The differential amount on discounting of bills with a non-resident financier are not liable to TDS under Section 195 and hence, Section 40(a)(i) cannot be invoked.

Issue

The differential amount on discounting of bills with a
non-resident financier are not liable to TDS under Section 195 and hence,
Section 40(a)(i) cannot be invoked.

In the course of its business, an Indian company (“IndCo”)
exported goods out of India. Usually, the exports would on a credit term of up
to six months. IndCo would draw the bill of exchange on the foreign buyer, which
would be accepted by the foreign buyer. After acceptance, IndCo would get the
bill of exchange discounted with its affiliate company, which was a tax resident
of Singapore (“SingCo”). SingCo would immediately remit the discounted amount of
the bill of exchange. The discounting was on ‘without recourse’ basis, i.e.,
even if the buyer does not pay on due date, SingCo cannot recover its value from
IndCo. Thus, SingCo would collect the payment on its own behalf. SingCo was
engaged, among others, in the business of subscribing, buying, underwriting or
otherwise acquiring, owning, holding, selling or exchanging securities or
investments of any kind including negotiable instruments, commercial paper, etc.
Further, in the course of its business, it would draw, make, accept, endorse,
discount, execute and issue promissory notes, bills of exchange, etc. SingCo did
not have a PE in India in terms of Article 5 of India-Singapore DTAA.

• The
  discounting charges were in the nature of “interest” within the meaning of
  Section 2(28A) of the Income-tax Act;

• As the
  payment of such interest was made to a non-resident, IndCo was required to
  deduct tax at source;

• As such tax
  was not deducted, it was disallowable in terms of Section 40(a)(i) of the
  Income-tax Act.

In reaching this conclusion, the AO relied upon Gujarat High
Court’s decision in CIT Vs Vijay Ship Breaking [2003] 261 ITR 113 (Guj).

In appeal, relying on CBDT’s Circular No 65, which provides
that in such a case where a supplier discounts a usance bill with a bank, the
discounting cannot technically be regarded as interest, CIT(A) held that the
discounting charges paid by IndCo were not “interest” as neither any money was
borrowed nor any debt was incurred. Therefore, no tax was required to be
deducted from such payment. Accordingly, the CIT(A) deleted the disallowance.

The Tribunal examined the issue: What is the nature of the
discount? It observed that, according to IndCo, the discount is not in the
nature of interest and hence, it is not disallowable under Section 40(a)(i) of
Income-tax Act, whereas, according to AO, it is in the nature of interest as
defined in Section 2(28A) of the Income-tax Act. The Tribunal then referred to
the definition of “interest” in Section 2(28A) of Income-tax Act (which does not
refer to discount on bill of exchange) and Section 2(7) of Interest-Tax Act
(which specifically refers to discount on bill of exchange). Noticing this
difference, the Tribunal observed that where legislature wanted to, it had
included discount on bill of exchange within “interest”.

Having relevance to the definition of “interest” in Section
2(28A) of the Income-tax Act, CBDT’s Circular No 65, which though was issued in
the context of Section 194A, would be relevant as regards discounting charges,
opining that since the property in the usance bill/hundi passes to the bank and
the collection by the bank being on its own behalf, it is the price paid for the
bill. The Gujarat High Court’s decision in CIT Vs Vijay Ship Breaking
Corporation [2003] 261 ITR 113(Guj) being reversed by the Supreme Court in Vijay
Ship Breaking Corporation Vs CIT [2009] 314 ITR 309 (SC) , the discounting
charges were not in the nature of “interest” paid by the assessee. Further, as
discounting charges were business profits of SingCo and as SingCo did not have
any PE in India, it was not liable to tax in India in respect of such discount
charges. Hence, IndCo did not have any obligation to deduct tax at source under
Section 195 of the Income-tax Act. Accordingly, the amount could not be
disallowed by invoking Section 40(a)(i) of the Income-tax Act.