The Bangalore Bench of the Income Tax Appellate Tribunal (ITAT) has held that payments made by an Indian software company to foreign subcontractors for onsite software development services are not liable for tax deduction at source (TDS) under Section 195 where the services do not satisfy the “make available” test under the applicable Double Taxation Avoidance Agreement (DTAA).
The bench of Prashant Maharishi (Vice-President) and Soundararajan K. (Judicial Member) has observed that although technical services had undoubtedly been rendered, the Revenue failed to establish that the foreign contractors had actually equipped the assessee with enduring technical capability.
The appeals arose from assessment orders passed under Section 143(3), wherein the Assessing Officer made several additions, including: Disallowance of over ₹10.09 crore paid by the company’s US branch to foreign contractors under Section 40(a)(i) for alleged failure to deduct TDS under Section 195. Disallowance of ₹7.13 lakh paid to UK-based Forrester Research Ltd. Disallowance under Section 14A read with Rule 8D. Denial of deduction under Section 80G for CSR donations.
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According to the department, although the payments were routed through the assessee’s US branch, the contracts were effectively controlled from India.
The Assessing Officer concluded that the foreign subcontractors provided technical and consultancy services; the income was sourced in India; the services constituted Fees for Technical Services (FTS); the agreements satisfied the “make available” condition; and tax was therefore deductible under Section 195.
Consequently, payments exceeding ₹10.09 crore were disallowed under Section 40(a)(i).
The Tribunal first observed that the services rendered by overseas subcontractors were indeed technical in nature.
It noted that the foreign contractors interacted directly with customers, functioned as solution architects, consultants and project managers, participated in software development, generated technical documentation, and worked under agreements containing confidentiality and intellectual property clauses.
Accordingly, the Tribunal agreed that the consideration could qualify as Fees for Technical Services under domestic law.
The Tribunal, however, emphasised that since the payments were made to US residents, the provisions of the India-US DTAA became applicable.
Referring extensively to the Karnataka High Court’s landmark judgment in De Beers India Minerals Pvt. Ltd., the Tribunal reiterated that merely rendering technical services is not enough.
For taxation under Article 12 of the DTAA, the service provider must transfer technical knowledge, skill, know-how or expertise in such a manner that the recipient becomes capable of applying it independently in future without further assistance.
The Tribunal observed that sharing reports, providing technical inputs, supplying project documentation, or delivering work products does not automatically satisfy the “make available” requirement.
Unless the recipient is enabled to independently perform the same functions after the contract ends, the DTAA protection continues to apply.
Having found that the “make available” condition was not satisfied, the Tribunal held that the payments were not chargeable to tax in India under the treaty.
Consequently, Section 195 was not attracted; no tax was deductible at source; and the disallowance of ₹10.09 crore under Section 40(a)(i) was deleted.
The Tribunal, however, did not extend similar relief regarding payment made to Forrester Research Ltd., UK.
It observed that the assessee had acquired licensed access to Forrester’s website and materials carrying its branding, copyright notices and logo.
The payment was therefore held to be royalty rather than fees for technical services.
Since royalty provisions do not depend upon the “make available” test, the Tribunal upheld the disallowance under Section 40(a)(i).
The Tribunal also granted significant relief on the Section 14A issue.
It held that although the Assessing Officer claimed dissatisfaction with the assessee’s suo motu disallowance, the assessment order failed to record proper satisfaction after examining the accounts, as mandated under Section 14A(2).
A mere reference to investment figures without explaining why the assessee’s computation was incorrect was held insufficient.
Accordingly, the disallowance under Section 14A read with Rule 8D was deleted for both assessment years.
The Tribunal further ruled in favour of the assessee regarding CSR donations.
It observed that although CSR expenditure cannot be claimed as business expenditure under Section 37(1), there is no statutory prohibition against claiming deduction under Section 80G where donations satisfy the conditions prescribed under that provision.
The Assessing Officer was therefore directed to allow the deduction after verification of eligibility conditions.
For Assessment Year 2020-21, the Tribunal considered a separate payment made to Tangent International, UK.
Since the assessee had failed to produce the detailed scope of work, the Tribunal held that it was impossible to determine whether the payment related merely to manpower supply or involved technical services.
Accordingly, the issue was remanded to the Assessing Officer. The assessee was granted 90 days to furnish the relevant agreements and scope of work, failing which the disallowance may continue.
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