Non-deduction of Tax at source (TDS) on the provision made for royalty payments under tax treaties would not give rise to disallowance under Section 40

Facts of the Case:

1. Assessee was engaged in the business of development of network security software product.
2. Assessee imported some anti-virus and anti-spam software components from its Associated Enterprise (AE) in Russia and Israel respectively and bundled this software with its own software. The bundled product was then sold to end customers through a chain of distributors.
3. Royalty was paid to AEs only when end user activated the license Key. However assessee recorded provision for royalty at the time of sale of bundled product.
4. During the Income tax Assessment proceeding of AY 2012-13, Assessing officer (AO) disallowed the provision of royalty under section 40(a) (i) of the Income tax act, 1961.
5. On appeal, CIT (A) also confirmed the action of AO. Aggrieved by the same, Assessee raised an appeal to ITAT.

Held by the Hon’ble ITAT Ahmedabad:

1. The taxability of royalty income in terms of Article 12(1) of treaties with Russia and Israel arises only at the point of time when the royalty income is paid to the resident of the other Contracting State.
2. Since the Assessee stands in the foot of benefit under tax treaties, provisions of Section 195, wherein tax liability arises at the earlier of credit or payment to the payee, cannot be invoked. Henceforth, the disallowance is devoid of legally sustainable merits and AO is directed to delete the impugned disallowance.

Conclusion:

The aid judgement shall provide huge relief to the Indian Assessees wherein transactions are done with foreign companies on a high scale without deduction of tax and tax liability is discharged at a much later stage at the time when payment is settled against such transaction. However, the decision on this issue has not reached to its finality since aggrieved party can challenge the same to higher authorities.

Deputy Commissioner of Income-tax, Circle 4(1) (1), Ahmedabad V/S Sophos Technologies (P.) Ltd.

[2018] 100 taxmann.com 374 (Ahmedabad – Trib.)