The Delhi Bench of the Indian Income Tax Appellate Tribunal (ITAT) delivered a ruling dated 23 February 2007, in the case of Assistance Commissioner of Income Tax v. Modicon Network (P) Ltd [2007 14 SOT 204), on whether remittances to a Hong Kong company towards reimbursement of certain expenses would be liable to withholding tax in India as Fees for Technical Services (FTS).
(a) Facts. A consortium was formed by three companies, i.e. Modi Wellvest Private Limited, Distacom Communications (HK) Ltd. (a Hong Kong based company) and Motorala Inc. (a US based company) to bid for the operation of GSM-based cellular/mobile services in India.
The respective consortium members were to bear their own pre-bid expenses till the bid was successful. For this purpose, the appellant (Modicon Network (P) Ltd, an Indian resident company) was formed as a "joint venture vehicle" (hereafter: JV vehicle). The understanding was that as soon as the JV vehicle was created, the consortium members would become entitled to get their share of the pre-bid expenses reimbursed out of the capital of the Indian company (i.e. the JV vehicle).
As per the agreement, the members incurred pre-bid expenses. The Hong Kong based member of the consortium issued an invoice to the JV vehicle for reimbursement of expenses incurred by it in Hong Kong. A certificate from chartered accountants verifying the expenses also accompanied the invoice.
The JV vehicle made an application under Sec. 195 of the Indian Income Tax Act 1961 (ITA) to the tax authorities for their authorization to remit the money to Hong Kong company without any withholding tax. It was contended in the application that since the amount being remitted was only a reimbursement of pre-bid expenses, there was no income element imbedded therein and that the remittance cannot also be considered as FTS since no technical services were rendered.
The tax authorities rejected the contentions and directed that 30% tax be withheld because the proposed remittance was FTS; the JV vehicle was getting technical services from the Hong Kong based company, which was acting as its agent in Hong Kong and it had made the payment (to another Hong Kong based service provider) on behalf of the JV vehicle.
The JV vehicle appealed to the Commissioner of Income Tax (Appeals) against the withholding tax order. The Commissioner of Income Tax (Appeals) agreed with the view of the tax authorities that the payment was in the nature of FTS and hence subject to tax in India. However, a partial relief was granted to the taxpayer; he directed that the tax was to be deducted at 20% and not 30%.
Both the JV vehicle as well as the tax authorities appealed to the ITAT against the decision of the Commissioner of Income Tax (Appeals).
(b) Issue. The key issue before the ITAT was whether the amount remitted by the JV vehicle to the Hong Kong based company contained any income element so as to be liable to tax in India at applicable tax rate and, accordingly, whether withholding tax will apply.
(c) Decision. The ITAT ruled that the payment to the Hong Kong company did not contain any income element and that such payment cannot be regarded as FTS under the provisions of ITA and hence, it was not liable to any income tax in India.
The ITAT observed that under Sec. 195 of the ITA, any person responsible for paying to a non-resident any sum that is chargeable to tax under the provisions of the ITA needs to deduct tax from such payment at the applicable rate. Also, under that section, if the payer believes that the whole of the amount payable is not the income chargeable to tax in the hands of the recipient, he can make an application to the tax authorities to determine the appropriate taxable proportion of such sum and accordingly, he has to deduct tax from such payment. Therefore, the obligation to deduct tax is only with reference to the income element embedded in the remittance that is liable to tax in India. Any remittance that does not have an income element that is chargeable to tax in India need not be subject to withholding tax.
The ITAT referred to the definition of FTS under Sec. 9(1)(vii) of the ITA, which states that FTS means any consideration for the rendering of any managerial, technical or consultancy services, including the provision of services of technical or other personnel. Therefore, the payment must be made as quid pro quo for such services rendered. This would mean that the remitter of the amount has received the benefit of the technical services and that the recipient of the amount has rendered the technical services. In this case, the Hong Kong based company had not rendered any services, much less any technical services, to the JV vehicle for which the amount was remitted. Rather, a consultancy firm engaged by the Hong Kong based company rendered the services. The Hong Kong based company made payment to the consultancy agency and sought reimbursement of the same from the JV vehicle as per the terms of the consortium arrangement.
Accordingly, the amount remitted by the JV vehicle was only by way of reimbursement of the expenses incurred by the Hong Kong based company and not by way of any consideration for rendering any technical or consultancy services. The ITAT noted that there was no evidence or allegation that the Hong Kong based company and the agency firm engaged by it were connected in any manner or that the entire transaction was done as a device to avoid withholding tax in India. Therefore, such payment cannot be viewed as FTS but labelled as reimbursement of expenses.
The ITAT further observed that by the very nature of things, 'reimbursement of expenses' cannot be considered as having an 'income' element embedded in it so as to attract withholding tax under provisions of the ITA. If under a bona fide arrangement, there is a provision for reimbursement of expenses to the parties involved, which they incur in furtherance of a common objective, such reimbursement cannot be considered as bearing the character of income so as to be subject to tax.
The ITAT noted that there was no dispute about the genuineness of the consortium agreement under which a consortium member was entitled to recover his share of pre-bid expenses as reimbursement from the JV vehicle. Since the Hong Kong based company did not have the requisite expertise to draw up the pre-bid documents, it had to engage services of a consultancy firm. It paid the consultancy firm and issued an invoice for the amount to the JV vehicle for reimbursement of amount paid by it.
The ITAT rejected the argument of the tax authorities that the nature of a remittance as FTS does not change merely because the Hong Kong entity had to engage another service provider to prepare pre-bid documents and reimbursement per se cannot bear the character of income.
The ITAT observed that the purpose of tax deduction under Sec. 195 of the ITA was not to collect a sum that is not taxable under the ITA. It was only to facilitate the collection of tax lawfully leviable under the provisions of the tax law. Accordingly, the ITAT held that payment to Hong Kong company was not liable to withholding tax in India as FTS.
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