1. Appeal against ITAT order — Disallowance of deduction under Section 35AB for technical know-how — Tax deduction not made. (Para 2 )
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2026 Supreme(Raj) 808
HIGH COURT OF JUDICATURE FOR RAJASTHAN AT JODHPUR
PUSHPENDRA SINGH BHATI, PRAVEER BHATNAGAR, JJ.
Hindustan Zinc Ltd. Through Sh.D.S. Rudra, Yashad Bhawan, Udaipur - Appellant
Versus
The D.C.I.T. (Assessment), Special Range, Udaipur – Respondent
D.B. Income Tax Appeal No. 65 of 2009
Decided On : 05-09-2026
Important Points
The use of a third-party administrative agency to discharge a contractual liability via a grant mechanism does not exempt an assessee from withholding tax obligations under Section 195 if the payment represents income chargeable in India, such as fees for technical services.
Subject
Tax Law - Income Tax
Act Referred
Headnote
(A) Income-tax Act, 1961 - Sections 4, 5, 9(1)(vii), 40(a)(i), 195 and 35AB - Double Taxation Avoidance Agreement (DTAA) - Article 13(7) - Source rule for fees for technical services - The obligation to deduct tax under Section 195 arises only where the payment contains income chargeable to tax in India, in conformity with the charging provisions (Paras 5.2, 5.4). Under Section 9(1)(vii), income by way of fees for technical services payable by a resident is deemed to accrue or arise in India unless the services are utilized for a business or profession carried on outside India (Para 5.4).
(B) Contractual Liability and Funding Mechanisms - A payment by a third person pursuant to an agreed funding mechanism discharges the liability of the contracting party without converting the third person into the person who incurred the underlying expenditure (Para 5.6). The physical place from which a remittance is transmitted is not determinative of the source of income; the material inquiry is the person on whom the obligation to make the payment rests (Para 5.9).
(C) Section 40(a)(i) - Disallowance of expenditure - A deduction can be denied where tax required to be deducted on fees for technical services payable outside India has not been deducted or paid in accordance with law, regardless of whether a third-party agency physically remitted the funds from a grant account (Paras 5.14, 5.15).
Facts of the case:
An assessee claimed a deduction under Section 35AB for the acquisition of technical know-how from a non-resident foreign contractor. Under a financial aid arrangement, a foreign government provided grant assistance administered through an agency in the foreign country. The agency released payments directly to the contractor from the grant account after the assessee certified the invoices. The assessee subsequently deposited equivalent rupee amounts with the domestic government. The revenue disallowed a portion of the deduction, alleging a failure to deduct tax under Section 195, which was subsequently sustained by the Tribunal.
Findings of Court:
The court found that the assessee remained the contracting party and the payment made by the agency was effectively made on behalf of the assessee to discharge its contractual liability. Since the technical know-how was used for the assessee's business in India, the consideration constituted fees for technical services chargeable to tax in India under the statutory source rules and the applicable treaty.
Issues: Whether the provisions of Section 40(a) are attracted when the sum is not physically paid by the assessee but by a third-party agency under a grant arrangement, and whether such sums are deemed to accrue or arise in India.
Ratio Decidendi: The court ruled that the substance of the contractual arrangement prevails over the physical situs of the bank account from which funds are released. Because the assessee treated the sum as expenditure incurred for its business, it cannot simultaneously claim the payment was not made by it. The interposition of a funding agency does not sever the nexus between the contracting party's liability and the chargeability of the income in India.
Result: Appeal dismissed.
(B) Contractual Liability and Funding Mechanisms - A payment by a third person pursuant to an agreed funding mechanism discharges the liability of the contracting party without converting the third person into the person who incurred the underlying expenditure (Para 5.6). The physical place from which a remittance is transmitted is not determinative of the source of income; the material inquiry is the person on whom the obligation to make the payment rests (Para 5.9).
(C) Section 40(a)(i) - Disallowance of expenditure - A deduction can be denied where tax required to be deducted on fees for technical services payable outside India has not been deducted or paid in accordance with law, regardless of whether a third-party agency physically remitted the funds from a grant account (Paras 5.14, 5.15).
Facts of the case:
An assessee claimed a deduction under Section 35AB for the acquisition of technical know-how from a non-resident foreign contractor. Under a financial aid arrangement, a foreign government provided grant assistance administered through an agency in the foreign country. The agency released payments directly to the contractor from the grant account after the assessee certified the invoices. The assessee subsequently deposited equivalent rupee amounts with the domestic government. The revenue disallowed a portion of the deduction, alleging a failure to deduct tax under Section 195, which was subsequently sustained by the Tribunal.
Findings of Court:
The court found that the assessee remained the contracting party and the payment made by the agency was effectively made on behalf of the assessee to discharge its contractual liability. Since the technical know-how was used for the assessee's business in India, the consideration constituted fees for technical services chargeable to tax in India under the statutory source rules and the applicable treaty.
Issues: Whether the provisions of Section 40(a) are attracted when the sum is not physically paid by the assessee but by a third-party agency under a grant arrangement, and whether such sums are deemed to accrue or arise in India.
Ratio Decidendi: The court ruled that the substance of the contractual arrangement prevails over the physical situs of the bank account from which funds are released. Because the assessee treated the sum as expenditure incurred for its business, it cannot simultaneously claim the payment was not made by it. The interposition of a funding agency does not sever the nexus between the contracting party's liability and the chargeability of the income in India.
Result: Appeal dismissed.
Legal Category Hierarchy
-
tax law
-
income tax
-
deductions
- section 35ab - technical know-how expenditure (Para 2)
-
withholding tax
- section 195 - tax deduction at source
-
disallowance of expenditure
- section 40(a)(i) - non-deduction of tax (Para 6)
-
source of income
- section 9 - income deemed to accrue or arise in india
-
double taxation avoidance agreement
- india-uk dtaa - article 13
-
deductions
- practice and procedure
-
income tax
Advocates Appeared:
For the Appellant :Mr. Deepak Chopra, Sr. Advocate assisted by Mr. Anjay Kothari, Mr. Amit Sharma
For the Respondent: Mr. K.K. Bissa
For the Appellant :Mr. Deepak Chopra, Sr. Advocate assisted by Mr. Anjay Kothari, Mr. Amit Sharma
For the Respondent: Mr. K.K. Bissa
Table of Contents
JUDGMENT :
Pushpendra Singh Bhati, J.
1. The instant appeal has been preferred by the appellant- assessee under Section 260A of the Income-tax Act, 1961 against the order dated 20.02.2009 passed by the learned Income Tax Appellate Tribunal, Jodhpur Bench, Jodhpur in ITA No.84/JU/1999 pertaining to Assessment Year 1994-95, claiming the following relief:
“(i) Allow the instant appeal and set aside or quash the impugned order of the ITAT dated 20.2.2009.
(ii) Decide the substantial questions of law in favour of the appellant and against the revenue.
(iii) Reframe suitable questions of law, if it is considered necessary, to do justice to the appellant.
(iv) Any other appropriate relief, as may be considered just and proper, including awarding of the costs may be granted in favour of the appellant.”
1.1. The record reflects that notice was initially issued in the appeal and, by order dated 10.05.2010, the appeal came to be admitted on the following substantial questions of law:
“1. Whether the provisions of Section 40(a) are attracted in the facts and circumstances of this case when the sum is not payable by the appellant (assessee) outside India to DML (foreign contractor) in terms of the agreement entered into between the parties?
2. Whether upon a true and correct interpretation of the relevant provisions of law, circulars issued, provisions of Double Taxation Avoidance Agreement and various clauses of the treaties and upon a true construction of the agreement, the sum payable to DML by the Crown Agents in U.K. out of grant given by U.K. Government can be said to be income accruing or arising to DML in India or deemed to be income accruing or arising to DML in India and whether the finding of the learned ITAT in this regard is perverse and contrary to the provisions of law?”
2. The material facts necessary for adjudication are that the appellant-assessee had claimed deduction under Section 35AB of the Act in respect of expenditure towards acquisition of technical know-how. The claim made was Rs.8,10,37,633/-. The Assessing Officer, taking into account the deduction determined with reference to the earlier assessment year, allowed Rs.3,99,00,468/- and disallowed the balance. The claim concerned technical know- how was obtained from M/s Davy McKee (Stockton) Limited, United Kingdom (“DML”), in connection with the lead-zinc smelter project at Chanderiya.
2.1. The transaction originated in the United Kingdom-India Hindustan Zinc Aid Arrangement, 1987, under which financial assistance was made available for development of the zinc and lead mining and smelter project. Hindustan Zinc Limited was nominated for implementation of the integrated project comprising the zinc-lead mines at Rampura Agucha and the lead-zinc smelter at Chanderiya. Under the financing arrangement, the U.K. Government made available grant assistance, the funds whereof were administered through the Crown Agents in the United Kingdom.
2.2. The appellant entered into an agreement dated 28.02.1987 with DML for basic engineering, technical know-how and allied services concerning the Chanderiya lead-zinc smelter. The agreement identifies Hindustan Zinc Limited as the “Owner” and DML as the “Contractor”. The scope of services included basic engineering and engineering information, licence/know-how, training and technical assistance connected with implementation of the project. The agreement forming part of the record also contains distinct provisions governing fees, payment and Indian income-tax liability.
2.3. Payments to DML were released by the Crown Agents out of the grant account. The contemporaneous Government correspondence, however, required the appellant to certify the invoices and, upon release of the foreign currency payment, to deposit the corresponding rupee amount with the Government of India from the budgetary/equity support made available for the project. The record thus discloses a funding and disbursement mechanism involving the Governments and the Crown Agents, whi
