The Rajasthan High Court (Jodhpur Bench) has held that disallowance under Section 40(a)(i) of Income Tax Act survives where foreign currency is routed through a third-party funding agency, since the contractual obligation to pay for technical know-how remained with the Indian assessee. The Court explained that where an Indian assessee contracts with a foreign company for technical know-how and services utilised in its Indian business, and the foreign currency consideration is released through a third-party funding agency such as the Crown Agents administering a foreign government grant, the assessee remains the person on whose behalf the payment is made.
The Court ruled that a third-party funding mechanism, including a sovereign grant administered through an agency such as the Crown Agents, discharges the assessee’s contractual liability without converting the third party into the person who incurred the underlying expenditure. Essentially, Article 13(7) of the India-UK DTAC deems fees for technical services to arise in the Contracting State of which the payer is a resident, reinforcing source-rule treatment where the Indian assessee is the contracting party.
The Court clarified that the physical situs from which foreign currency is released is not determinative of who is the ‘payer’ for purposes of TDS deduction under Section 195, and the inquiry centres on the person on whom the contractual obligation to pay rests. The Court also clarified that an Indian assessee cannot claim deduction under Section 35AB for technical know-how expenditure while simultaneously denying that it ‘paid’ or ‘incurred’ the consideration for Section 40(a)(i) purposes.
The Division Bench comprising Dr. Justice Pushpendra Singh Bhati and Justice Praveer Bhatnagar observed that the two substantial questions of law admitted for consideration were interconnected, with the principal controversy being whether the payment to DML ceased to be attributable to the assessee merely because the foreign currency was released by the Crown Agents in the United Kingdom under the financial aid arrangement. The Court noted that Section 195(1) fastens the obligation to deduct tax only upon a person paying to a non-resident any ‘sum chargeable under the provisions of this Act’, and that the Supreme Court in GE India Technology Centre (P) Ltd. v. CIT [(2010) 327 ITR 456 (SC)], explained that Section 195 must operate in conformity with the charging provisions contained in Sections 4, 5 and 9 of the Act.
The Court further observed that Section 9(1)(vii) provides a source rule under which fees for technical services payable by a resident are deemed to accrue or arise in India, except where the services are utilised for a business carried on outside India. The Court pointed out that the assessee itself claimed deduction under Section 35AB on the footing that lump-sum consideration had been paid/incurred for acquisition of technical know-how for use in its business, and that the assessee could not simultaneously claim the deduction while denying that it had made the payment.
The Court emphasised that the source from which the contractual liability was financially discharged cannot be confused with the existence or character of that liability, and that a payment by a third person pursuant to an agreed funding mechanism may discharge the liability of the contracting party without converting the third person into the person who incurred the underlying expenditure. The Court noted that Article 13(7) of the India-United Kingdom Double Taxation Avoidance Convention embodies a source rule under which royalties and fees for technical services are deemed to arise in a Contracting State where the payer is a resident of that State, and that the physical place from which the remittance is transmitted is not determinative of the source of the income.
Briefly, Hindustan Zinc Limited, a Government company engaged in zinc and lead mining and smelting, claimed a deduction of Rs. 8.10 crores under Section 35AB of the Income-tax Act, 1961 for expenditure incurred on acquiring technical know-how from M/s Davy McKee (Stockton) Limited, United Kingdom (DML), in connection with its Chanderiya lead-zinc smelter project. The Assessing Officer allowed only Rs. 3.99 crores and disallowed the balance on the ground that tax had not been deducted at source on the amount payable to the foreign company.
The transaction originated under the United Kingdom-India Hindustan Zinc Aid Arrangement, 1987, under which the U.K. Government extended grant assistance for the project, with the funds being administered through the Crown Agents in the United Kingdom. Hindustan Zinc entered into an agreement dated Feb 28, 1987, with DML, identifying itself as the ‘Owner’ and DML as the ‘Contractor’, for basic engineering, technical know-how and allied services. Payments to DML were released by the Crown Agents out of the grant account, while Hindustan Zinc was required to certify the invoices and deposit the corresponding rupee amount with the Government of India from budgetary/equity support. The Commissioner of Income Tax (Appeals) sustained the disallowance, and the Income Tax Appellate Tribunal, Jodhpur Bench, also upheld the disallowance.
