Withholding tax provisions

Withholding tax provisions cannot be applied to payments
representing reimbursement of expenses. Further when
income is computed as per the special provisions (section 42),
no disallowance of expenditure can be made (under section
40(a)(i) of the Income-tax Act).

The Chennai Bench of the Income-tax Appellate Tribunal (the Tribunal)
in the case of M/s. Cairn Energy India Pty. Ltd.1 held that the
withholding tax provisions under section 195 of the Income-tax Act,
1961 (the Act) cannot be applied to payments representing
reimbursement of expenses having no element of income.
Further it was held that when income is computed as per the special
provisions of section 42, no disallowance can be made under section
40(a)(i) as it is a settled law that general provisions cannot override
special provisions.

Facts of the case

The taxpayer, a non-resident company, incorporated in Australia was
engaged in prospecting for and production of mineral oils in India. It
carried out its activities under a Production Sharing Contract (PSC),
approved by the Parliament as per the requirements of section 42 of the
Act.
The taxpayer had made certain reimbursements to its non-resident
parent company in respect of expenditure incurred by the parent
company in connection with the business activity carried on by the
taxpayer in India and these amounts were claimed as revenue
expenditure by the taxpayer under section 42.

The Assessing Officer (AO) disallowed the above expenditure under
section 40(a)(i) of the Act on the ground that the taxpayer failed to
deduct the tax at source under section 195 of the Act. The
Commissioner of Income-tax (Appeals) [CIT(A)] confirmed the order of
the AO.

Issue raised before the Tribunal

Whether the expenditure is disallowed under section 40(a)(i) of the Act
on the ground that the taxpayer had failed to deduct tax at source under
section 195 of the Act?

Taxpayer’s contentions

• Section 40 has to be strictly interpreted and its application has to be
restricted only to those provisions over which it has the overriding
effect i.e. sections 30 to 38 of the Act.
• Section 42 of the Act is a special provision2 and therefore the
computation of income had to be made in accordance with that
section only and provisions of a section 40 being a general section
cannot be applied to section 42.
• The payments represented reimbursement of the expenditure
incurred by the parent company and had no element of profit in it3;
consequently the provisions of section 195 could not be applied. In
this context, attention was drawn towards the clauses of the PSC and
the auditor’s certificate of the parent company to stress that the
payments represented actual expenditure.
• Neither the services were rendered in India nor the payment was
received in India by the parent company and therefore the provisions
of section 44BB could not be applied. Consequently the parent
company was not chargeable to tax as per the provisions of the Act
and therefore even on this ground the provisions of section 195
could not be applied.
• Alternatively, it was contended that in respect of assessment years
1998-99 and 1999-00 tax has been paid in the subsequent year and
therefore deduction should be allowed in the year of payment.

Tax Department’s contentions

• The provisions of sections 195 as well as section 40(a)(i) are
applicable for all kinds of payments irrespective of the element of
profit4 and that profit element is not required for deduction of taxes
at source5.
• Section 42 is only a provision enabling special deductions and not a
special provision, therefore the payments covered by section 42 are
subject to application of section 40(a)(i), and section 42 does not
have an overriding effect on section 40(a)(i).
• It is for the AO to decide the applicability of section 195 and not for
the taxpayer6. If the taxpayer was of the view that no profit element
was there, then it should have applied to the AO under section
195(2) and in absence of the same the provisions of section 195
became applicable.
• The taxpayer has not adduced any evidence to prove that the
recharges by the parent company were made at cost and there may
be income hidden or otherwise embedded therein.
• The taxpayer is deducting tax for and from the AY 2001-02 on
similar payments and since there is no change in law and
circumstances in the AY 2001-02, the taxpayer cannot argue now
that it is not liable for deducting taxes at source7.

Tribunal’s ruling

• A sum can be chargeable to tax only when it contains element of
profit, if there is no element of profit embedded, then provisions of
section 195 would not apply. The Tribunal referred to various
rulings to hold that no income accrued to the parent company from
payments by way of reimbursement of expenses and hence the
provisions of section 195 were not applicable8. The Tribunal while
discussing the rulings relied upon by the tax department held that all
the decisions were distinguishable and therefore cannot be applied
to the present case.
• The Tribunal referred to the clauses of the PSC and the auditor’s
certificate of the parent company and agreed with the taxpayer’s
expenditure and there was no profit element embedded therein.
• The argument of the tax department that the taxpayer has himself
deducted taxes at source on similar payments in subsequent years
and that the taxpayer cannot argue now that it is not liable for
deducting taxes at source, was not accepted by the Tribunal in light
of the Supreme Court’s decision in the case of National Thermal
Power Co. Ltd. (229 ITR 383), wherein it has been held that even if
the taxpayer has returned an income, the same can be challenged
before the appellate authority on the ground that it is not taxable.
• The Tribunal further held that scheme of the Act makes it clear that
the provisions of section 42 would prevail over the general
provisions9 of computing income contained in section 30 to 38.
Provisions of section 40 cannot be invoked when the income is to be
computed under section 42 of the Act as it is a settled law that
general provisions must give way to the special provisions10.