The Hyderabad Bench of the Income Tax Appellate Tribunal (ITAT) in its notable judgment in the case of Nippon Koei Company Limited vs. Assistant Director of Income-Tax, International Taxation, [ITA. 670 HYD 2023, A/Y 2021-22] addressed various issues of Indian International tax law applicable to foreign companies whose branches were functioning in the country and had hired overseas professionals or experts for their projects.
Issues dealt with by the Tribunal
The Tribunal dealt with the allowability of interest for the delay in depositing the TDS, whether the payments made to a foreign expert were liable to be assessed as salary or fees for consultation, the disallowance in accordance with the provisions of Section 40 A(I) and 44DA of the Income Tax Act, and the applicability of the provisions relating to TDS in the case of bank guarantee charges.
The ruling is further a reminder of settled case law relating to the relationship between an employer and an employee, and the need for the substance over the form in characterizing a transaction from a taxing perspective.
Facts of the Case
Nippon Koei Co. Ltd., being a foreign concern engaged in the business of engineering and consultancy services, has filed its return of income for the assessment year 2021-22, showing income from its Indian Branch Office. The assessment for the year was chosen for scrutiny assessment, and a draft assessment order underlining a sum of ₹3.47 crores to its income was passed by the Assessing Officer. Thereafter, objections were raised before the Dispute Resolution Panel (DRP), and a final assessment order underlining disallowance on account of interest payment under Section 201(1A), payment to a foreign expert, expenses under Section 44DA, and bank guarantee charges to a sum of ₹3.47 crores under Section 40(a) was passed.
The assessee was aggrieved by the final assessment order and thus preferred an appeal before the ITAT.
Interest under Section 201(1A): Not an Allowable Business Expenditure
One of the issues before the Tribunal was whether interest paid under section 201(1A) for delayed deposit of tax deducted at source could be allowed as a business expenditure under section 37(1). The assessee argued that such interest was compensatory in nature and relied on certain tribunal decisions in support of its claim.
In the same case, the ITAT, however, disagrees with the assessee’s view and follows the judgment of the Madras High Court in the case of CIT vs Chennai Properties & Investments Ltd (239 ITR 435). The Tribunal held that the interest paid due to non-compliance of the statutory requirements of TDS cannot be said to be incurred wholly and exclusively for the purpose of business.. Accordingly, the disallowance of interest under section 201(1A) was upheld. This finding reaffirms the settled position that interest arising from tax defaults remains a non-deductible expense.
Salary vs Consultancy: Substance Prevails Over Form
The major issue arising out of the case is with respect to the payment of around ₹3.08 crores made to a foreign expert hired by the assessee for the Chennai Metro Rail Project. The assessee treated the nature of payment as consultancy charges without deducting tax under section 192 of the Act. The Assessing Officer, on the other hand, held that the payment was made towards salary. Therefore, on account of non-deduction of TDS by the assessee, the AO disallowed the expense under section 40(a)(i) of the Act.
Even assessee argued that the payments were consultancy fees because invoices were raised, GST was paid under the reverse charge mechanism, and the agreement used the word “consultancy”, the Tribunal looked at the actual terms and real nature of the arrangement.
On examining the agreement, the Tribunal found that the expert:
- worked full-time and exclusively for the assessee,
- reported directly to the management of the assessee,
- was entitled to paid leave, and
- received fixed monthly payments.
Further, the expert functioned as a team leader within the assessee’s organisational structure.
Based on these facts, the Tribunal concluded that the relationship was that of employer and employee, and not an independent consultant.
The ITAT held that the mere characterization of payment as consultancy or the discharge of GST under RCM cannot override the real nature of the relationship. Applying the principle of substance over form, the Tribunal decided that the arrangement bear all the characteristics of an employer-employee relationship. Consequently, the payment was held to be treated as salary income, attracting TDS under section 192, and the disallowance under section 40(a)(i) was upheld.
Disallowance under Section 44DA Remanded for Fresh Examination
Another issue was with regard to small payments made by the Indian branch to the head office in Japan, which were not allowed by the Assessing Officer under section 44DA. The assessee argued that the documents were produced before the DRP, but the DRP did not properly adjudicate on the issue.
The Tribunal held that though the DRP recorded the factual submissions by assessee, it did not give a clear finding on the issue. In the interest of justice, the issue was remanded to the Assessing Officer for fresh adjudication after considering the evidences produced by the assessee. Thus, the issue was allowed for statistical purpose.
Bank Guarantee Charges - No TDS under Section 194H
The Tribunal was also required to decide whether the charges on bank guarantee and bank performance bonds were liable for deduction under section 194H as “commission or brokerage.” The AO had disallowed the claim on the ground that the expenditure was not deducted under section 40(a) on the ground that tax was not deducted. The ITAT, relying on the decision given by the Coordinate Bench in the case of Navnirmaan Highway Project Pvt. Ltd. vs. DCIT, held that “when a bank guarantee is given by the bank, a relationship does not exist between the bank and the customer as principal and agent.” Therefore, such charges do not fall within the scope of commission or brokerage under section 194H. The disallowance was accordingly deleted.
Conclusion
The judgment in Nippon Koei Co. Ltd is an important to note for foreign entities and MNCs operating in India. The judgment again makes it clear that no amount of contractual characterization, billing arrangements, or GST treatment can affect the nature of payments under the Income-tax Act. This is subject to the true nature of the arrangement, level of control, and terms of engagement.
The judgment also makes it clear that interest on TDS defaults is not deductible and that bank guarantee charges are still not liable to section 194H. For taxpayers engaging foreign professionals, the judgment is an important reminder of the need to draft agreements carefully and review TDS positions from time to time to avoid large disallowances.