2016 Supreme(Del) 1967

IN THE HIGH COURT OF DELHI AT NEW DELHI
S. MURALIDHAR & VIBHU BAKHRU, JJ.
COMMISSIONER OF INCOME TAX - Appellant
Vs.
HERBALIFE INTERNATIONAL INDIA PVT. LTD. - Respondent
ITA 7/2007
Decided On : 13-05-2016

Headnote:

INCOME TAX - Section 40(a)(i) - Disallowance of expenditure - Non-deduction of tax at source - Applicability of Article 26(3) of the India-US Double Taxation Avoidance Agreement (DTAA) - Whether Section 40(a)(i) of the Income Tax Act, 1961 (the Act) is discriminatory and therefore, not applicable in terms of Article 26(3) of the DTAA - Held, yes - Section 40(a)(i) of the Act is discriminatory and therefore, not applicable in terms of Article 26(3) of the DTAA.

Fact of the Case:

The assessee, an Indian subsidiary of Herbalife International Inc. (HII), USA, claimed an expenditure of Rs. 5.83 crores as administrative fee paid to HIAI as consideration for the various services provided to the assessee under the Administrative Services Agreement (ASA). The assessee entered into a Licence and Technical Assistance Agreement (LTAA) with HII, the owner of the incorporeal right relating to the process of manufacture of the various products, for the purpose of manufacturing the products in India on a contract basis. The Revenue disallowed the claim for deduction of the administrative fee on the ground that since the services were rendered in the previous year 1999-2000, the liability had to be accounted for in the accounts for the year ending on 31st March 2000. The assessee contended that the payment by the assessee to HIAI required the prior permission of the Reserve Bank of India (RBI) under the Foreign Exchange Regulation Act, 1973 (FERA). The assessee also contended that the expenditure in question cannot be deemed to have accrued to the assessee in accordance with law without the RBI approval. The assessee accordingly treated the expenditure as having accrued only during the previous year relevant to AY 2001-02. The assessee further submitted that by 31st March 2000 when the accounting year for AY 2000-01 ended, the assessee had not received the details regarding the share of common expenses payable by it to HIAI. The assessee pointed out that since the ASA commenced only from 11th September 2000 (M/s. HIAI had waived ASA fee from 11th September 2000 to 31st December 2000) there was no past precedent which enabled the assessee to make a provision for administrative fee on an estimate basis. The assessee stated that an interim invoice was received on 30th June 2000 for US$ 333,333. The second interim invoice for the same sum was raised on 30th September 2000 and the final invoice on the same amount on 31st December 2000. The last invoice duly supported with cost allocation sheets was received on 31st January 2001 and the total amount payable to HIAI towards administrative fee worked out to US$ 1,015,240. In terms of the approval granted by the RBI only an amount of US$ 1 million was remitted. The balance US$ 15,240 was waived by HIAI. According to the assessee, this formed a prudent basis for determining accrual of such expenses for the first quarter of 2001 (1st January to 31st March 2001) in the assessee’s books. For the period 1st January 2001 to 31st March 2001, the assessee pointed out that the bills up to 31st December 2000 were received from HIAI and on the basis of the above proceeds, it had estimated the same at 1/4th of the sum payable for a period of 12 months. The second plea was that with the Foreign Exchange Management Act, 1999 (FEMA) becoming effective from 1st June 2000, the payment could be made on current account transactions. In terms of Section 5 of FEMA foreign exchange could be drawn from an authorized dealer without RBI's prior permission. On account of both factors it was contended that the sum payable by the assessee to HIAI could be ascertained, and had accrued and arisen to the assessee and was, therefore, allowable as deduction during the AY in question.

Finding of the Court:

The Court held that Section 40(a)(i) of the Act is discriminatory and therefore, not applicable in terms of Article 26(3) of the DTAA. The Court also held that the ITAT was correct in allowing a deduction of Rs. 5.83 crores being the administrative fee paid by the assessee to HIAI. The Court further held that the expenses for the period 1st January 2000 to 31st March 2000 accrued as a liability to the assessee only during the previous year and that the said expenditure was rightly allowed as deduction during the AY in question. The Court also held that the payment of administrative fee by the assessee to HIAI during the period 1st January 2001 to 30th March 2001, the liability should be held as accrued and arisen during the previous year relevant to the AY 2001-02 and therefore, is rightly allowed by the ITAT.

Issues: Whether Section 40(a)(i) of the Act is discriminatory and therefore, not applicable in terms of Article 26(3) of the DTAA.

Ratio Decidendi: The Court held that Section 40(a)(i) of the Act is discriminatory and therefore, not applicable in terms of Article 26(3) of the DTAA. The Court observed that the condition under which deductibility is disallowed in respect of payments to non-residents, is plainly different from that when made to a resident. Under Section 40(a)(i), as it then stood, the allowability of the deduction of the payment to a non-resident mandatorily required deduction of TDS at the time of payment. On the other hand, payments to residents were neither subject to the condition of deduction of TDS nor, naturally, to the further consequence of disallowance of the payment as deduction. The Court held that the expression ‘under the same conditions’ in Article 26(3) of the DTAA clarifies the nature of the receipt and conditions of its deductibility. It is relatable not merely to the compliance requirement of deduction of TDS. The lack of parity in the allowing of the payment as deduction is what brings about the discrimination.

Final Decision: The appeal is accordingly dismissed but, in the facts and circumstances of the case, with no orders as to costs.