Payments For Certification Services Rendered By Foreign Entities Not Taxable In India In Absence Of Fixed Place Of Business In India: Ahmedabad ITAT

Section 9(1)(vii) of Income Tax Act states that any income that is deemed to accrue or arise in India, even if the income is earned by a non-resident, is subject to tax in India.

Referring to Supreme Court decision in CIT Vs. Kotak Securities Ltd, the Division Bench of T.R. Senthil Kumar (Judicial Member) and Makarand V. Mahadeokar (Accountant Member) reiterated that “routine services not involving technical knowledge do not constitute technical services and it is mere in the nature of facility offered or available”.

Facts of the case:

The assessee is primarily engaged in the business of development of software product. It had paid Product Certification Expenses to non-resident company and submitted before AO that the company is required to get its software product certified from various authorities for which product certification charges have been paid. The services include measuring and evaluating technical quality of the software product against standardized set of quality criteria against which certificate is issued. The sum is paid for AES Interoperability test which assures VPN users that IPsec systems are generally interoperable with other IPsec systems when using the new AES encryption algorithm. In respect of tax deduction on the payments made to those parties, it was submitted that the services relate to certifying/ registering the product. The services have been availed from parties outside India viz. USA, UK, Korea and China. Hence, as per Section 90(2) of the Act, applying beneficial provisions of the tax treaty, it is submitted that the services rendered to ETPL are not technical nature and hence, the payments made are not covered within the definition of Fees for Technical Services as provided under the respective treaties. Further, in absence of fixed place of business of such parties in India, the payment made to them is not chargeable to tax in India even as business income.

The AO was not satisfied with the reply and concluded that the expenses are not reasonable and genuine. He also concluded that since the income derived by these parties, to whom payment was made, is from the source in India, in terms of provisions of section 5(2)(b) of the Act, this income is deemed to accrue or arise in India and since the assessee has failed to withhold tax u/s 195(2), added back u/s 40(a)(i) of the Act.

Observations of the Tribunal:

The Bench observed that the royalty is payable to the vendor only upon the activation of the software by the end user, which creates a time gap between the provision made by the assessee and the actual activation by the end user.

The Bench also noted that the provision for royalty expenses is made at the time of recording sales, but the actual payment is not immediately due to the third-party vendor as the end user has not yet activated the software.

Thus, referring to the judicial precedents, the Bench clarified that the withholding tax liability is dependent on the existence of tax liability in the hands of the payee/recipient of income.

If the income embedded in the payment is not taxable under the Act, the tax withholding liability does not arise, added the Bench.

The Bench accepted the opinion of the CIT(A) that the withholding tax liability under Section 195(2) of the Act does not arise until the royalty payment is actually due and payable, and the income embedded in the payment must be taxable under the Act for the withholding tax provisions to apply.

The Bench went on to observe that under the DTAA provisions, the payments for certification services rendered by entities in the USA, UK, Korea, and China are not taxable in India in the absence of a fixed place of business in India.

Hence, the ITAT deleted the additions made by AO u/s 40(a)(i) while concluding that the payments are not liable for withholding tax u/s 195 and dismissed the Revenue's appeal.

Counsel for Appellant/ Revenue Atul Pandey

Counsel for Respondent/ Assessee: Dhinal Shah

Case Title: DCIT verses Elitecore Technologies Pvt.Ltd.

Case Number: ITA No.1728/Ahd/2019

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