ASST CIT 16(3), MUMBAI vs. D.A. JHAVERI, MUMBAI

Although the Revenue has raised three Grounds of appeal, but two issues have been raised, which we shall deal in seriatim.

Insofar as the Ground of appeal no. 1 is concerned, the same relates to an amount of Rs.22,95,152/- representing payment to one M/s. HRD, Antwerp NV, Belgium (in short ‘HRD’), which has been disallowed by the Assessing Officer by invoking Sec. 40(a)(i) of the Act on the ground that assessee failed to deduct tax at source on such payment. The CIT(A) has since set-aside the disallowance by holding that Sec. 40(a)(i) of the Act was inapplicable since assessee was not required to deduct tax at source on such payment.

The relevant facts are that the respondent-assessee is a partnership firm engaged in the business of import of rough diamond, cutting and polishing and sale thereof. HRD is a body corporate whose Registered office is located in Antwerp, Belgium. During the period under consideration, assessee paid Rs.22,95,152/- to HRD towards grading and certification of diamonds. Assessee had explained before the lower authorities that it sends cut and polished diamonds to HRD’s office at Belgium for necessary certification for which a separate series of invoice numbers are prepared in the name of HRD giving quantitative and qualitative details and the shipping bill for such transaction is certified by the Customs Department. Upon completing the certification of diamonds received, HRD raises an invoice in favour of the assessee with necessary particulars and the diamonds are shipped back to the assessee alongwith certification and other documents like invoice, airway bill, etc. The certified diamonds are released to assessee through Customs and a bill of entry. For such services, assessee had made payment of Rs.22,95,152/- to HRD, for which no deduction of tax at source was required to be made. Firstly, as per the assessee, the goods are directly sent to HRD at Belgium and the said concern does not have a Permanent Establishment (PE) or agency in India to receive the goods on its behalf; secondly, it was contended that the service of certification is carried out by HRD entirely outside India, i.e., in Belgium. Further, it was also pointed out that the gradation certificate/report given by HRD was only an analysis of the quality of each piece of diamond and did not constitute transfer of any technology, commercial interest, skill or technical knowledge in favour of the assessee and, therefore, such services could not be regarded as ‘fees paid for technical services’. Under these circumstances, the case set-up by assessee was that there was no income liable to be taxed in the hands of HRD in India and accordingly, no tax was required to be deducted at source on the diamond gradation or certification charges paid to HRD.

On the contrary, the Assessing Officer noted that HRD was having a specialized knowledge in diamond grading and certification, which was technical in nature, and therefore, the impugned payment fell in the category of ‘fees paid for technical services’. The Assessing Officer further referred to the provisions of Sec. 9(1)(vii) of the Act, specially Explanation 2 to the said clause, and noting that the Explanation prescribed that the impugned payment amount to income accrued to HRD in India, being ‘fees for technical services’ rendered, he held that assessee was liable to deduct tax at source therefrom. In the assessment order, the Assessing Officer has also referred to Article 12 of the Double Taxation Avoidance Agreement (DTAA) between India and Belgium and noted that the definition of ‘fees for technical services’ prescribed therein was on a similar footing to the definition of ‘fees for technical services’ provided in Explanation 2 to Sec. 9(1)(vii) of the Act. In nutshell, the Assessing Officer held that the impugned payment was made towards ‘fees for technical services’ rendered by HRD, which was liable to be taxed in India in view of Sec. 9(1)(vii) of the Act and, therefore, assessee was liable to deduct tax at source on such payment u/s 195(1) of the Act. Having failed to do so, Assessing Officer invoked the provisions of Sec. 40(a)(i) of the Act and disallowed the expenditure of Rs.22,92,152/-.

In appeal, assessee reiterated the submissions made before the Assessing Officer and pointed out that there was no requirement to deduct tax at source in India as said payment was not to be construed as income liable to be taxed in the hands of HRD in India. Before the CIT(A), assessee also made an alternative plea that Explanation to Sec. 9(1)(vii) of the Act, inserted by the Finance Act, 2010 retrospectively, prescribing that income is deemed to have been accrued in India to a recipient even in the case where services were rendered outside India under sub-section 2 to Sec. 9 of the Act was not available to the assessee during the previous year relevant to the assessment year under consideration and, therefore, assessee could not be made liable to deduct tax at source on such basis. On this basis also, it was sought to be contended that the payment to HRD could not be disallowed by invoking Sec. 40(a)(i) of the Act.

The CIT(A) has considered the fact and legal situation and affirmed the stand of assessee. According to the CIT(A), HRD does not have any PE or any office or dependent agent or representative in India and, therefore, it is a non-resident for the purposes of the Act. Secondly, CIT(A) has concluded that the impugned certification services of the diamonds sent by the assessee were entirely carried out outside India, i.e., in Belgium. Regarding the nature of services rendered by HRD, CIT(A) observed that no doubt the said concern was possessing expertise and technology to grade or certify the diamonds to determine their true features, and it was using such commercial or technical knowledge for grading the diamonds and giving a report thereon to its clients, which included the assessee. In this background, CIT(A) relied upon the judgment of the Hon'ble Bombay High Court in the case of Diamond Services International Pvt. Ltd., (2008) 169 Taxmann 201 to hold that the impugned certification services do not involve parting of any technical knowledge to the clients, though HRD was using the expertise and technical know-how possessed by it.

Further, the CIT(A) examined the issue as to whether the payment made by the assessee for availing the services from HRD would fall within the meaning of expression “fees for technical services” for the purposes of the Act as well as the India-Belgium DTAA. On this aspect, CIT(A) observed that the definition of the expression “fees for technical services” is similar under the Act as well as in the India- Belgium DTAA, so however, he referred to the Protocol Article of India- Belgium DTAA which prescribes that if under any convention and agreement between India and a third state, entered after 1.1.1990, India limits it taxation on “royalties” or “fees for technical services” to a rate lower or a scope more restricted than the rate or scope provided for in the DTAA with Belgium on the said items of income, then the same rate or scope as provided for in the later convention or agreement with the third state on the said items of income shall also apply to the India-Belgium DTAA with effect from the date on which the present agreement with Belgium or the convention or agreement with third state is effected, whichever date is earlier. On the strength of the said Protocol, CIT(A) noted that the subsequent DTAA between India and United Kingdom prescribed that “fees for technical services” would be taxable in India only if technical knowledge, expertise, skill, know- how or process, etc., which are the basis for the services rendered, are ‘made available’ or ‘parted with’ in favour of the client located in India along with the rendering of services. Considering the aforesaid meaning of the expression “fees for technical services” in the context of the instant fact-situation, CIT(A) noted that in providing grading or certification services of diamonds to the assessee, HRD has not parted with any technical knowledge or made available any technical expertise to the assessee so as to classify the impugned payment to HRD as “fees for technical services”. The CIT(A) has reproduced the relevant paras of India-United Kingdom DTAA and given his findings in the context of the Protocol clause in the India-Belgium DTAA. Therefore, the CIT(A) concluded that the impugned payment made to HRD could not be termed as an income accruing to HRD by way of “fees for technical services” u/s 9(1)(vii) of the Act, and under these circumstances, considering that HRD does not have a PE in India, the impugned payments were not in the nature of ‘business profits’ liable to be taxed in India in the hands of HRD. Therefore, it has been concluded that the impugned payment is not susceptible to deduction of tax at source u/s 195(1) of the Act and accordingly, he deleted the disallowance made by the Assessing Officer by invoking Sec.40(a)(i) of the Act. Against such a decision of CIT(A), Revenue is in appeal before us.

Before us, the ld. DR appearing for the Revenue has assailed the order of CIT(A) by referring to the points raised by the Assessing Officer, which we have already adverted to in the earlier part of this order and are not being repeated for the sake of brevity.

On the other hand, the learned representative for the assessee has defended the order of CIT(A) and pointed out that the decision of CIT(A) is in line with the following decisions of the Tribunal wherein by virtue of the Most Favoured Nation (MFN) clause in the relevant Treaty, the expression “fees for technical services” has been understood with the requirement of making available of technology :-

We have carefully considered the rival submissions. The factual aspects of the controversy have already been noted by us in the earlier part of this order in detail and are not being repeated for the sake of brevity. It would suffice to note at this stage that the impugned payment to HRD has been made towards grading and certification of diamonds. The question is as to whether the payment made to HRD constitutes “fees for technical services” or not ? For this purpose, the elaborate discussion by CIT(A) in his order reflects that so far as the definition of “fees for technical services” in the India-Belgium DTAA is concerned, it is an expanded definition if considered in the light of the definition prescribed in the India-United Kingdom DTAA. The scope of the expression “fees for technical services” has been restrictively defined in the India-United Kingdom DTAA to mean that the technical knowledge, expertise, skill or know-how, etc., which are the basis for providing the services, ought to be transferred to or parted with in favour of the client so as to fall within the meaning of “fees for technical services”. Now, in the present case, CIT(A) has rightly relied upon the judgment of the Hon'ble Bombay High Court in the case of Diamond Services International Pvt. Ltd. (supra) to hold that the impugned payment is made to obtain gradation or certification of diamonds and is not meant for obtaining use of the technical know- how, expertise or knowledge possessed by HRD to issue such gradation certificate. Therefore, in the absence of any ‘making available’ of technical knowledge, expertise, skill or know-how by HRD to the assessee in the course of giving gradation certificate, such services cannot be characterised as “fees for technical services” in terms of the India-United Kingdom DTAA. The aforesaid restrictive scope of “fees for technical services” provided in the India-United Kingdom DTAA has been applied by the CIT(A) in the present case owing to the MFN clause in the India-Belgium DTAA. On this aspect of the matter, we find no fault on the part of CIT(A) because on the strength of the MFN clause available in the Protocol between India and Belgium, assessee can rightly be allowed the benefit of restrictive definition of “fees for technical services” contained in the subsequently entered India-United Kingdom DTAA. The phraseology of MFN clause in the India-Belgium DTAA, which has been reproduced by the CIT(A) in para 7.1 of his order, is itself quite clear and justifies the approach of CIT(A). Even otherwise, the decisions relied upon by the learned representative before us supports the said approach of CIT(A). As a consequence, we affirm the conclusion of CIT(A) that the impugned payment cannot be characterised as “fees for technical services” having regard to the meaning and scope of the expression “fees for technical services” provided in the India-United Kingdom DTAA, which is amenable for application in the instant case having regard to MFN clause in the India- Belgium DTAA. As a consequence, once it is held that such payment is not to be regarded as “fees for technical services”, as inferred by the Assessing Officer, and considering that HRD does not have any PE in India, the CIT(A) has rightly concluded that such payments are not liable to be taxed in India in the hands of HRD. Thus, there was no justification for the Assessing Officer to have invoked Sec. 40(a)(i) of the Act citing failure of the assessee to deduct tax at source u/s 195(1) of the Act. In the result, we hereby affirm the decision of CIT(A) on this aspect and Revenue fails.

Before parting, we may also refer to the alternative plea raised by assessee, which also supports the ultimate conclusion of CIT(A) that Sec. 40(a)(i) of the Act is not applicable. The alternative plea proceeds on the basis that even if the services rendered by HRD are in the nature of technical services, and are rendered and utilised in India so as to be taxable in terms of Sec. 9(1)(vii) of the Act, even then the disallowance is not warranted. In this regard, the requirement of rendering of services in India in order to attract Sec. 9(1)(vii) of the Act was removed by insertion of the Explanation by the Finance Act, 2010 with retrospective effect from 1.4.1976. According to the Revenue, inspite of the services having been rendered by HRD outside India, the same is deemed to be taxable in India in view of the aforesaid amendment and, therefore, according to the Revenue assessee was liable to deduct tax at source u/s 195(1) of the Act.

In our considered opinion, such retrospective amendment is determinative of the tax liability in the hands of a recipient of income, but so far as the present case is concerned, what is held against the assessee is the failure to deduct tax at source at the time of payment of such income. Ostensibly, de hors the aforesaid amendment, the impugned income was not subject to tax deduction in India as per the prevailing legal position when the payments were made. Thus, the taxability of a sum in the hands of the recipient on account of a subsequent retrospective amendment would not expose the payer of income to an impossible situation of requiring deduction of tax at source on the anterior date of payment of such income. Thus, on this count also, assessee cannot be held to be in default for not deducting tax at source so as to trigger the disallowance u/s 40(a)(i) of the Act. At the time of hearing, the learned representative for the assessee has relied on the following decisions in support of the aforesaid proposition:-

Channel Guide India Ltd. v. ACIT, 139 ITD 49 (Mum-Trib) 3. New Bombay Park Hotel Pvt. Ltd. v. ITO(IT), 61 SOT 105 (Mum-Trib) 4. (URO) United Helicharters (P) Ltd. v. ACIT, 60 SOT 58 (Mum-Trib) 5. Holcim Services South Asia Ltd. v. DCIT, 157 ITD 892 (Mum-Trib)

Insofar as the Ground of appeal nos. 2 & 3 are concerned, the same relate to a common issue relating to assessee’s claim for Additional depreciation @ 20% in terms of Sec. 32(1)(iia) of the Act amounting to Rs.18,26,347/- on the new plant and machinery acquired and installed during the year under consideration. The Assessing Officer denied the claim of assessee for Additional depreciation solely on the ground that assessee’s activity of cutting and polishing of diamonds does not amount to ‘manufacture or production of goods’ in view of the judgment of Hon'ble Supreme Court in the case of Gem India Manufacturing Co., 249 ITR 307 (SC). On appeal by the assessee, CIT(A) held that the business of cutting and polishing of rough diamonds constitutes a manufacturing activity and in coming to such conclusion, he relied on the decision of Mumbai Bench of the Tribunal in the case of Sheetal Diamonds Ltd., to 6689/Mum/2003 dated 23.3.2011. The CIT(A) noted that the decision of Tribunal in the case of Sheetal Diamonds Ltd. (supra) dealt with an activity which was identical to that carried out by the assessee, and further that the decision of the Hon'ble Supreme Court in the case of Gem India Manufacturing Co. (supra) was also considered. Therefore, the CIT(A) has held the assessee entitled to the claim of Additional depreciation u/s 32(1)(iia) of the Act on the ground that the activity of cutting and polishing of rough diamonds constituted manufacturing. Against such a decision of CIT(A), Revenue is in appeal before us.

We have carefully considered the rival submissions. The short controversy before us is as to whether the activity of cutting and polishing of rough diamonds amounts to manufacture or not? At the time of hearing, the learned representative for the assessee has also furnished an Explanatory Note dealing with the various steps and stages involved in cutting and polishing of rough diamonds into polished diamonds. The Assessing Officer has heavily relied on the judgment of the Hon'ble Supreme Court in the case of Gem India Manufacturing Co. (supra) to emphasise that cutting and polishing of uncut raw diamonds does not amount to manufacture or production of any article or thing. In this context, the following paragraph in the judgment of the Hon'ble Supreme Court is relevant:-

In fact, the aforesaid observations of the Hon'ble Supreme Court were before the Tribunal in the case of Heaven Diamonds Pvt. Ltd. in & 2817/Mum/2004 dated 22.12.2014, wherein the matter was remanded back to the file of Assessing Officer to examine the process undertaken by the assessee for cutting and polishing of diamonds, as to whether it constituted manufacture for the purposes of Sec. 80IB of the Act. Considered in this light, the decision of the Tribunal in the case of Sheetal Diamonds Ltd. (supra) is quite eloquent wherein the entire process involved in the activity of cutting and polishing of rough diamonds into polished diamonds has been examined and it has been held that it constituted manufacture. The said decision of the Tribunal has been further followed by our coordinate benches in the case of Parmes Diamond Exports Pvt. Ltd. and Flawless Diamonds Pvt. Ltd. (supra). Considered in this light, in our view, the CIT(A) made no mistake in holding that the activity of cutting and polishing of diamonds amounts to manufacture so as to enable the assessee to claim Additional depreciation u/s 32(1)(iia) of the Act. Thus, on this aspect also, Revenue fails.

In the result, appeal of the Revenue is dismissed.