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India: Ruling on applicability of deduction non-discrimination clause

Rajendra Nayak
To encourage compliance with withholding tax (WHT) provisions of the Indian Tax Laws (ITL), payments made without such compliance are disallowed as an expense for the payer, thereby enhancing its tax base. Relief from such disallowance can be availed where the resident recipient includes such payment as its income in its return of income (ROI), pays tax and certain other conditions are met. A comparable relief is absent where the recipient is a non-resident. However, like some of India's double taxation avoidance agreements (DTAA), the India – Japan DTAA contains a deduction neutrality clause in its non-discrimination article (DND clause). According to this clause, when computing taxable income of an Indian enterprise, payments made by it to a resident of Japan would be deductible under the same condition as if they had been paid to an Indian resident.

In its recent ruling in the Mitsubishi Corporation India Pvt. Ltd case, the Delhi Income Tax Appellate Tribunal (Tribunal) had to analyse the applicability of the DND clause on certain payments to its Japanese group entities having permanent establishment (PE) in India. These payments were made without complying with WHT provisions. However, the recipient Japanese entities filed their ROIs, including such payment as income and paid the necessary taxes. The tax authorities disallowed the payments for non-compliance of WHT provisions and contended that protection under the DND clause cannot be accessed by an Indian resident taxpayer. Aggrieved by this, the taxpayer appealed to the Tribunal.

The Tribunal held that though the DND clause impacts income determination of Indian residents, the subject matter is payment to a Japanese tax resident. The DND clause was therefore rightly invoked by the taxpayer. Additionally, the DND clause is designed to provide parity in eligibility for deduction between payments made to residents and those made to non-residents. If WHT is a pre-condition for deductibility of payments to non-residents, it cannot be enforced unless there is a similar pre-condition on payments to residents.

As the payment to a resident does not result in disallowance of expense for the taxpayer where the resident recipient complies with requisite conditions, it will have to be allowed as a deduction by applying the DND clause where the non-resident recipient also complies with the relevant conditions.

The Tribunal has also elucidated various facets of availing the benefit of the DND clause. Separately, by a recent amendment, ITL has restricted the disallowance on payments made to residents, without WHT, to 30% of the payment. A corresponding change has not been made for payments to non-residents. This ruling should help taxpayers avail deduction parity in appropriate cases by invoking the DND clause.

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