Article 7, India-Malaysia DTAA; Article 7, India-UK DTAA – Compensation paid for contractual default, being business profit, was not taxable in India if recipient had no PE in India – Rebate given for quality issues effectively being discount in sale price, was not taxable; even otherwise, rebate being business profit, was not taxable in India if recipient had no PE in India

19. 
[2019] 108 taxmann.com 79 (Vizag. – Trib.) 3F Industries Ltd. vs. ACIT, Circle-1, Eluru ITA No.: 01 (Viz.) of 2015 A.Y.: 2007-08 Date of order: 17^th July, 2019;

Article 7, India-Malaysia DTAA; Article 7,
India-UK DTAA – Compensation paid for contractual default, being business
profit, was not taxable in India if recipient had no PE in India – Rebate given
for quality issues effectively being discount in sale price, was not taxable;
even otherwise, rebate being business profit, was not taxable in India if
recipient had no PE in India

FACTS

The assessee was an Indian company engaged
in trading of certain products. The assessee procured the products from
suppliers in India and exported the same to foreign customers. Among others, it
had entered into export contracts with a Malaysian company (Malay Co) and a UK
company (UK Co). In respect of the contract with the Malay Co, as the price in
the Indian market was substantially higher the assessee could not procure the
products and did not fulfil the contract. Hence, the Malay Co claimed
compensation towards the losses suffered because of default by the assessee. To
maintain its business reputation and relationship with the Malay Co, the
assessee agreed upon the amount of compensation and paid up. In respect of its
contract with the UK Co, there were certain quality issues. Hence, the UK Co
claimed price rebate. Again, to maintain its business reputation and
relationship with the UK Co, the assessee agreed to a rebate.

The AO completed the assessment u/s 143(3)
of the Act. Subsequently, CIT undertook revision of the order u/s 263 and held
that as payment was made to a foreign company and no tax was deducted u/s 195
of the Act, the assessment was erroneous and prejudicial to the interest of the
Revenue. He directed the AO to examine disallowance u/s 40(a)(i) of the Act.
The AO proposed disallowance, which the DRP upheld.

HELD

Compensation for contractual default

The transaction of export was a business
transaction. Compensation was paid because of failure of the assessee to supply
the products. Thus, the payment was to compensate the Malay Co for the loss
suffered by it because of non-fulfilment of contract by the assessee.

Therefore, the receipt was business income
in the hands of the Malay Co. Further, the Malay Co did not have a PE in India.
In terms of Article 7 of the India-Malaysia DTAA, business income of the Malay
Co would be taxable only in Malaysia unless it had a PE in India. But since it
did not have a PE in India, the business income was not chargeable to tax in
India. Therefore, the question of disallowance u/s 40(a)(i) of the Act did not
arise.

Quality rebate

Quality rebate was given because of certain
quality issues. The perusal of the documents showed that the quality rebate
was, effectively, a discount in sale price. Hence, there was no question of
TDS.

Even otherwise, quality rebate was in the
nature of business profit for the UK Co. In terms of Article 7 of the India-UK
DTAA, the business income of the UK Co would be taxable only in the UK unless
it had a PE in India. But since it did not have a PE in India, the business
income was not chargeable to tax in India. Therefore, the question of
disallowance u/s 40(a)(i) of the Act did not arise.