I did not withhold tax on an administrative fee paid to my US parent. Can the Assessing Officer disallow the whole expense under section 40(a)(i) when a payment to an Indian party would not be disallowed?
No, where the India-USA treaty applies. The Delhi Tribunal held that Article 26(3) of that treaty forbids exactly this discrimination: a disbursement to a resident of the other State must be deductible on the same conditions as a payment to a resident. As section 40(a)(i) then stood, non-deduction of tax led to disallowance only for payments to non-residents, so an Indian payer would prefer a resident supplier. Article 26(3) neutralises that, and by section 90(2) the more beneficial treaty provision prevails. The Tribunal therefore held section 40(a)(i) could not be invoked, even assuming the sum was chargeable in India, and left the chargeability question open.
Decided by the ITAT (Income Tax Appellate Tribunal, Delhi) on 2006-02-28, reported as [2006] 101 ITD 450 (Delhi); (2006) 103 TTJ (Delhi) 78. It bears on section 40(a)(i), section 90(2), section 9(1)(vii), section 195 of the Income Tax Act 1961, in Deductions & Disallowances and TDS Defaults matters.
This is the leading Tribunal authority on using a treaty non-discrimination article against section 40(a)(i), and the reasoning is transferable to every treaty with an equivalent of Article 24(4) of the OECD Model. The Tribunal relied on the OECD Commentary, which explains that the paragraph exists to end the practice of allowing a deduction without restriction when the recipient is resident while restricting or prohibiting it when he is not. The practical effect is that the disallowance and the chargeability of the payment become separate questions: the payer can defeat the disallowance without having to establish that the receipt is outside Indian tax. Note the limits - the Tribunal decided the point for section 40(a)(i) as it stood before the Finance Act 2003 amendment effective from 1 April 2004, and it expressly left chargeability to be decided elsewhere.
Binding on the AO and CIT(A) within the Tribunal's jurisdiction. Persuasive elsewhere.
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The assessee traded and marketed herbal products in India as a wholly foreign owned company set up with the approval of the Ministry of Industry, which required it to have the products manufactured on contract in India rather than import them. By an Administrative Services Agreement with Herbalife International of America Inc, a California company, it received data processing, accounting, financial and planning, marketing and other services, the parent's centralised costs being allocated among its subsidiaries worldwide. For assessment year 2001-02 it claimed Rs.5.83 crore as administrative fee, made up of US$10,00,000 for calendar year 2000 and US$2,50,000 for January to March 2001. No tax was deducted. The Assessing Officer held the payment was fees for technical services within Explanation 2 to section 9(1)(vii), rejected the plea that it was a mere reimbursement of costs, and disallowed the whole sum under section 40(a)(i). He also held the part relating to January to March 2000 was a prior period expense, and that the liability for January to March 2001 was a dead liability that had been given up. The Commissioner (Appeals) upheld the disallowance, holding the fixed quarterly billing of US$2,50,000 showed there was no point to point reimbursement, and did not deal with the timing arguments. Separately the Assessing Officer had rejected the manufacturing and trading results because the stock records did not reconcile with the audited accounts, and made a lump sum addition of Rs.5 crore.
The appeal was partly allowed. On the main issue the Tribunal held that in view of Article 26(3) of the India-USA treaty the Assessing Officer cannot invoke section 40(a)(i) to disallow the deduction, even on the assumption that the sum is chargeable to tax in India; the question whether it is chargeable was expressly left open for adjudication in the appropriate proceedings. On timing, applying Nonsuch Tea Estates and John Fowler (India), the Tribunal accepted that where a payment cannot lawfully be made without an approval, the liability accrues only when the approval is granted, the Reserve Bank's permission having come on 30 June 2000. On the foreign exchange fluctuation ground the loss was allowed, the assessee having consistently accounted for fluctuation at the year end. On the rejection of books, the Tribunal held the discrepancies in the stock records were established and the trading results were rightly ignored, but found the Assessing Officer's comparison of manufacturing cost ratios unsound because the increase was largely excise duty and because the mix had shifted from traded to manufactured goods, and because there was no material showing sales outside the books; it reduced the addition from Rs.5 crore to Rs.3 crore.
On the central point the Tribunal read Article 26(3) of the India-USA treaty against the OECD Commentary on the corresponding Article 24(4). That paragraph exists to end a particular form of discrimination: in some countries the deduction of interest, royalties and other disbursements is allowed without restriction where the recipient is resident but is restricted or prohibited where he is not, and the article requires that such payments to a resident of the other Contracting State be deductible to the same extent as if paid to a resident of the same State, so preventing indirect discrimination. Section 40(a)(i), as it stood before the Finance Act 2003 amendment effective from 1 April 2004, disallowed a payment for failure to deduct tax only where the payee was a non-resident; an identical payment to a resident suffered no disallowance. An Indian payer choosing between a resident and a non-resident supplier would therefore prefer the resident, and to that extent the non-resident is discriminated against. Article 26(3) neutralises the rigour of section 40(a)(i), and section 90(2) requires the more beneficial of the treaty and the Act to be applied to an assessee to whom the treaty applies. Because that disposed of the disallowance, the Tribunal did not decide whether the payment was a reimbursement, whether it was fees for technical services under section 9(1)(vii), or how Article 12(4) of the treaty applied. On timing it distinguished Associated Cement Companies, where the Supreme Court held a Reserve Bank approval for remittance was not decisive of a customs classification question, as arising in a different context.
This clause in DTAA neutralizes the rigour of the provisions of Section 40(a)(i).
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Handle my notice → Ask a CA on WhatsAppNo, where the India-USA treaty applies. The Delhi Tribunal held that Article 26(3) of that treaty forbids exactly this discrimination: a disbursement to a resident of the other State must be deductible on the same conditions as a payment to a resident. As section 40(a)(i) then stood, non-deduction of tax led to disallowance only for payments to non-residents, so an Indian payer would prefer a resident supplier. Article 26(3) neutralises that, and by section 90(2) the more beneficial treaty provision prevails. The Tribunal therefore held section 40(a)(i) could not be invoked, even assuming the sum was chargeable in India, and left the chargeability question open. This was decided by the ITAT (Income Tax Appellate Tribunal, Delhi) and bears on section 40(a)(i), section 90(2), section 9(1)(vii), section 195 of the Income Tax Act 1961. It is reported as [2006] 101 ITD 450 (Delhi); (2006) 103 TTJ (Delhi) 78. This is the leading Tribunal authority on using a treaty non-discrimination article against section 40(a)(i), and the reasoning is transferable to every treaty with an equivalent of Article 24(4) of the OECD Model. The Tribunal relied on the OECD Commentary, which explains that the paragraph exists to end the practice of allowing a deduction without restriction when the recipient is resident while restricting or prohibiting it when he is not. The practical effect is that the disallowance and the chargeability of the payment become separate questions: the payer can defeat the disallowance without having to establish that the receipt is outside Indian tax. Note the limits - the Tribunal decided the point for section 40(a)(i) as it stood before the Finance Act 2003 amendment effective from 1 April 2004, and it expressly left chargeability to be decided elsewhere. If it applies to you, the first step is this: Check whether the applicable treaty has a non-discrimination article in the form of Article 26(3) of the India-USA treaty or Article 24(4) of the OECD Model, and plead it as an independent answer to a section 40(a)(i) disallowance.
The assessee traded and marketed herbal products in India as a wholly foreign owned company set up with the approval of the Ministry of Industry, which required it to have the products manufactured on contract in India rather than import them. By an Administrative Services Agreement with Herbalife International of America Inc, a California company, it received data processing, accounting, financial and planning, marketing and other services, the parent's centralised costs being allocated among its subsidiaries worldwide. For assessment year 2001-02 it claimed Rs.5.83 crore as administrative fee, made up of US$10,00,000 for calendar year 2000 and US$2,50,000 for January to March 2001. No tax was deducted. The Assessing Officer held the payment was fees for technical services within Explanation 2 to section 9(1)(vii), rejected the plea that it was a mere reimbursement of costs, and disallowed the whole sum under section 40(a)(i). He also held the part relating to January to March 2000 was a prior period expense, and that the liability for January to March 2001 was a dead liability that had been given up. The Commissioner (Appeals) upheld the disallowance, holding the fixed quarterly billing of US$2,50,000 showed there was no point to point reimbursement, and did not deal with the timing arguments. Separately the Assessing Officer had rejected the manufacturing and trading results because the stock records did not reconcile with the audited accounts, and made a lump sum addition of Rs.5 crore. The matter was decided on 2006-02-28 by the ITAT (Income Tax Appellate Tribunal, Delhi). On those facts the ITAT held as follows. The appeal was partly allowed. On the main issue the Tribunal held that in view of Article 26(3) of the India-USA treaty the Assessing Officer cannot invoke section 40(a)(i) to disallow the deduction, even on the assumption that the sum is chargeable to tax in India; the question whether it is chargeable was expressly left open for adjudication in the appropriate proceedings. On timing, applying Nonsuch Tea Estates and John Fowler (India), the Tribunal accepted that where a payment cannot lawfully be made without an approval, the liability accrues only when the approval is granted, the Reserve Bank's permission having come on 30 June 2000. On the foreign exchange fluctuation ground the loss was allowed, the assessee having consistently accounted for fluctuation at the year end. On the rejection of books, the Tribunal held the discrepancies in the stock records were established and the trading results were rightly ignored, but found the Assessing Officer's comparison of manufacturing cost ratios unsound because the increase was largely excise duty and because the mix had shifted from traded to manufactured goods, and because there was no material showing sales outside the books; it reduced the addition from Rs.5 crore to Rs.3 crore.
On the central point the Tribunal read Article 26(3) of the India-USA treaty against the OECD Commentary on the corresponding Article 24(4). That paragraph exists to end a particular form of discrimination: in some countries the deduction of interest, royalties and other disbursements is allowed without restriction where the recipient is resident but is restricted or prohibited where he is not, and the article requires that such payments to a resident of the other Contracting State be deductible to the same extent as if paid to a resident of the same State, so preventing indirect discrimination. Section 40(a)(i), as it stood before the Finance Act 2003 amendment effective from 1 April 2004, disallowed a payment for failure to deduct tax only where the payee was a non-resident; an identical payment to a resident suffered no disallowance. An Indian payer choosing between a resident and a non-resident supplier would therefore prefer the resident, and to that extent the non-resident is discriminated against. Article 26(3) neutralises the rigour of section 40(a)(i), and section 90(2) requires the more beneficial of the treaty and the Act to be applied to an assessee to whom the treaty applies. Because that disposed of the disallowance, the Tribunal did not decide whether the payment was a reimbursement, whether it was fees for technical services under section 9(1)(vii), or how Article 12(4) of the treaty applied. On timing it distinguished Associated Cement Companies, where the Supreme Court held a Reserve Bank approval for remittance was not decisive of a customs classification question, as arising in a different context. In the words reproduced by the source cited on this page: "This clause in DTAA neutralizes the rigour of the provisions of Section 40(a)(i)."
It was decided by the ITAT on 2006-02-28 and is reported as [2006] 101 ITD 450 (Delhi); (2006) 103 TTJ (Delhi) 78. Binding on the AO and CIT(A) within the Tribunal's jurisdiction. Persuasive elsewhere. A Tribunal decision binds the assessing officer and the Commissioner (Appeals) within that Tribunal's jurisdiction, and is persuasive before other benches. It is not binding on a High Court, and a contrary co-ordinate bench decision will be argued against you, so check whether the point has been taken the other way before you build a reply around it. On section 40(a)(i), section 90(2), section 9(1)(vii), section 195, the practical question is whether the facts of your own notice match the facts of this case closely enough for the same rule to apply.
It cuts both ways and is cited by both sides. The appeal was partly allowed. On the main issue the Tribunal held that in view of Article 26(3) of the India-USA treaty the Assessing Officer cannot invoke section 40(a)(i) to disallow the deduction, even on the assumption that the sum is chargeable to tax in India; the question whether it is chargeable was expressly left open for adjudication in the appropriate proceedings. On timing, applying Nonsuch Tea Estates and John Fowler (India), the Tribunal accepted that where a payment cannot lawfully be made without an approval, the liability accrues only when the approval is granted, the Reserve Bank's permission having come on 30 June 2000. On the foreign exchange fluctuation ground the loss was allowed, the assessee having consistently accounted for fluctuation at the year end. On the rejection of books, the Tribunal held the discrepancies in the stock records were established and the trading results were rightly ignored, but found the Assessing Officer's comparison of manufacturing cost ratios unsound because the increase was largely excise duty and because the mix had shifted from traded to manufactured goods, and because there was no material showing sales outside the books; it reduced the addition from Rs.5 crore to Rs.3 crore. It arises in Deductions & Disallowances and TDS Defaults matters, on section 40(a)(i), section 90(2), section 9(1)(vii), section 195 of the Income Tax Act 1961, and was decided by Income Tax Appellate Tribunal, Delhi. Before relying on it, read the source linked on this page and check whether it has since been distinguished, overruled or overtaken by an amendment to the Income Tax Act. In practice the steps that follow from it are these. Invoke section 90(2) expressly, so that the more beneficial treaty provision displaces the section. Keep the two issues apart in your grounds: whether the sum is chargeable in India, and whether the disallowance can be made at all. Where a payment needs regulatory approval, keep the application, the approval and the invoices; the date of approval can fix the year in which the liability accrues. Reconcile stock records to the audited accounts before any write-off of obsolete inventory is claimed; unreconciled records here cost the company a Rs.3 crore estimated addition.
Validity check could not be completed. This is a Tribunal order, not a Special Bench, so it does not bind other benches or any High Court. It construes section 40(a)(i) as it stood before the Finance Act 2003 amendment with effect from 1 April 2004, and the Tribunal's reasoning on discrimination depends on the disallowance applying only to non-resident payees, which is a feature of that earlier text. I have not checked whether this order was appealed or how High Courts have since treated non-discrimination arguments against section 40(a)(i). Both points must be checked before it is relied on. No source could be cited for that finding. Checking whether an authority still stands matters as much as knowing what it held: a decision may be overruled on one point and survive on another, or the provision it interprets may have been amended since. Read the source and the editor's note on this page before relying on it in a reply to an Assessing Officer or in an appeal.
The harvested page is clipped: about 8,900 characters from the middle are missing, covering the text of Article 26(3) of the treaty, the authorities on non-discrimination and the opening of the Tribunal's own analysis; the surrounding reasoning and the operative conclusion were read. The Tribunal expressly left open whether the administrative fee is chargeable to tax in India, so nothing here decides whether it was a reimbursement or fees for technical services. The order is internally inconsistent about the date of the Administrative Services Agreement, giving 10 November 1999 in its recital of the facts and 11 September 2000 later, and gives the rupee equivalent of US$12,50,000 as both Rs.5.83 crore and Rs.5.33 crore. The names of the members of the Bench do not appear in the harvested text. This library shows the verification state of every entry openly. This entry has not yet been read in full by a chartered accountant. The summary reflects the sources listed on this page. Read the source before you rely on it in a reply to an Assessing Officer or in an appeal before the Commissioner (Appeals) or the Income Tax Appellate Tribunal.
The appeal was partly allowed. On the main issue the Tribunal held that in view of Article 26(3) of the India-USA treaty the Assessing Officer cannot invoke section 40(a)(i) to disallow the deduction, even on the assumption that the sum is chargeable to tax in India; the question whether it is chargeable was expressly left open for adjudication in the appropriate proceedings. On timing, applying Nonsuch Tea Estates and John Fowler (India), the Tribunal accepted that where a payment cannot lawfully be made without an approval, the liability accrues only when the approval is granted, the Reserve Bank's permission having come on 30 June 2000. On the foreign exchange fluctuation ground the loss was allowed, the assessee having consistently accounted for fluctuation at the year end. On the rejection of books, the Tribunal held the discrepancies in the stock records were established and the trading results were rightly ignored, but found the Assessing Officer's comparison of manufacturing cost ratios unsound because the increase was largely excise duty and because the mix had shifted from traded to manufactured goods, and because there was no material showing sales outside the books; it reduced the addition from Rs.5 crore to Rs.3 crore.
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