A. Kalyanasundharam, Accountant Member - (1.)THIS appeal has been instituted by the assessee, a limited company against the order of the CIT(A) dated 22nd Nov., 1983, wherein he had confirmed the action of the ITO Under Section 195(2) of the I.T. Act for realization of the income-tax on the fees paid for technical services to M/s Hokushin Electric Works Ltd. on the basis of grossing up the tax with the fees.
(2.)The assessee company had applied for the no-objection certificate for remittance of 7,70,000 Yen to the non-resident company M/s Hokushin Electric Works Ltd. Japan, Tokyo. The I.T.O. examined the request with reference to the agreement between the two companies for the period covering from 10th Dec. to 21st Dec., 1979 and found that the Indian Company was to bear the taxes. The Indian equivalent of the foreign exchange was Rs. 29,627 and applying the provisions of clause 2(b)(iv)(B) of part II of the rate schedule of the Finance Act, which prescribed the rate of tax to be deducted at 40%, the ITO after grossing up the amount of tax with the net amount payable, arrived at the tax figure of Rs. 19,750, which amount he directed the assessee to deposit.
2.1 The assessee aggrieved by this directive order of the ITO passed Under Section 195(2) preferred appeals to the CIT(A). The CIT(A) considered the case of CIT v. American Consulting Corporation [1980] 123 ITR 513 (Ori.). He was of the view that the Mysore High Court ruling in the case of Tokyo Shibaura Electric Co. Ltd. v. CIT [1964] 52 ITR 283 was the direct authority on the subject as in that case of payment of royalty, it was held that thereal income by way of royalty was such amount as would, if the tax thereon had been deducted, have left the sum in the hands of the assessee and not the royalty payable plus the tax thereon. He also placed reliance on Sandwell & Co. v. ITO [1983] 6 ITD 183 (Cal.).

2.2 Before us the learned counsel Shri M.S. Syali placing reliance on the Andhra Pradesh High Court ruling in the case of CIT v. Superintending Engineer [1985] 152 ITR 753, submitted that his plea is only that the grossing up has to be limited to the tax on the technical services and not the tax on tax. The learned departmental representative only relied on the orders of the authorities below. 3. We have given our very careful considerations to the arguments of the parties. As per the proposal of the non-resident company dated 4th June, 1979, which proposal had been accepted and given effect to by the assessee company, clause 7 provides "All taxes and any other charges and expenses leviable in India in connection with payments hereof shall be borne by the purchaser". This means that the foreign company shall be paid their dues as specified in their proposal and all taxes that might arise in respect of the transactions shall be the obligation and liability of the Indian Company. To put it in other words, the nonresident company shall receive the said amount net of taxes.

Ection 115A was introduced with effect from 1st June, 1976. This was so introduced along with the modifications to the SEction 9 whereby agreements entered into after 1-4-1976 were brought into the tax net. SEction 195(2) also was simultaneously modified with effect from 1-6-1976. SEction 115A covered the incomes that are earned by a foreign company in India from dividends, royalty and technical services and prescribed the rate of income-tax payable on such incomes by the foreign companies. SEction 195 fastened on the Indian Company the obligation to deduct the income-tax at the rates in force on the income payable by it to the non-resident company. It reads as under :

SEction 195

(1) Any person responsible for paying to a non-resident not being a company or to a company which is neither an Indian company nor a company which has made the prescribed arrangements for the declaration and payment of dividends within India, any interest, not being "interest on securities", or any other sum, not being dividends, chargeable under the provisions of this Act, shall, at the time of payment, unless he is himself liable to pay any income-tax thereon as an agent, deduct income-tax thereon at the rates in force.

(Emphasis supplied)

Provided nothing in this sub-sEction shall apply to any payment made in the course of transactions in respect of which a person responsible for payment is deemed under the proviso to Sub-sEction (1) of SEction 163 not to be an agent of the payee.

(2) Where the person responsible for paying any such sum chargeable under this Act (other than interest on securities, dividend and salary) to a non-resident considers that the whole of such sum would not be income chargeable in the case of the recipient, he may make an application to the Income Tax Officer to determine, by general or special order, the appropriate proportion of such sum so chargeable, and upon such determination, tax shall be deducted under Sub-sEction (1) only on that proportion of the sum which is so chargeable.

SEction 115A would also be necessary to be brought out here :

(1) Subject to the provisions of Sub-sEction (2) where the total income of an assessee, being a foreign company, includes any income by way of -

(b) royalty or fees for technical services received from an Indian concern in pursuance of an agreement made by the foreign company with the Indian concern after the 31st day of March, 1976, and approved by the Central Government,

income-tax payable shall be the aggregate of-

(iii) the amount of income-tax calculated on the income by way of fees for technical services, if any, included in the total income, at the rate of forty per cent.

[Emphasis supplied]

(3.)THE reading of the above sections make it clear that the non-resident company shall be liable for Indian income-tax at the rate of 40% on the income of fees for technical services received by it from the Indian Company.
In a situation, where the non-resident has agreed to discharge its obligation under the Indian Income-tax Act, i.e., it requires the Indian Company to pay it a certain gross amount of fee for technical services before any taxes, then the taxes payable shall be equal to 40% of such gross amount.

In a situation as in the instant case before us, where the non-resident company does not wish to be bothered of the Indian income-tax but demands the fee for technical services free of all taxes or net of all taxes, then it has to be taken to mean that such net amount payable is 60% of a certain gross amount, after deduction of tax at 40% of such gross amount. THErefore, in such situations, keeping the net amount as agreed to be paid as the starting point, calculations are needed to be made to arrive at a certain gross amount, from which gross amount, the tax at 40% when deducted, would leave the balance amount equal to the net amount payable. It is situations like these that have evolved the tax on tax basis which is applicable with reference to Section 115A.

This can be elucidated by the following example-

Situation 1

Non-resident company is paid Rs. 100 (gross) as fees for technical services and the non-resident is to bear all taxes under the Indian income-tax. THE rate of income-tax being 40%, the tax payable would be Rs. 40, which would leave in the hands of the non-resident Rs. 60, net after all taxes.

Situation 2

Non-resident company is paid Rs. 60 (net) as fees for technical services and all taxes are to be borne by the Indian Company. THE rate of tax still being 40%, and the amount payable, net of taxes is Rs. 60, the gross amount needs to be calculated, from which gross amount the tax at 40% when deducted would leave the net amount payable at Rs. 60.

In situation 1, the net amount of Rs. 60 was arrived at after deduction of Rs. 40 towards taxes from the gross amount of Rs. 100, therefore in situation 2 also the gross amount has to be Rs. 100 and the tax payable is Rs. 40.

Thus it can be seen from the above example that only when the tax payable is related to a gross amount, which amount when not so specified needs to be arrived at first, on which gross amount the tax payable at 40% when deducted, would result in the net amount (net of taxes) that is payable to the non-resident company.