In a recent judgment, Delhi High Court has ruled that for the purpose of income deemed to accrue or arise in India, exclusion under section 9(1)(vii)(b), the “source” rule ( i.e the purpose of the expenditure incurred, i.e for earning the income from a source in India), is applicable.

Case Details:
ITA 95/2005
Director of Income Tax Delhi …..Appellant Vs  M/S. Lufthansa Cargo India ….Respondent
Date of Judgment: 27-05-2015
Coram: Hon’ble Justice S. Ravindra Bhat;  Hon’ble Justice R. K. Gauba

Questions before the Court:
1. Whether the Income Tax Appellate Tribunal (ITAT) has rightly interpreted the agreements between the assessee and non-residents and is right in holding that payments made by the assessee to the non-residents are not fee for technical services within the meaning of Section 9(1)(vii) of the Income Tax Act, 1961 so as to oblige the assessee to deduct tax at source under Section 195 of the Act from such payments?
2. Whether the ITAT was right in holding that payments made by the assessee fell within the purview of the exclusionary clause of Section 9(1)(vii)(b) of the Act and were not, therefore, chargeable to tax at source?

Case Laws Referred:
Sundaram Pillai v. Pattabiraman 1985 (1) SCC 591
GVK Industries Ltd. v. ITO 371 ITR 453 (SC)

Facts of the Case:
The assessee was engaged in the business of wet-leasing. It had acquired four old Boeing aircrafts from a non-resident company outside India. DGCA granted the license to operate these aircrafts on international routes only. According to DGCA directives various components and the aircraft had to undergo periodic overhaul repairs before the expiry of prescribed flying hours. Such overhaul repairs were allowed only in authorised workshops.

The assessee's all four aircrafts were wet-leased to a foreign company, Lufthansa Cargo AG, Germany (LCAG). The assessee had entered into an agreement with a German company; Lufthansa Technik for overhaul services. Before the expiry of flying hours, the assessee used to dismantle component needing overhaul/repairs or replacement and flown to Lufthansa Technik‟s workshops in Germany. The parts were supplied by Technik under separate agreement of sale, loan or exchange. Technik used to dispatch the overhauled component along with airway bill for which the freight would be paid by the assessee. The overhauled component would be fitted into aircrafts by the assessee's own personnel. No Technik personnel were deputed to India for rendering any technical or advisory services to the assessee. Similarly, none of the assessee's technical personnel were involved in the overhaul repairs carried out abroad by Technik or other foreign workshops.

During assessment, assessee contended that Technik carried out normal maintenance repairs including supply of spares, and therefore, had Technik been a domestic company, the payments to it would be covered by the provisions of Section 194C and not by the provisions of Section 194J, which cover fees for technical services as defined in Section 9(1)(vii). The assessee contended that it satisfied the requirements of the DGCA for carrying out prescribed maintenance repairs of the aircraft. These repairs, therefore, do not constitute 'managerial', 'technical' and 'consultancy services as defined under Explanation 2 to Section 9(1) (vii)(b) of the Act with regard to income deemed to accrue or arise in India. Assessing Officer (AO) noticed that no tax was deducted at source on payments to Technik and no application under Section 195(2) was filed.

The AO held that payments were in the nature of 'fees for technical services' defined in Explanation 2 to Section 9(1)(vii)(b) of the Act, and were, therefore, chargeable to tax on which tax should have been deducted at source under Section 195(1). The AO relying on the explanation to section 9(2) rejected the assessee's plea that the payments for repairs were incurred for earning income from sources outside India and therefore, the case fell within the exclusionary clause of Section 9(1)(vii)(b).

CIT (Appeal) also rejected the assessee’s contentions but ITAT gave order in favour of the assessee.

The Delhi High Court opined that services rendered by Technik were technical services within the meaning of Section 9(1)(vii) of the Act and on this point held ITAT’s findings erroneous. However, on the second question the Court

Excerpts from the Judgment:

The explanation to Section 9(2) was inserted by the Finance Act, 2007 with retrospective effect from 1.6.1976. The said Explanations read as under:
"For the removal of doubts, it is hereby declared that for the purposes of this section, where income is deemed to accrue or arise in India under clauses (v), (vi) and (vii) of sub- section (1), such income shall be included in the total income of the non-resident, whether or not the non-resident has a residence or place of business or business connection in India."

It is evident that Parliamentary endeavor – through the later retrospective amendment, was to target income of non-residents. But importantly, the condition spelt out for this purpose was explicit: “ where income is deemed to accrue or arise in India under clauses (v), (vi) and (vii) of sub- section (1), such income shall be included in the total income of the non-resident... whether or not,- (ii) the non-resident has rendered services in India." The revenue urges that the fiction created by the said amendment is to do away with the requirement of the non-resident having a place of business, or business connection, irrespective of whether “..the non-resident has rendered services in India." Did this amendment make any difference to payments made to such companies – even in relation to income accruing abroad? The revenue grounds its arguments in the assumption that the later, 2010 retrospective amendment, overrides the effect of Section 9 (1) (vii) (b) exclusion. While no doubt, the explanation is deemed to be clarificatory and for a good measure retrospective at that, nevertheless there is nothing in its wording which overrides the exclusion of payments made under Section 9(1)(vii)(b).

Thus, it is evident that the “source” rule, i.e the purpose of the expenditure incurred, i.e for earning the income from a source in India, is applicable. This was clearly stated by the Supreme Court, when it later held that:

“The exception carved out in the latter part of clause (b) applies to a situation when fee is payable in respect of services utilized for business or profession carried out by an Indian payer outside India or for the purpose of making or earning of income by the Indian assessee i.e. the payer, for the purpose of making or earning any income from a source outside India. On a studied scrutiny of the said Clause, it becomes clear that it lays down the principle what is basically known as the "source rule", that is, income of the recipient to be charged or chargeable in the country where the source of payment is located, to clarify, where the payer is located. The Clause further mandates and requires that the services should be utilized in India.”

In the present case, the ITAT held that the overwhelming or predominant nature of the assessee‟s activity was to wet-lease the aircraft to LCAG, a foreign company. The operations were abroad, and the expenses towards maintenance and repairs payments were for the purpose of earning abroad. In these circumstances, the ITAT‟s factual findings cannot be faulted. The question of law is answered in favour of the assessee and against the revenue.

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