of Cost Contribution Agreements

2011-09-15T21:28:00.000+05:30

Dresser-Rand India Pvt Ltd vs. ACIT (ITAT Mumbai)

The assessee entered into a ‘cost contribution agreement’ with its parent company pursuant to which it paid a sum of Rs. 10.55 crores as its share of the costs. The TPO, AO & DRP disallowed the expenditure on the ground that (i) the ALP was ‘Nil’ as no real services had been availed by the assessee and the arrangement was not genuine, (ii) the cost sharing could not be on the basis of head count but on the basis of actual services availed by the assessee, (iii) the expenditure was “excessive & unreasonable” u/s 40A(2) and (iv) as there was no TDS, the disallowance u/s 40(a)(i) had to be made. The assessee also rendered field services to its associated enterprises where it granted a discount of 10% over the price charged to third parties on the basis that such discount was a part of reciprocal global policy. It was held that the ALP had to be computed by ignoring the discount. On appeal by the assessee, HELD:

(i) The TPO was not entitled to determine the ALP under the cost contribution agreement at “Nil” on the basis that the assessee did not need the services at all. How an assessee conducts his business is entirely his prerogative and it is not for the revenue authorities to decide what is necessary for an assessee and what is not. The TPO went beyond his powers in questioning the commercial wisdom of the assessee’s decision to take benefit of its parent company’s expertise. Further, the TPO’s argument that the assessee did not benefit from the services is irrelevant because whether there is benefit or not has no bearing on the ALP of the services. The fact that similar services may have been granted in the past on gratuitous basis is also irrelevant in determining the ALP. The argument that no evidence of services having been rendered was produced is not acceptable because the assessee did produce voluminous evidence before the DRP which was not dealt with. The DRP ought to have dealt with the material and given reasons. Matter remanded to the AO to determine actual rendering of services (Vodafone Essar Ltd vs. DRP 240 CTR 263 (Del) followed);

(ii) A cost contribution arrangement has to be consistent with the arm’s length principle. The assessee’s share of overall contribution to costs must be consistent with the benefits expected to be received, as an independent enterprise would have assigned to the contribution in hypothetically similar situation. The TPO’s objection that the cost should be shared in the ratio of actual use of services and should be charged as per Indian employee costs is not acceptable. There is no objective way in which the use of services can be measured and as is the commercial practice even in market factors driven situation, the costs are shared in accordance with some objective criterion, including sales revenues and number of employees. The question of charging as per domestic employee costs cannot be a basis of allocating the costs because such an allocation will deal with some hypothetical pricing whereas the allocations are to be done for the actual costs incurred;

(iii) The disallowance of payment under the ‘cost contribution agreement’ u/s 37(1) & 40A(2) is not justified because the payment did not involve mark-up and was at arms length price. The services were for furtherance of the assessee’s business interests;

(iv) The disallowance of payment u/s 40(a)(i) for want of TDS is not justified because the payment was not taxable in the AE’s hands under Article 5 & 12 of the India-USA DTAA as the AE did not have a PE and the services did not constitute “fees for included services”. (GE India Technology Centre 327 ITR 456 (SC) followed);

(v) The TPO’s argument that in charging for the services rendered to the AE, a 10% discount could not be given is not acceptable because (i) the assessee had followed the TNMM for determination of ALP which had not been disputed as the appropriate method, (ii) Even under CUP, all sales need not be at the same price and there can be variations of prices for the same product or services on grounds such as quantum of business, risk factors, etc. Discount is a normal occurrence even in independent business situations. The material factor is whether the 10% discount is an arm’s length discount and there is nothing on record to suggest that it is not so.

Profits attributable to “Dependent Agent Permanent Establishment” Taxable in India

2011-09-09T15:08:00.000+05:30

Rolls Royce Singapore Pvt Ltd vs. ADIT (Delhi High Court)

The assessee, a Singapore company, rendered repair and maintenance services and supplied spares to customers in India. While the income from repairs was offered to tax as “fees for technical services“, the income from supply of spares was claimed to be not taxable on the ground that it had accrued outside India. The AO, CIT (A) and Tribunal took the view that the assessee had a “permanent establishment” on the basis that it had a “dependent agent” in India under Article 5(9) of the India-Singapore DTAA and that the income earned from supplying spare parts was taxable in India. The AO held that 25% of the profits on sales of spare parts were chargeable to tax which was reduced to 10% by the CIT (A) & the Tribunal. On appeal to the High Court, HELD:

(i) To constitute a “Dependent Agent Permanent Establishment” under Article 5(9) of the DTAA it has to be seen whether the activities of the agent are “devoted wholly or almost wholly on behalf of the assessee“. While the issues as to (a) whether the agent is was prohibited from taking competitive products and (b) whether the assessee exercised extensive control over the agent were relevant, they are not conclusive. It is not correct to say that merely because the agent is prohibited from taking a competitive product means that it is not an agent of independent status. What has to be seen is whether the “activities” of the agent are devoted wholly or almost wholly on behalf of the assessee. If the assessee can show that it was not the sole client of the agent and that activities of the agent were not devoted wholly or almost wholly on behalf of the assessee, there may be no DAPE. The income earned by the agent from other clients and the extent of such income is very relevant to decide whether the criteria stipulated in Article 5(9) is satisfied or not. (Matter remanded for fresh consideration);

(ii) While in principle it is correct that if a fair price is paid by the assessee to the agent for the activities of the assessee in India through the DAPE and the said price is taxed in India at the hands of the agent, then no question of taxing the assessee again would arise, this is subject to a Transfer Pricing Analysis being undertaken u/s 92. The facts showed that the manner in which the commission/ remuneration had been fixed was usually not done between independent parties in an uncontrolled transaction. The assessee was in a position to dictate terms to the agent and so it could not be said that the commission was at “arms length” within the meaning of Article 7 (2) of the DTAA. The Transfer Pricing analysis to determine the “arms length” price has to be done by taking the “Functions, Assets used and Risk involved” (FAR). As this has not been done, the assessee’s argument on “arms length” price is not acceptable (Morgan Stanley 292 ITR 416 (SC) & Set Satellite (Singapore) 307 ITR 205 (Bom) distinguished);

(c) As the commission paid by the agent to the DAPE is not at “arms length“, the estimation that 10% of the profits on sales of spare parts were attributable to the activities carried out by the agent in India and taxable is reasonable. The test is “profits expected to make” and has to be determined bearing in mind the fact that the agent was merely rendering support services and had no authority to negotiate and accept contracts and also assumed limited risk.

Payment made by the resident company to KPMG, Brazil for assisting in the acquisition of sugar mills in Brazil is not “Fees for Technical Services

2011-08-28T10:35:00.000+05:30

The payment made by the resident company to KPMG, Brazil for assisting in the acquisition of sugar mills in Brazil is not “Fees for Technical Services”. Hence, the assessee is not liable to deduct TDS, as held by MumTrib in ITO(IT)-TDS-3 v Bajaj Hindustan Ltd — In favour of: The assessee.

12 August 2011.

ITO(IT)-TDS-3 v Bajaj Hindustan Ltd.

ITAT BENCH “L”, MUMBAI

ITA No. 63/MUM/09(2007-08)

1. This is an appeal by the assessee against the order dated 17/9/2008 of CIT(A) 33 Mumbai relating to assessment year 2007-08.

2. The assessee is a company. It is engaged in the business of manufacturing of sugar. According to the assesse, it engaged the services of M/s. KPMG Corporate Finance Ltd.,
Brazil (KPMG)(Non-Resident), to advice and assist the assessee in acquisition of Sugar Mills/Distilleries in Brazil. In connection with the services rendered by KPMG for the said
purpose, the assessee had made payment to KPMG. The question before the ITO (International Taxation),TDS-3, Mumbai (AO), was as to whether the Assessee was bound to deduct tax at source on the payment made to KPMG in terms of Sec.195 of the Income Tax Act, 1961 (the Act). That would again depend on the question whether the payment by the Assessee to KPMG would be taxable in the hands of KPMG in India.

3. According to Sec.9 of the Act, the following incomes shall be deemed to accrue or arise in India.

(vii) income by way of fees for technical services payable by……..

(b) a person who is a resident, except where the fees are payable in respect of services utilized in a business or profession carried on by such person outside India or for the
purposes of making or earning any income from any source outside India; or The aforesaid clause (b) provides two exceptions. In the first case, the payment if made by a
resident for services which are utilized in a business or profession carried out by such person outside India, then the said payment would not be deemed to be income accruing or arising to the payee in India. The second exception envisaged by clause(b) of Sec.9(1)(vii) of the Act, is if the payment is made by a resident for the purpose of making or earning any income from any source outside India, then the said payment would not be deemed to be income accruing or arising to the payee in India.

4. The AO was of the view that the assessee ought to have deducted tax at source on the payment made to KPMG. According to the AO the amount received from the assessee by
KPMG was in the nature of fees for technical services rendered. The AO was also of the view that in terms of section 9(1)(vii) of the Income Tax Act, 1961(the Act) income by way of Fees for Technical Services (FTS) payable to a person who is a resident shall be income deemed to accrue or arise in India. According to the AO the payment by the assessee to KPMG did not fall within the exceptions and, therefore, the payment would be income which accrues or arises in India in the hands of KPMG chargeable to tax. The AO therefore held that since the amount was chargeable to tax in India in the hands of KPMG, the assessee in the terms of section 195 of the Act ought to have deducted tax at source on the payment made to KPMG.

Since the assessee had not done so the AO treated the assessee as an assessee in default and passed an order for recovery of the taxes that ought to have been deducted and interest thereon in terms of section 201(1) and 201(1A) of the Act.

5. Before CIT(A), the assessee submitted that the assessee was the largest sugar producer in India and in order to expand their operations they appointed KPMG to explore the possibility of acquiring sugar mill/distillery plant in Brazil. In this regard the assessee submitted that KPMG was to provide the assessee the following services:

(i) Assistance in the identification of targets fitting assessee’s needs and contact of those companies;

(ii) Present the assessee selected information on those targets.

(iii) Perform pricing analysis of selected targets;

(iv) Assist the assessee in the acquisition process of target(s), with the internal team of the Assessee and other external advisors named by the company, for a closing of the transactions9s) in the best possible conditions.

6. It was further submitted that the assessee incorporated a company called Bajaj International Paatici Pacoes Ltd. in Brazil in order to acquire sugar mills/distillery plants in Brazil. A copy of the Memorandum of Association of the subsidiary company so incorporated in Brazil was also filed. It was pointed out that the objective of appointing KPMG was to identify and acquire sugar mills/distillery plants in Brazil. Thus the assessee made the payment in question to carry on business outside India and for the purpose of earning any income from any source outside India. It was submitted that the payment made by the Assessee was towards services which would be utilized in the business which will be carried out outside India i.e. Brazil through the Assessee’s subsidiary company and therefore the aforesaid payment would be squarely covered by the first exception provided in section 9(1)(vii)(b) of the Act and will therefore not be taxable in India. It was submitted that the very fact that the sugar mills/distillery plants to be acquired are located outside India would only mean that the income derived from the said mills/plants will be earned from a source outside India therefore payment made to KPMG would be covered even by the second exception provided in clause (b) of section 9(1)(vii) of the Act viz., “for the purposes of making or earning any income from any source outside India”. It was therefore submitted that the payment of USD 100,000 to KPMG does not constitute income deemed to accrue or arise in India under section 9(1)(vii) of the Act and is not taxable in India in the hands of KPMG and therefore the Assessee was not liable to liable to deduct tax at source thereon.

7. Since the aforesaid submission was made by the assessee for the first time before the CIT(A), the CIT(A) called for a remand report from the AO. In his remand report dated
18/1/08, the AO accepted that the contention put forth by the assessee was legal contention and requested the CIT(A) to consider the said contention on merits. However, the CIT(A) informed the CIT(A) that the facts regarding incorporation of a subsidiary by the Assessee in Brazil needed to be verified.

8. On a consideration of the above submissions the CIT(A) noticed that the agreement between the assessee and KPMG was in the form of proposal dated 11/5/2006. The proposal refers to the Assessee being the largest sugar producer in India and its desire to study the possibility of expanding its operations, through transactions involving the acquisition of a sugar mills/ distillery plants in Brazil. For the said purpose the Assessee was considering appointment of a financial advisor to assist during the acquisition process. KPMG being one of the leaders in Brazil in Mergers and Acquisitions (M&A) in the sugar and alcohol section and have already advised in transactions related to disposals of sugar mills and sugar refinery were being engaged for the aforesaid purpose. The proposal also mentions that the acquisition is to be done by the Assessee or any of its subsidiaries or its nearest company or any company controlled by the Assessee.

9. On a consideration of the above features of the Agreement, the CIT(A) was of the view that the Assessee wanted to acquire sugar mills/distillery plants in Brazil. For that purpose, the Assessee had availed the services of KPMG. He found that the services were to be rendered in Brazil and that services are connected with the acquisition of sugar mills/distilleries in Brazil. The CIT(A) was of the view that the words used in Sec.9(1)(vii) clause (b) second exception was “ for the purposes of earning any income from any source outside India.”. He was of the view that the services rendered by KPMG were to be used for the purpose of acquisition of sugar mill / distillery in Brazil for the purpose of earning income from sugar mill / distillery from Brazil. He was of the view that the words used in sec. 9(1)(vii) were vide enough to cover even future source of income. The CIT(A) therefore held that that the services rendered by M/s. KPMG was utilized by the Assessee for the purpose of earning income from a source outside India and therefore the payment by the Assessee of fees for technical services rendered by M/s. KPMG was outside the scope of Sec. 9(1)(vii) of the Income Tax Act. Hence it cannot be considered as income deemed to have accrued in India and not chargeable to tax in India and hence the Assessee is not liable to deduct tax u/s. 195 of Income Tax Act. The demand raised for tax and interest u/s.201(1) and 201(1A) of the Act was deleted.

10. Aggrieved by the order of the CIT(A) the revenue has preferred the present appeal before us.

11. The ld. D.R submitted that the assessee initially accepted before the AO that there was an obligation on its part to deduct tax at source while making payment to KPMG. Only on 17/8/2007 the assessee in a letter to the AO took a stand that the services rendered by KPMG were in the nature of market research and, therefore, not in the nature of FTS. The ld. D.R also drew our attention to the proposal dated 11/5/06 and submitted that the proposal( contained in page 1 to 17 of the assessee’s paper book) is not in the form of an agreement and the genuineness of the claim of the assessee that this was the agreement for rendering services is doubtful. We have examined this contention and find that in the letter dated 17/8/2007 the assessee has made a claim that the proposal ( contained in page 1 to 17 of the assessee’s paper book) was the agreement between assessee and KPMG. The Assessee also made it clear that KPMG was engaged to study the possibility of expansion of assessee’s business for acquisition of sugar mills/distillery plants in Brazil. The AO has proceeded to examine the proposal dated 11/5/2006 accepting the same as an agreement between the parties. At this stage it is not open to the ld. D.R to raise issues concerning the genuineness of the agreement. We, therefore, proceed to examine the case on the basis that the proposal dated 11/5/2006 as contained in page 1 to 17 of the assessee’s paper book constitutes the agreement between the assessee and KPMG in connection with which the assessee made payment to KPMG.

12. The next submission of the ld. D.R was that the assessee was utilizing the services of KPMG in respect of a business or profession carried on by the assessee in India and, therefore, the payment was FTS. Further it was submitted that the claim of the assessee that the payment made to KPMG was “for the purpose of earning any income from any source outside India” ought not to have been accepted by the CIT(A) because the exception contemplated in section 9(1)(vii)(b) of the Act is only in respect of an existing source of income. It was submitted by him that in a case where the source of income is to come into existence at future date the exception cannot apply. It was pointed out by the ld. D.R that the payment in question was for the purpose of earning income from a source outside India which source had not come into the existence and the assessee only proposed to create the source of earning income outside India in future. The ld. D.R brought to our notice Circular No.202, para 16.2 which explains the provisions of Finance Bill 1976, wherein it has been observed as follows:

“16.2 Under the new provision, income by way of “fees for technical services” of the following types will be deemed to accrue or arise in India:

(a) fees for technical services payable by the Central Government or any State Government;

(b) fees for technical services payable by a resident, except where the payment is relatable to a business or profession carried on by him outside India or to any other source of his income outside India, and

(c) fees or technical services payable by a non-resident if the payment is relatable to a business or profession carried on by him in India or to any other source of his income in India.”

13. It was argued that even the Circular talks about source of income outside India which means that it should be an existing source. It was submitted that the exception in clause (b) cannot apply to a future source to be set up. Reliance was also placed on the decision of the ITAT Mumbai in the case of Hindalco Industries Ltd. vs. ITO 91 ITD 64(Mum), wherein it was held that utilization of services is essential by the resident only in business or profession carried on by the resident outside India. If a resident pays FTS outside India for the services to be utilized in India then that income per-se will be treated as income accruing or arising to the person in India.

14. We have considered the arguments of ld. D.R. There is not dispute that the payment in question made by Assessee to KPMG is in respect of services which otherwise fell within the definition of FTS as given in the Act. The dispute is whether the exceptions mentioned in clause (b) to Sec. 9(1)(vii) of the Act would apply so that it can be said that the fees in thenature of FTS has not accrued or arisen to KPMG in India. As far as the first exception in Sec.9(1)(vii) clause (b) of the Act, is concerned viz., “where the fees are payable in respect of services utilized in a business or profession carried on by such person outside India”, we find that the Assessee carries on business in India and has utilized the services of KPMG in connection with such business. Therefore the case of the Assessee would not fall within the first exception, notwithstanding the fact that services were rendered only in Brazil. As far as the second exception mentioned in Sec.9(1)(vii) clause (b) is concerned viz., “ for the purposes of earning any income from any source outside India.”, the undisputed facts are that the Assessee wanted to acquire sugar mills/distillery plants in Brazil and for that purpose also wanted to set up a subsidiary company. In fact, the Assessee had set up a subsidiary company on 8.8.2006 in Brazil. Thus the Assessee was contemplating to create a source for earning income outside India. It is no doubt true that the source of income had not come into existence. But there is nothing in Sec. 9(1)(vii) clause (b) of the Act, to show that the source of income should have come into existence so as to except the payment of fees for technical services. The expression used is “for the purpose of earning any income from any source outside India”. There is nothing in the language of Sec.9(1)(vii) clause (b) of the Act, which would go to show that the same is restricted to only to an existing source of income. We therefore agree with the conclusions of the CIT(A) on this aspect. We therefore uphold the order of the CIT(A) holding that the payment by the Assessee of fees for technical services rendered by M/s. KPMG was outside the scope of Sec. 9(1)(vii) of the Income Tax Act. Hence it cannot be considered as income deemed to have accrued in India and not chargeable to tax in India and hence the Assessee was not liable to deduct tax u/s. 195 of Income Tax Act. The demand raised for tax and interest u/s.201(1) and 201(1A) of the Act was therefore rightly
directed to be deleted. We find no grounds to interfere with the order of the CIT(A) and uphold the order of CIT(A) and dismiss the appeal by the Revenue.

15. In the result, the appeal by the Revenue is dismissed.

Income from license of software not assessable as “royalty”-- Gracemac not followed/Motorola still good law

2011-08-28T10:17:00.001+05:30

ADIT vs. TII Team Telecom International Pvt Ltd (ITAT Mumbai)

Income from license of software not assessable as “royalty”. Gracemac not followed; Motorola still good law

The assessee, an Israeli company, entered into an agreement with Reliance Infocomm for supply and licence of software for RIL’s wireless network in India. The assessee received Rs. 3 crores which it claimed to be “business profits” and not taxable for want of a permanent establishment (PE) in India. The AO took the view that the said sum was assessable as “royalty”. This was reversed by the CIT (A) following Motorola Inc 96 TTJ 1 (Del) (SB). In appeal before the Tribunal, the department argued that in view of Gracemac Corp 42 SOT 550 (Del), the use of software was assessable as “royalty”. HELD dismissing the appeal:

(i) Under Article 12 (3) of the India-Israel DTAA, royalty is defined inter alia to mean payments for the “use of” a “copyright” or a “process”. There is a distinction between “use of copyright” and “use of a copyrighted article”. In order to constitute “use of a copyright”, the transferee must enjoy four rights viz: (i) the right to make copies of the software for distribution to the public, (ii) The right to prepare derivative computer programmes based upon the copyrighted programme, (iii) the right to make a public performance of the computer programme and (iv) The right to publicly display the computer programme. If these rights are not enjoyed, there is no “use of a copyright”. The consideration is also not for “use of a process” because what the customer is paying for is not for the “process” but for the “results” achieved by use of the software. It will be a “hyper technical approach totally divorced from ground business realities” to hold that the use of software is use of a “process”. (Motorola Inc 96 TTJ 1 (Del) (SB) and Asia Sat 332 ITR 340 (Del) followed. Gracemac Corp 42 SOT 550 (Del) not followed);

(ii) It is well settled that a DTAA prevails over the Act where it is more favourable to the assessee. The view taken in Gracemac, relying on Gramophone Co AIR 1984 SC 667, that the Act overrides the treaty provisions where there is irreconcilable conflict is not acceptable because (a) it is obiter dicta, (b) contrary to Azadi Bachao Andolan 263 ITR 706 (SC) and (c) Gramophone Co not applicable to I. T. Act as it dealt with law in which specific enabling clause for treaty override did not exist. (Ram Jethmalani vs UOI also considered).

Source: ITATonline

Fees paid to a foreign company for rendering testing and certification services--Not Income accrued in India

2011-08-21T19:06:00.000+05:30

Fees paid to a foreign company for rendering testing and certification services could not be treated as income deemed to accrue or arise in India under Section 9(1)(vii) of the Income-tax Act

Recently, the Delhi Bench of Income-tax Appellate Tribunal (the Tribunal) in case of Havells India Ltd1 (the taxpayer) held that testing fees paid to non-resident company could not be treated as income deemed to accrue or arise in India under Section 9(1)(vii) of the Income-tax Act 1961 (the Act).

Further since the income did not accrue or arise in India, the question of deducting tax at source does not arise and consequently payment made to the non-resident was not to be disallowed under Section 40(a)(i) of the Act.

Havells India Ltd v. ACIT [ITA No.1300/Del/2010, dated 27 May 2011]

Facts of the case

• The taxpayer paid INR 1.48 million to CSA International (CSA), a US Company for getting witness testing of AC Contactor as part of CB report and KEMA certification. CSA was assigned this job since it had a specialized knowledge and facility for the requisite testing and certification.

• The Assessing Officer (AO) held that fees paid for testing and certification services rendered by CSA were in the nature of making available of technical knowledge, expertise and skill of CSA, rendering such services to be ‘Fees for Included Services” as per Article 12(4)(b) of the India-USA tax treaty (tax treaty).

• The AO observed that irrespective of whether the non-resident is having a business connection in India or not, the payment made by the taxpayer as Fees for Technical Services (FTS) being utilised in business in India would lead to income being deemed to accrue or arise in India. Further the AO held that since tax was not deducted at source under Section 195 of the Act in respect of testing fees paid by the taxpayer, the amount of INR 1.48 million would be disallowed under Section 40(a)(i) of the Act.

• The Commissioner of Income Tax Appeal [CIT (A)] relying on the decision of Cochin Refineries Ltd.2 confirmed the disallowance made by the AO.

2 Cochin Refineries Ltd. v. CIT [1996] 222 ITR 354 (Ker)

3 GE India Technology Centre P Ltd v. CIT [2010] 327 ITR 456 (SC)

4 Titan Industries Ltd v. ITO [2007] 11 SOT 206 (Bang)

5 Ishikawajima–Harima Heavy Industries Ltd v. DIT [2007] 158 Taxman 259 (SC)

Taxpayer’s contentions

• The taxpayer contended that it had made exports to the USA and the fees in question had been paid to earn income from the USA, i.e. from a source outside India. Therefore, the fees paid to CSA could not be deemed to accrue or arise in India under Section 9(1)(vii) of the Act and tax was not required to be deducted at source on such payments under Section 195 of the Act.

• The taxpayer relied on the decision of GE India Technology Centre P Ltd3 where it was held that duty to withhold tax did not arise on a mere remittance to a non-resident, unless the remittance consisted of wholly or partly taxable income. Since the fees were payable in respect of services utilised outside India, the said income was not taxable and tax was not required to be deducted at source.

• The taxpayer relying on the decision of Titan Industries Ltd4 contended that provisions of Section 40(a)(i) of the Act had no applicability since services has been utilised outside India for earning an income from a source outside India. Accordingly, the payment was covered in the exception provided in Section 9(1)(vii)(b) of the Act, due to which, there was no need to deduct tax at source under Section 195 of the Act.

• The taxpayer further contended that the CIT(A) had failed to consider the decision of the Supreme Court in Ishikawajimi–Harima Heavy Industries Ltd5 where it had been held that income can be deemed to accrue or arise in India, only if the services were utilised in India as well as rendered in India; that in the taxpayer’s case, neither were the services rendered by CSA in India, nor were they utilised in India.

• The taxpayer further contended that services of CSA did not make available technical know-how to the taxpayer, therefore, it did not amount to FIS under the tax treaty and there was no obligation on the part of the taxpayer to deduct tax under Section 195 of the Act.

Tax department’s contentions

• The tax department contended that testing reports and certifications were obtained from CSA in respect of the manufacturing activity of the taxpayer in India and that the taxpayer did not deduct tax at source while making the payment to CSA.

• The tax department relying on the decision of Cochin Refineries Ltd contended that fees paid to CSA US was in the nature of FTS and it would fall under the definition of FTS within the provisions of Section 9(1)(vii) of the Act and the income was thus taxable in India.

• The tax department contended that the payment was covered as “Fees for Included Services” as referred to in Article 12(4)(b) of the tax treaty as the testing report and certification made available to the taxpayer were in the nature of technical knowledge, expertise and skill made available to the taxpayer. Further the same was utilised in the manufacture and sale of products in the business of the taxpayer in India.

• The tax department contended that if the assessment order was found to be deficient with regards to whether services was utilised in India or not, the matter should be referred to the AO for a fresh decision concerning this aspect of the matter.

Tribunals ruling

• The Tribunal observed that the testing and certification was necessary for the export of the product and was utilised for such export. The said services were rendered and utilised outside India. Therefore, the income fell outside the purview of Section 9(1)(vii) of the Act and did not deem to accrue or arise in India.

• The Tribunal observed that the tax department had failed to prove its contention that the testing and certification were utilised in the taxpayer’s production activity in India. The burden in this regard was entirely on the tax department, which the tax department had failed to discharge.

6 Raymond Ltd v. DCIT [2003] 86 ITD 791 (Mum)

Joint Accreditation System of Australia and New Zealand [2010] 326 ITR 487 (AAR)

Diamond Services P Ltd v. Union of India & Others [2008] 304 ITR 201 (Mum)

NQA Quality System Registrar Ltd v. DCIT [2005] 92 TTJ 946 (Del)

ICICI Bank Ltd v. DCIT [2008] 20 SOT 453(Mum)

• The tax department’s argument on remitting the matter to the AO was neither required, nor appropriate to be adopted. The Tribunal observed that it was not possible to remit the matter to the AO since the appellate authority examines whether the assessment had been framed in accordance with law and if the assessment was not framed in accordance with law it was not the responsibility of the authority to start investigation suo moto and in order to fill up the gap which was missing.

• The Tribunal further observed that the tax department did not bring anything on record to substantiate its observation of the testing and certification services provided to the taxpayer by CSA having been utilised for the taxpayer’s business activity in India. Accordingly, it was held that fees paid by the taxpayer did not deemed to accrue or arise in India and withholding of tax under Section 195 of the Act was not required and thus disallowance under Section 40(a)(i) of the Act was also not required.

Payment for Patent Infringement is allowable u/s 37(1)

2011-08-16T19:54:00.000+05:30

[2011] 12 taxmann.com 373 (Delhi)

HIGH COURT OF DELHI--Commissioner of Income-tax v. Desiccant Rotors International (P.) Ltd.*

The assessee-company was engaged in the business of manufacturing of environmental control systems such as Rotors, Heat Recovery Wheels, Desiccant Rotors, etc. For the assessment year 2005-06, the assessee filed its income-tax return declaring certain income. Along with the return, necessary documents including profit and loss account was filed. On perusal of the profit and loss account, it was noticed by the Assessing Officer that the assessee had debited certain amount on account of compensation paid towards settlement of dispute. On being asked to clarify the position, the assessee-company furnished a note stating that it had been exporting its products to one of its customers, 'VENMAR', Canada for selling those products further in foreign countries. SEMCO Inc., USA had filed a suit against VENMAR for infringement of their registered patents in USA by selling the products of the assessee-company. VENMAR settled the dispute with SEMCO by paying certain compensation to it. Subsequently, SEMCO instituted the proceedings against the assessee company in the Court of USA alleging that sale of products by the assessee to VENMAR amounted to infringement of their registered patents. Since the cost of litigation was expected to be exorbitant, the assessee-company after considering the advice of its legal representative, settled the dispute with SEMCO by making payment of US $6,75,000. It was, thus, claimed by the assessee that the payment was compensatory in nature to compensate the loss incurred by SEMCO as a result of selling the product covered by patent held by SEMCO to VENMAR. The Assessing Officer opined that amount paid by the assessee to SEMCO was nothing but a 'penalty' or as something akin to penalty and the payment was made only due to infringement which would, in any way, result into a compensation. The Assessing Officer, further, observed that violation of the patents/trademark, etc., is always prohibited by law and, therefore, in view of the provisions contained in Explanation to section 37(1), the expenditure so incurred by the assessee was not allowable. The Commissioner (Appeals) confirmed the order of the Assessing Officer. On second appeal, the Tribunal, accepting the contention of the assessee that the payment was not in the nature of any penalty and no such violation of patent law was held to be proved, and it was only in the nature of compensation due to settlement arrived at between the parties, permitted it as allowable expenditure under section 37.

A.K. Sikri, J. - Before we reproduce the substantial questions of law, which are to be answered, we deem it appropriate to state the facts and circumstances under which these questions of law arise for consideration. The respondent-assessee was incorporated in the year 1984 and has been engaged in the business of manufacturing of environmental control system such as Rotors, Heat Recovery Wheels, Desiccant Rotors, etc. For the assessment year 2005-06, the assessee filed its Income-tax return on 31-10-2005 declaring total income at Rs. 2,49,28,630. Along with the return, necessary documents including Profit and Loss account was filed. Books of account were also produced at the time of assessment and were examined by the Assessing Officer. On perusal of the Profit & Loss account, it was noticed by the Assessing Officer that the assessee has debited an amount of Rs. 3,12,57,152 on account of compensation paid towards settlement of dispute. On being asked to clarify the position, the assessee company furnished a note with relevant documents, vide letter dated 26-12-2007. In the notice, it was stated that the assessee has been exporting its products to one of its customers, viz., M/s Venmar Ventilation Inc. (hereinafter referred to as 'VENMAR'), Canada for selling their products. SEMCO Inc. USA had filed a suit against VENMAR for infringement of their registered patents in USA by selling the products of the assessee company. VENMAR settled the dispute with SEMCO by paying certain compensation to it. Subsequently, SEMCO instituted the proceedings against the assessee company a swell in the Court of USA alleging that sale of products by assessee to VENMAR amounted to infringement of their registered patents. Since the cost of litigation was expected to be exorbitant, the assessee company after considering the advice of its legal representative, settled the dispute with SEMCO by making payment of US $6,75,000. It was, thus, claimed by the assessee that the payment was compensatory in nature to compensate the loss incurred by SEMCO as a result of selling the product covered by patent held by SEMCO to VENMAR. The assessee also filed certain documents along with its submissions.

2. The contention of the assessee, before the Assessing Officer, which has been remained consistent throughout, was that the assessee company had made the payment to SEMCO as a result of settlement arrived at and not on account of infringement of patent law, did not accept the Assessing Officer. The Assessing Officer was of the view that SEMCO had filed the Suit for damages and injunction due to infringement of SEMCO's United States Patent bearing No. 4769053 caused by the assessee company and its customers for manufacturing and marketing the Energy Recovery Wheel products. Further, SEMCO had sued VENMAR in the same Court for infringement of SEMCO's patent by selling the assessee company's product in their patented territory and in those proceedings, the VENMAR had acknowledged that the patent held by SEMCO was valid and enforceable and thus, agreed not to sell the products that would infringe the patent of SEMCO and accordingly compensated SEMCO for such infringement. In these circumstances, according to the Assessing Officer, the amount paid by the assessee to SEMCO was nothing but a "penalty" or as something akin to penalty and the payment was made only due to infringement which would, in any way, resulted into a compensation. The Assessing Officer, further, observed that violation of the patents/trademark, etc. is always prohibited by law and therefore, in view of the provisions contained in Explanation to section 37(1) of the Income-tax Act (hereinafter referred to as 'the Act'), the expenditure so incurred by the assessee was not allowable. The Assessing Officer further took the view that the payment was made to avoid any conviction by the Court of Law for infringement of patent which is not a normal incident of business and therefore, it is not allowable as business expenditure. On this reasoning, the Assessing Officer disallowed the payment of compensation paid by the assessee to settle the dispute and added the same to the assessee's total income.

3. Feeling aggrieved, the assessee preferred an appeal before the CIT(A). The case as pleaded before the Assessing Officer was reiterated before the CIT(A). It was exemplified by submitting that whatever allegations were levelled by SEMCO were denied and disputed in toto by the assessee and even the suit was defended for three years. However, keeping in view the cost of litigation and the advice given by its legal consultants, the assessee found it expedient and proper to reach an out-of-Court settlement. The assessee company emphatically argued before the CIT(A) that the settlement was not on account of any infringement of any law inasmuch as no Court of law held anything or given any finding against the assessee company. It was, therefore, contended that the assessee's case is not covered by Explanation to section 37(1) of the Act and therefore, the payment made in the course of carrying on assessee's business activity is to be allowed as business expenditure. The assessee also placed reliance on the decision of the Supreme Court in the case of Prakash Cotton Mills (P.) Ltd. v. CIT [1993] 201 ITR 684/67 Taxman 546. After considering the Assessing Officer's order and the assessee's submissions, the CIT(A) confirmed the Assessing Officer's order in disallowing the assessee's claim of deduction of payment to SEMCO as a result of out of Court settlement in respect of the proceedings initiated by M/s SEMCO against the assessee company for infringement of their patent rights.

4. Still aggrieved, the assessee went in appeal before the Tribunal. In this appeal, the assessee has been able to convince the Tribunal. Accepting the contention of the assessee that the payment was not in the nature of any penalty and no such violation of patent law was held to be proved, and it was only in the nature of compensation due to settlement arrived at between the parties, the Tribunal has permitted it as allowable expenditure under section 37 of the Act.

5. Section 37, which is a residuary provision, allows the expenditure as deductable while computing the income on the satisfaction of the following conditions:

"(a) Expenditure must not be governed by the provisions of sections 30 to 36 of the Act;

(b) The expenditure must have been laid out wholly and exclusively for the purposes of the business of the assessee:

(d) The expenditure must not be capital in nature."

6. The Explanation to sub-section (1) of section 37 of the Act has been inserted by the Finance (No. 2) Act, 1988 with full retrospective effect from 1-4-1962 and provides:

"For removal of doubts, it is hereby declared that any expenditure incurred by an assessee for any purposes, which is an offence or which is prohibited by law, shall not be deemed to have been incurred for the purpose of business or profession and no deduction or allowance shall be made in respect of such expenditure."

7. The dispute revolves around the issue as to whether the aforesaid expenditure incurred by the assessee was for a purpose which would be treated as an "offence" or which is prohibited by law. If this be so, the expenditure is not allowable. The Tribunal has held that the expenditure incurred is not for a purpose which is an offence or which prohibited by a law. As there was no dispute that the expenditure was, in fact, incurred which is neither personal in nature nor capital in nature and it was incurred wholly and exclusively for the purposes of business of the assessee, the Tribunal permitted the said expenditure thereby allowing the appeal of the assessee.

8. Against this order, present appeal is preferred which was admitted on the following substantial questions of law:

"(i) Whether learned ITAT erred in holding that the payment by the assessee to SEMCO vide Settlement Agreement is not hit by the provisions in Explanation 1 to section 37 of the Income-tax Act, 1961?

(ii) Whether learned ITAT erred in deleting the addition of Rs. 3,12,57,152 paid on Settlement of Dispute which was incurred wholly and exclusively for the purposes of business?"

9. Since the counsel for the parties were ready to finally argue the matter, the arguments were heard simultaneously with framing of aforesaid questions of law. On the conclusion of arguments, request from both the sides was made for filing the written submissions within one week. The same was granted. Though the learned counsel for the assessee has filed the written submissions, the learned counsel for the revenue has not availed of this opportunity. In these circumstances, we proceed to decide the questions of law framed, on the basis of oral submissions of both the parties as well as written submissions tendered by the learned counsel for the assessee.

10. Mr. Sanjeev Sabharwal, learned counsel for the revenue, argued that no doubt, the payment was made by the assessee to M/s SEMCO under the settlement before the judgment could be pronounced by the United States District Court, but the tenor of the said settlement would clearly reveal that such a settlement was arrived at accepting the fact that the assessee had violated/infringed the patent of SEMCO. Damages were paid by the assessee because of this infringement and such a payment, submitted the counsel, was for a purpose which is prohibited by law. His argument was that the law mandates not to infringe patent right of any person and once it is found that the assessee had violated the patent rights of SEMCO thereby compelling SEMCO to institute proceedings against the assessee, it would be a clear case where the payment was made for a purpose which is prohibited by law. Thus, the Explanation was fully applicable and expenses could not be treated as having been incurred for the purpose of business and no deduction is to be allowed on such expenses in the nature of penalty.

11. Learned counsel also took support from the reasons given by the Assessing Officer as well as the CIT(A) in their respective orders. He pointed out that the CIT(A) had clearly held that it was a case where there was an infringement of United States Patent Law by the assessee. The goods were manufactured and sold by the assessee to VENMAR for sale in US and Canada markets and as a manufacturer, the assessee could not escape the primary responsibility by stating that it was not directly involved in infringement. Further, for making a disallowance under section 37 in respect of penalty, etc. finding by a competent Court was not a condition precedent to attract the Explanation to section 37(1). According to the CIT(A), the Explanation simply states that if expenditure is incurred for any purpose, which is an offence, or which is prohibited by law, such expenditure will not be deeded to have been incurred for the purpose of business. The Explanation does even imply that there must be a finding of a Competent Authority or Court that an offence was committed or that any law was infringed. In fact, there may be numerous situations where expenditure is incurred for a purpose, which is prohibited by law, but there may not necessarily be any order of any authority or Court to this effect. Payment of protection money, hafta money, ransom, etc. are examples of such expenditure. There may not be any order prohibiting a person from making payment of protection money but nonetheless the payment will be for a purpose prohibited by law and would not be allowable under section 37 of the Act.

12. Mr. Sabharwal further submitted that the expenditure was not compensatory in nature. It was incurred to avoid the penal consequence of the aforesaid infringement.

13. Ms. Shashi M. Kapila, learned counsel appearing for the assessee countered the aforesaid submission and sought to justify that the reasons given by the Tribunal in spite of its decision. Her first submission was that the provisions of the Explanation were not attracted per se as the expression "prohibited by law" occurring in the said Explanation is limited to law of land alone, i.e., Indian Law. Dilating on this submission, she argued that the expression "offence" and "prohibited by law" occurring in Explanation to section 37(1) of the Act are not defined in the Act. However, section 3(38) General Clauses Act, 1897 defines "offence" to mean "any act or omission made punishable by law for the time being in force". The Calcutta High Court in the case of Susanta Mukherjee v. Union of India [1975] 94 CWN 412 after referring to section 3(38) of the General Clauses Act read with Articles 13(3), 366(10) and 372(1) of the Constitution of India and the decision of the Supreme Court in the case of Edward Mills Co. Ltd. v. State of Ajmer AIR 1955 SC 25 observed in paragraph 13 of the judgment:

"13. It is abundantly clear from the foregoing references to various provisions of the Constitution that a person cannot be convicted of an offence except for violation of law in force at the time of commission of the act charged as an offence. Therefore, in my opinion, the word "any law for the time being in force" as occurring in section 3(38) of the General Clauses Act, 1997 must be construed as "any law for the time being in force" in India. Obviously it has no reference to any law of other countries of the world."

14. According to her, similarly, the expression "prohibited by law" can only mean prohibited by law in force in India. The expression "prohibited by law" as used in the Explanation to section 37(1) has the same contextual import as the expression "forbidden by law" as used in section 23 of the Indian Contract Act, 1872. This came up for the consideration of the Full Bench in the case of Abdul Hameed v. Mohd. Ishaq AIR 1975 All. 166 wherein the Allahabad High Court observed as under:

"12. The expression 'law' has not been defined in the Contract Act, nor in the U. P. General Clauses Act, 1904, but in the Central General Clauses Act, 1897, 'Indian Law' is defined in section 3(29) as below:—

"'Indian law' shall mean any Act, Ordinance, Regulation, rule, order, bye-law or other instrument which before the commencement of the Constitution had the force of law in any Province of India or part thereof, or thereafter has the force of law in any Part A State or Part C State or part thereof, but does not include any Act of Parliament of the United Kingdom or any Order in Council, rule or other instrument made such Act."

This definition is applicable to all the Central Acts and Regulations made after the commencement of the General Clauses Act. The Contract Act was enacted in 1872 before the commencement of the General Clauses Act, 1897. Therefore, this definition is not directly applicable to the Contract Act, but there appears to be no reason why the principles contained in the above definition be not made applicable to even the earlier enactments. 'Law' must, therefore, include not only an Act and Ordinance but also Regulations, rule, order, bye-Law or other instrument which has the force of law. Similar inference can be drawn from the provisions of the Constitution also. For the purposes of Article 13 of the Constitution the term law' includes any Ordinance, order, bye-law, rule, regulation, notification, custom or usage having in the territory of India the force of law.

13. Consequently, where any agreement is forbidden by an order of the competent authority having the force of law, it shall be an agreement forbidden by law as contemplated by section 23 of the Contract Act."

Ms. Kapila, thus, emphatically put that in view of the above, it is clear that the phrase "prohibited by law" as used in the Explanation to section 37(1) of the Act contemplates law in force in India. Her submission was that in the present case, it is an undisputed fact that there is no violation of any patent laws within the territory of India. Section 2(m) of Indian Patent Act, 2005 defines patent as "patent for any invention granted under this Act". Patent right is a statutory right and this right can be applicable only in such states which recognise this right. Patent is valid only in the country of registration. Therefore, a patent registered in USA, Canada, etc. is not a patent recognised by the Indian Patent Act. It is for this reason that the respondent/assessee still continues to manufacture and sell the impugned energy recovery wheel desiccant in India.

15. Without prejudice to the above, her alternate submission was that there was no infringement of even US laws and on the facts of this case, no such finding was recorded by any Court. The payment was made as a result of settlement which payment was compensatory in character. The reason for settlement was explained to the authorities below, viz., in order to buy peace and not to face litigations in US Courts, which is costly. She argued that no damages had been paid under the Indian Patent Act or under the US Patent Laws and there was no evidence to show the infringement. She also argued that in absence of any violation of the provisions of Indian Patent Act, the payment under settlement with SEMCO does not fall within the meaning and scope of expression 'offence' and 'prohibited by law' used in Explanation to section 37(1) of the Act. The assessee still manufactures the energy saving wheel using the impugned desiccant and sells it in India as well as exports it to other countries without any restrictions and no suit has been filed by SEMCO for infringement of its patent in India. However, exports to USA and Canada, past settlement is as per the Settlement Agreement.

16. Ms. Kapila further submitted that even if it is presumed that the payment was made for infringement of patent, that entails only civil damages, which are compensatory in nature and it cannot be said that the payment made was in the nature of penalty. She pointed out that the averments in the plaint filed by SEMCO as per which the only civil damages were claimed and criminal suit was scored out in the plaint. Once the payment is treated as purely compensatory in nature, the same could not be disallowed as per the law settled by the Supreme Court in the case of Prakash Cotton Mills (P.) Ltd. (supra) which principle was reaffirmed by the Apex Court in the case of Mrs. Rajalakshmi Narayanan v. Mrs. Margret Kathleen Gandhi 211 ITR 244 (sic).

17. After giving our thoughtful consideration to the respective submissions, we are of the view that the order of the Tribunal does not call for any interference and both the questions of law set out above need to be answered in negative, i.e., in favour of the assessee and against the revenue.

18. At the outset, we are inclined to accept the submission of the assessee that the paramount and governing consideration behind such a settlement/agreement can be to avoid the expenses and uncertainty of further litigation. It is a matter of common knowledge that litigation can turn out to be quite expensive and it cannot be even possible, what to talk of feasible, for a small time/middle level company in India like the assessee to litigate in US Court. Furthermore, the settlement agreement contains a specific recital to this effect inasmuch as it records "whereas, in order to avoid the expenses or uncertainty or further litigation, the parties desired to settle and adjust all differences and controversies among themselves subject to the terms of this Agreement." No doubt in the Agreement, the assessee accepted the patent of SEMCO. That by itself would not mean that the assessee also accepted that it was infringing the said patent. Secondly, payment is made by the assessee to SEMCO for "loss of goodwill and damages to its capital and for terminating of case US Courts" as is clearly mentioned in clause (3) of the Agreement. No finding is given by any Court that the assessee had violated the patent right of SEMCO. With the aforesaid payment, the "Covenants to Release" recorded in clause (2) is as under:

"2. Covenants to Release

2.1 SEMCO hereby releases, remises and forever discharges the Settling Entities and their agents, attorneys, consultants, offices, employees, representatives, heirs, successors and assigns and their Customers form any and all claims, demands, or causes of action that arise out of or relate to the Action, and any and all obligations, actions, causes of action, suits, debts, contracts, controversies, agreements, promises, damages, judgments, awards, executions, claims and demands whatsoever in law or in equity, and any and all claims for damages (and attorneys' fees and costs) based upon the violation of a federal, state or other statute, regulation or law or arising out of any conduct, contract, employments, action, event or circumstance, under the law of any and all nations, whether known or unknown, which occurred at any time up to an including the date of the execution of this Agreement, except obligations created by this Agreement, any associated licence Agreement and/or by the Consent Judgment to be filed in accordance with this Agreement."

19. It would be pertinent to highlight that the Agreement is applicable within the area defined as "territory". This territory mentions some specific countries in Europe as well as Japan, Australia and Korea. There is no mention of 'India' at all. That clearly implies that SEMCO has no objection if the assessee continues to manufacture the goods in the same manner using same patent which it has been using and marketing it in India or any other countries, which are not stipulated in the 'territory' with respect to which only restraint is provided in the agreement. It is for this reason the assessee even today continues to manufacture those goods and is selling the products in this country. Once we find that the settlement has arrived at under the aforesaid circumstances, there is no room to hold that it was because of the reason that the assessee was violating the patent laws or the payment was made for an objective prohibited by law. This is our view even when we presume that the expression 'prohibited by law' would include US laws and would not be confined to law in India.

20. Moreover, we also agree with the contention of the learned counsel for the assessee that the payment under the settlement is compensatory in nature. The remedy for infringement of patent involves civil action for compensating the damage to private properties. It may be noted that in the plaint filed by it, SEMCO has sought civil damages under sections 284 and 285 of the US Patent Code (US 35). Criminal Suit is scored out in the plaint. The relevant provisions of US 35 (Patent Code) read as follows:

"284. Damages.—Upon finding for the claimant the Court shall award the claimant damages adequate to compensate for the infringement, but in no event less than a reasonable royalty for the sue made of the invention by the infringer, together with interest and costs as fixed by the Court.

"285. Attorney fees.—The Court in exceptional cases may award reasonable attorney fees to the prevailing party."

21. It will be seen from the above that the damages are calculated for compensating the owner of the patent rights for the loss of profit/royalty even under the laws of USA. There is no element of penalty even in USA. Even the Indian Patents Act, 1970 (as amended by the Act of 2005) does not prescribe any penalty or fine for infringement of a patent registered under that Act. This is clear from the section 108 of the Indian Patent Act, which reads as under:

"108 Reliefs in suit for infringement.—The reliefs which a Court may grant in any suit for infringement include an injunction (subject to such terms, if any, as the Court things fit) and, at the option of the plaintiff, either damages or an account of profits."

22. Therefore, any payment for infringement of patent, being purely compensatory in nature, cannot be disallowed as per the law settled by the Supreme Court in the case of Prakash Cotton Mills (P.) Ltd. (supra), where the Apex Court observed as under:

"…Therefore, whenever any statutory impost paid by an assessee by way of damages or penalty or interest is claimed as an allowable expenditure under section 37(1) of the Income-tax Act, the assessing authority is required to examine the scheme of the provisions of the relevant statute providing for payment of such impost notwithstanding the nomenclature of the impost as given by the statute, to find whether it is compensatory or penal in nature. The authority has to allow deduction under section 37(1) of the Income-tax Act, wherever such examination reveals the concerned impost to be purely compensatory in nature. Wherever such impost is found to be of a composite nature, that is, partly of compensatory nature and partly of penal nature, the authorities are obligated to bifurcate the two components of the impost and give deduction to that component which is compensatory in nature and refuse to give deduction to that component which is penal in nature."

23. It was an expenditure which was motivated purely by commercial purpose and would be allowable under section 37(1) of the Act as held by the Apex Court in the case of Sri Venkata Satyanarayana Rice Mill Contractors Co. v. CIT [1997] 223 ITR 101.

24. As regards consent judgment passed by the US District Court in accordance with clause 2 read with clause 3 of the Settlement Agreement, the law is well-settled by the Supreme Court in the case of Pulavrathi Venkata Subba Rao v. Valluri Jagannadha Rao AIR 1967 SC 591, wherein the Court held that:

"A compromise decree is not a decision of the Court. It is the acceptance by the Court of something to which the parties had agreed. A compromise decree merely sets the seal of the Court on the agreement of the parties."

25. Since questions formulated are answered on the aforesaid reasoning, it is not necessary to go into the issue as to whether the expression 'prohibited by law' would confine to law in force in Indian only. We leave that question open.

26. We, thus, do not find any merit in this appeal, which is dismissed with costs.

Use of Disk Space--Not Taxable as Royalty

2011-07-12T16:47:00.002+05:30

Amount received by the assessee, a tax resident of Singapore, from SCB India for use of disk space in the hardware of the assessee at its data centre in Singapore is not taxable as royalty, as held by MumTrib in Atos Origin IT Services Singapore (P) Ltd v ADIT — In favour of: The assessee; ITA No 2428 (Mum) of 2009: (AY 2005–2006).

Atos Origin IT Services Singapore (P) Ltd. v ADIT ITAT, Mumbai
ITA No. 2428 (Mum.) of 2009 Assessment Year: 2005-06
Decided on: 27 May 2011

1. This appeal by the assessee is directed against the order dated 30-1-2009 for the assessment year 2005-06. The only dispute raised by the assessee is regarding taxability of Rs.12,92,68,070 receivable from the assessee from Standard Chartered Bank (SCB) as royalty.

2. Briefly stated facts of the case are that the assessee who was tax resident of Singapore had entered into a hubbing agreement for providing data processing support to Standard Chartered Bank (SCB) a non-resident company engaged in the business of banking in India. The Assessing Officer on perusal of agreement noted that SCB India though it was not in physical possession of infrastructure owned by the assessee for the purpose of data processing, it did have constructive control over the same because it could utilize the same as per terms of agreement. It was also observed by him that these equipments were at the disposal of SCB India and it was a case of renting out of disc space in hardware system and therefore, the payment made by SCB was royalty as per Article 12(3)(a) of
DTAA between India and Singapore. The Assessing Officer further observed that use of embedded secret software provided by the assessee for processing raw data also fell within the ambit of Article 12(3)(a) of DTAA. The Assessing Officer accordingly taxed payment as royalty.

3. The assessee disputed the decision of the Assessing Officer and submitted before CIT(A) that providing services for processing of data of customers was part and parcel of normal business activity of the assessee and, therefore, fee payable by assessee was per se business profit of the assessee. Thus, under the provisions of Article 7(1) of DTAA, the business profit could be taxed in India only if the assessee had permanent establishment (PE) in India. Since assessee did not have a PE in India, income was not taxable. CIT(A) however, did not accept the contentions raised. He agreed with the finding of Assessing Officer that it was a case of renting out of disc space in the hardware system and
embedded software by the assessee in favour of SCB India and therefore, the income earned by the assessee was of the nature of royalty within the meaning of Article 12(3) of DTAA and also within the meaning of clause (iii) of Explanation (2) below section 9(vi) of the Income-tax Act. He therefore confirmed the order of Assessing Officer assessing the amount as royalty. Aggrieved by said decision the assessee is in appeal before Tribunal.

4. Before us ld. AR for the assessee at the very outset pointed out that the same issue had already been decided by the Tribunal in assessee's own case in ITA No. 1457/Mum./2008 for assessment year 2004-05 in which Tribunal allowed the case of the assessee holding that the amount receivable by assessee was not taxable as royalty. The ld. Departmental Representative fairly conceded that the issue was covered by the said decision of the Tribunal.

5. We have perused the records and considered the matter carefully. The dispute is regarding taxability of the amount received by assessee from SCB India for use of disc space in the hardware of the assessee at its data centre in Singapore. The authorities below have held that it was a case of renting out of disc space along with embedded software of the infrastructure of the assessee and therefore, the income was of the nature of royalty under the provisions of Article 12(3) of DTAA between India and Singapore. We find that the same issue has already been considered by the Tribunal in assessee's own case in assessment year 2004-05 in which the Tribunal noted that as per definition in Article 12(3)(b), royalty meant payment of any kind received as a consideration for useor right to use any industrial, commercial or scientific equipment, other than payments received from
activity described in para-4(b) of Article 8. The Tribunal observed that in the context and collocation of 2 expressions 'use' and 'right to use' followed by the word "equipment" indicated that there must besome positive use or employment of equipment for the desired purpose. The customer must come face to face with the equipment, operate it or control it or control its functions in some manner. If an advantage was taken from sophisticated equipment installed and provided by another person it could not be said that the recipient/customer used the equipment as such. Even where an earmarked circuit
was provided for offering the facility, unless there was material to establish that the circuit/equipment could be accessed and put to use by means of some positive acts, it did not fall within the category of royalty. The Tribunal held that in this case, the assessee did not have the right to access the computer hardware except for transmitting raw data for further processing. The assessee had no control over computer hardware or physical access to it. Therefore, there was nothing to show any positive act of utilization, application or employment of equipment for the desired purpose. The Tribunal

accordingly held that payment was not royalty within the meaning of Article 12(3)(b). Facts, in this year are identical. Therefore, respectfully following the decision of the Tribunal in assessment year 2004-05 in assessee's own case (supra), we set aside the order of the CIT(A) and deleted the addition made.

6. In the result, the appeal of the assessee is allowed.

Praveen Boda

Service tax on construction services - Circular 151/2/2012_CBEC

Taxation of Keyman Insurance Policy

"Lease equalization charge” as per ICAI Guidelines is allowable--In Finance Lease

Outsourcing of Manufacture attracts 194C--Nova Nordisk--Karnataka HC

Taxability in respect of International Private Leased Circuit (IPLC)--Telegraph Authority u/s 65 (111) of the Finance Act, 1994 – reg

S. 9: Profits from offshore supply of equipment & software not taxable in India--Delhi HC

Changes in e-furnishing form 15CA

Set-off” of export receivable​s against import payables-L​iberalizat​ion of Procedure

Expenditure on ‘Application Software’ is revenue in nature

Payment on shrink-wrapped software is royalty, rules High court of Karnataka

Accreditation Fee Paid to UK Co--Not a 'Royalty' Income

Taxability of Cost Contribution Agreements

Profits attributable to “Dependent Agent Permanent Establishment” Taxable in India

Payment made by the resident company to KPMG, Brazil for assisting in the acquisition of sugar mills in Brazil is not “Fees for Technical Services

Income from license of software not assessable as “royalty”-- Gracemac not followed/Motorola still good law

Fees paid to a foreign company for rendering testing and certification services--Not Income accrued in India

Payment for Patent Infringement is allowable u/s 37(1)

Use of Disk Space--Not Taxable as Royalty

Set-off” of export receivables against import payables-Liberalization of Procedure