Pranav B Prem

The Income Tax Appellate Tribunal (ITAT), Delhi Bench has partly allowed cross-appeals filed by the Revenue and the assessee in a significant ruling on tax deduction at source obligations relating to cross-border payments for marketing and support services under the India–US Double Taxation Avoidance Agreement (DTAA). The Tribunal held that mere marketing support services rendered outside India do not constitute “Fees for Included Services” (FIS), but cautioned that excessive or unexplained cost components require proper substantiation, failing which disallowance under Section 40(a)(i) of the Income-tax Act, 1961 may follow.

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The Bench comprising Sudhir Pareek (Judicial Member) and S. Rifaur Rahman (Accountant Member) examined cross-appeals relating to Assessment Years 2012–13 and 2013–14, arising from payments made by the Indian assessee to its US-based Associated Enterprise (AE) towards marketing and support services.

For AY 2013–14, the assessee had declared a substantial loss and claimed deduction of nearly ₹198 crore paid to its AE without deduction of tax at source, contending that the payments constituted business income of the AE earned outside India. It was the assessee’s case that the AE had no permanent establishment in India and that the services did not “make available” any technical knowledge, skill or process so as to fall within Article 12 of the India–US DTAA.

The Assessing Officer, however, treated the payments as “Fees for Included Services” under Article 12 of the DTAA and “fees for technical services” under Section 9(1)(vii) of the Act. On this basis, the AO disallowed the entire payment under Section 40(a)(i) for failure to deduct tax under Section 195. The AO also disallowed a provision created towards customer refunds and made other disallowances, including delayed deposit of employees’ PF and ESI contributions.

On appeal, the Commissioner of Income Tax (Appeals) deleted the disallowance under Section 40(a)(i), holding that the services were rendered outside India, did not satisfy the “make available” test and were therefore not taxable in India. The deletion of disallowance relating to provision for refunds was also granted. Aggrieved, the Revenue approached the Tribunal.

The ITAT examined the master services agreement, invoices raised by the AE and the detailed break-up of costs annexed thereto. While noting that the AE had no permanent establishment in India and that pure marketing support services rendered abroad would ordinarily not be taxable in India, the Tribunal expressed serious reservations regarding the nature and magnitude of certain cost components claimed.

The Bench observed that a substantial portion of the billed amounts comprised process outsourcing costs, on-ground technical support charges and payment gateway costs, which together formed a disproportionately high share of the total administrative expenses. The assessee was unable to satisfactorily explain the basis of allocation or the precise nature of these services. The Tribunal held that mere labeling of payments as “marketing support” is insufficient, and that some components, particularly process outsourcing costs, could potentially fall within the ambit of FIS if they involve technical or specialised services.

In the absence of proper documentation and evidence to substantiate the allocation and nature of these expenses, the Tribunal held that blanket acceptance of the assessee’s claim was unwarranted. Accordingly, the ITAT set aside this issue and directed the Assessing Officer to allow clearly identifiable marketing expenses, while restricting the remaining administrative and support costs to 20%, unless the assessee is able to substantiate the same with proper evidence after being afforded an opportunity of hearing.

On the issue of provision for customer refunds, the Tribunal observed that refund liabilities are inherent in subscription-based technical support businesses. However, it held that provisions cannot be allowed mechanically year after year without verification. The assessee must demonstrate a consistent correlation between provisions created and actual refunds paid. The matter was remanded to the AO to verify historical data, with directions to reverse any excess provision and bring it to tax.

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The Tribunal also admitted and allowed an additional ground raised by the Revenue relating to delayed deposit of employees’ contributions to PF and ESI. Relying on the Supreme Court’s ruling in Checkmate Services Pvt. Ltd., the ITAT restored the disallowance under Section 36(1)(va). Accordingly, the appeals filed by both the Revenue and the assessee were partly allowed, with key issues remanded for fresh examination in accordance with law, while reaffirming that mere marketing support services, by themselves, do not amount to Fees for Included Services under the India–US DTAA.

Cause Title: Addl.CIT Versus Iyogi Technical Services Private Limited

Case No.: ITA No.2064/Del/2018

Coram: Sudhir Pareek (Judicial Member) and S. Rifaur Rahman (Accountant Member)