*connectedthinking pwc
Background
The Bombay High Court (“High Court”) has, in a recent ruling1 in the case of McKinsey & Company Inc. (“the assessee”), held that there must be a valid and acceptable basis for making a departure from the order passed by a superior official and that the hierarchical discipline should be observed while implementing the fiscal legislation. In the absence of that, the exercise of the powers by the Assessing Officer (“AO”) would be arbitrary and open to challenge.
Facts
• The assessee is a non-resident company incorporated in the United States. The assessee forms a part of the McKinsey Group and provides international management consultancy services.
The parent company of the assessee has a branch
1 McKinsey & Company Inc, United States v. Union of India [2010-TII-09-HC-MUM-INTL]
office in India (“McKinsey India”). The assessee provides two kinds of services to McKinsey India:-
- Borrowed services which are the services rendered by the assessee to McKinsey India as a part of consultancy, which the latter provides to its clients;
- Firm function services which include administrative and support services provided to the worldwide offices of the Group including to the McKinsey India.
• As regards borrowed services, the Income-tax Appellate Tribunal held that the services would have to be regarded as business income relying upon the Memorandum of Understanding (“MoU”) between the governments of India and United States of America (“USA”), and not as fees for included services.
Hierarchical Discipline should be observed while implementing fiscal legislation Tax & Regulatory Services
News Alert*
2 June, 2010
PricewaterhouseCoopers
• The firm function services are charged on the basis of cost allocation together with an agreed mark up of 3% in accordance with the MoU entered into by the assessee and McKinsey India with effect from 1 April, 2005. The question involved is in respect of imposition of withholding tax in the case of such firm function services.
• In this regard, the assessee made an application to the Deputy Director of Income- tax (International Taxation) (“DDIT”) under section 197 of the Income-tax Act, 1961 (“Act”) for AY 2010-11 seeking a nil withholding tax certificate in respect of payments received from McKinsey India for firm function services.
• The assessee also referred to the orders passed by the Director of Income-tax (International Taxation) (“DIT”) under section 264 of the Act and by the AO under section 197 of the Act for the AY 2007-08 to 2009-10, which specifies the withholding tax rate of 1.5% and 1.3%, respectively, on similar gross payments.
• The AO, however, rejected the application on the grounds that the schedules to the preparation of the consolidated accounts were not made available for AY 2006-07 and hence the assessee’s claim that the receipt is in the nature of business income was not verifiable. Consequently, the AO held that the payments made were in the nature of fees for included services covered under Article 12 of India-USA Tax Treaty (“Tax Treaty”) and were subject to withholding tax at the rate of 15% on gross basis.
Issue
Is the AO’s order directing the withholding tax at 15% on the gross amount without following the hierarchical discipline founded on logical or cogent grounds?
Assessee’s contentions
• The payments received from Mckinsey India are not subject to tax in India because they are not fees received for technical services;
• Receipt in respect of administrative and support services forms part of normal business income under Article 7 of the Tax Treaty and is not taxable in India in absence of a permanent establishment in India;
• In light of the MoU entered into between the payer and the recipient, the income relating to the firm function services cannot be higher than 3%. Consequently, without prejudice to its submissions, the assessee was willing to submit itself to a deduction of tax at source to the extent of the income element involved in the payment received, which can be no higher than 3% of the total payment;
• The Transfer Pricing Officer, for AY 2006 - 2007 had accepted the consideration involved in the transaction as being reflective of an arm’s length price and that determination would be binding on the AO;
• The DIT, in exercise of powers under section 264 had directed that tax for AY 2008-09 should be deducted at 1.5 % of the gross receipts. Furthermore, the AO for AY 2009- 10 had also passed an order under section 197 determining the withholding tax rate at the rate of 1.3%.
• There was no justification for the AO not to follow the order passed by the DIT for AY 2008-2009.
Revenue’s contentions
• Reliance was placed by the AO on the draft assessment order for AY 2006-07, wherein it was held that the amount received by the assessee for firm function services would be taxable in India as fees for technical services within the meaning of section 9(i)(vii) of the Act and would be taxable as fees for included services under Article 12 of the Tax Treaty. In doing so the AO showed consistency in his approach by following the approach taken in the draft assessment order;
• An alternative remedy was available to the assessee under section 264 of the Act and hence the writ petition should not be entertained.
PricewaterhouseCoopers
High Court ruling
• The AO's order directing that the withholding of tax computed at 15% on the gross amount for AY 2010-2011 is not founded on any logical or cogent basis;
• Reliance by the AO on his order for AY 2006-07 cannot prima facie be accepted since that order is a draft assessment order, pending the conclusion of the Dispute Resolution Procedure;
• Unless there was a valid and acceptable basis for making a departure from the order passed by the DIT and cogent material was available before the AO to do so, the exercise of discretion would become arbitrary and vulnerable to challenge;
• The fact that the assessee had alternative remedies available, does not bar the exercise of the writ jurisdiction in cases where the AO has chosen to act in complete departure from a duly considered determination made by the superior officer.
• Unless a sense of hierarchical discipline is observed; while implementing fiscal legislation, the exercise of powers by AO would be rendered arbitrary. This would be impermissible and contrary to the norms of fairness which are otherwise embodied in Article 14 of the Constitution of India;
• The prescriptions of Article 14 must at all times influence statutory interpretation and must be rigorously applied to the exercise of statutory discretion;
• In the absence of material on record to justify the departure, the Court set aside the order of the AO and directed him to issue a certificate under section 197(1) of the Act in accordance with the order passed by the DIT for AY 2008-2009
Conclusion
This is a very important judgment upholding the hierarchical discipline while implementing fiscal legislation. It provides relief to all taxpayers who are often subjected to arbitrary changes in opinion by the tax authorities without logical or valid grounds. The judgment would ensure consistency to be followed by tax officers as regards the approach of their superiors.
PricewaterhouseCoopers For private circulation only Contact
Ahmedabad
President Plaza, 1st Floor Plot No 36 Opp Muktidham Derasar
Thaltej Cross Road, SG Highway Ahmedabad, Gujarat 380054 Phone +91-79 3091 7000
Bangalore
6th Floor, Millenia Tower 'D' 1 & 2, Murphy Road, Ulsoor, Bangalore 560 008 Phone +91-80 4079 6000
Bhubaneswar
IDCOL House, Sardar Patel Bhawan Block III, Ground Floor, Unit 2 Bhubaneswar 751009
Phone +91-674-253 2279 / 2296
Chennai
PwC Center, 2nd Floor 32, Khader Nawaz Khan Road Nungambakkam
Chennai 600 006
Phone +91-44 4228 5000
Hyderabad
#8-2-293/82/A/113A Road no. 36, Jubilee Hills, Hyderabad 500 034,
Andhra Pradesh Phone +91-40 6624 6600
Kolkata
South City Pinnacle, 4th Floor, Plot – XI/1, Block EP, Sector V Salt Lake Electronic Complex Bidhan Nagar
Kolkata 700 091
Tel: 44046000 / 44048225
Mumbai
PwC House, Plot No. 18A, Guru Nanak Road - (Station Road), Bandra (West), Mumbai - 400 050 Phone +91-22 6689 1000
New Delhi / Gurgaon Building No. 10, Tower - C 17th & 18th Floor, DLF Cyber City, Gurgaon Haryana -122002 Phone : +91-124-3306000
Pune
GF-02, Tower C, Panchshil Tech Park, Don Bosco School Road, Yerwada, Pune - 411 006 Phone : +91-20 41004444
For more information :
The above information is a summary of recent developments and is not intended to be advice on any particular matter. PricewaterhouseCoopers expressly disclaims liability to any person in respect of anything done in reliance of the contents of these publications. Professional advice should be sought before taking action on any of the information contained in it. Without prior permission of PricewaterhouseCoopers, this Alert may not be quoted in whole or in part or otherwise referred to in any documents
©2010 PricewaterhouseCoopers. All rights reserved. "PricewaterhouseCoopers", a registered trademark, refers to PricewaterhouseCoopers Private Limited (a limited company in India) or, as the context requires, other member firms of PricewaterhouseCoopers International Limited, each of which is a separate and independent legal entity.
