Volume 6, Issue 3

22nd April, 2013

Tax Alert

Third party payment directed through related company not reimbursement: Mumbai ITAT


This tax alert summarizes a recent ruling of the Mumbai Bench of the Income-tax Appellate Tribunal (‘ITAT’) in the case of C. U. Inspections India Pvt. Ltd. (‘taxpayer’) on taxability of payments made to related company which are in the nature of reimbursements. The ITAT has held that only in case where the payment is ultimately stopping with the related party, can it be considered as a payment to the associated concern and not otherwise. In other words, payment to a third party, directed through a related concern, would not be considered as a reimbursement. Consequently, whether tax is required to be withheld on such payment would depend upon the taxability of the payment in the hands of the third party.

Facts of the case and the taxpayer’s approach:

  • C. U. Inspections India Pvt. Ltd.(‘taxpayer’) is engaged in the business of certification of activities in respect of quantity, quality, pre-shipment inspections, surveys etc.
  • The taxpayer is a subsidiary of P.S.O Beheer. B.V (‘parent company’), a resident of Netherlands.
  • The taxpayer entered into an agreement with its parent company whereby the parent company agreed to incur various costs for and on behalf of the taxpayer and other group concerns.
  • During Assessment Year 2006-07, the taxpayer made the following payments to the parent company on the basis of the above agreement:
    • Reimbursement of overhead costs borne by the parent company for various group companies in respect of accounting services, legal and professional services, communication, R & D, etc.
    • Reimbursement of training expenses paid to third parties on behalf of the taxpayer.
  • The taxpayer did not withhold tax from the said payments claiming them to be in the nature of reimbursement.
  • The tax authority disallowed deduction for both the payments while computing taxable income of the taxpayer on the ground that the taxpayer defaulted on withholding taxes as per the Income Tax Act, 1961 (‘the Act’).
  • On appeal before the first appellate authority [‘CIT(A)’], the order of the lower tax authority was upheld.
  • Aggrieved by the order of the CIT(A), the taxpayer went into appeal before the second appellate authority (i.e. the ITAT).

Issues before the ITAT:

  1. Whether expenditure in the nature of reimbursement can be disallowed under the Act on account of failure to withhold taxes from the same?
  2. Whether third party payments made by parent company and reimbursed by the taxpayer can be disallowed under the Act on account of failure to withhold taxes from the same?

ITAT’s Ruling:

Issue 1 – Reimbursements of Overhead Costs

  • The ITAT made following observations:
    • As per the agreement, the total overhead costs were to be collected from various group companies at certain percentage of the total cost determined as per arm’s length principle by considering the size of the group company, percentage of ownership, time spent by the management, number of visits etc.
    • Taking into account all the parameters, the taxpayer’s share was fixed at 4% of the total overhead costs.
    • The auditors certified that the taxpayer’s share of such overhead expenses at 4% did not contain any profit element. This certification was not controverted by the tax authorities.
  • In light of the above facts, the ITAT concluded as under:
    • It is amply clear that taxpayer’s share is 4% of total overhead charges, without any profit element and thus constitutes reimbursement.
    • Disallowance of expenses in the hands of taxpayer can be made only if the amount paid is chargeable to tax in the hands of the recipient.  In other words, an amount will be liable to tax withholding if it inter alia contains some income element.
    • Accordingly, this being a case of pure reimbursement, the disallowance was unwarranted and hence deleted.

Issue 2 – “Reimbursement” of third party payments

    • The ITAT made following observations:
      • It is an undisputed fact that the amount paid by the taxpayer to parent company was, in turn, paid by the parent company to some outside trainers.
      • The training was imparted solely to taxpayer’s employees by trainers independent of the parent company.
    • In light of the above facts, the ITAT ruled as under:
      • If an Indian subsidiary company incurs any expenses or avails any service from some third party abroad and the payment to such third party is routed through its parent or related company abroad, the withholding tax provisions would apply as if the Indian subsidiary company has made the payment to such independent party de hors the routing of payment through the parent company.
      • If the contention of the tax payer is accepted and the payment to third party, routed through its related concern, is considered as reimbursement of expenses to the related party, then probably all the relevant provisions in this regard will become redundant.
      • In order to invoke the provisions of the Act, it is of paramount importance to ascertain the chargeability of the amount to tax in the hands of the trainers who were eventual receivers.
      • However, since the orders of lower authorities do not discuss about the taxability of the receipts in the hands of the trainers, the matter was remanded back to the tax authority to ascertain the taxability of the payments in the hands of the trainers.

SKP’s Comments:

In the present case, the Mumbai ITAT has held that payment to a third party, routed through a related concern, would not be considered as a reimbursement. It may be noted that recently, the Mumbai ITAT in the case of SKOL Breweries Ltd. has pronounced a similar ruling while rejecting the plea of treating payment to a third party routed party through group company as reimbursement. It held that if the contention of the assessee is accepted, then the relevant provisions the Act can be circumvented by simply following the modus-operandi to make the payment to the third party not directly but through intermediary and giving the colour of reimbursement of the cost to the intermediary.

These two back to back rulings pronounced by Mumbai ITAT provide more clarity on reimbursement payments carried on within group companies. Indian entities effecting remittances to foreign related parties should clearly analyse the nature of remittance in context of the ultimate beneficiaries / service providers before remitting it as a reimbursement. Needless to say, the importance of documentation cannot be undermined in strengthening the case for non withholding of tax on reimbursements.