3F INDUSTRIES LTD. vs. ACIT (2019] 108 taxmann.com 79 (Vizag. – Trib.)

The ITAT held that Compensation paid for contractual default and Rebate given for quality issues is business profits and same is not taxable in India if recipient does not have PE in India


The assessee was an Indian company engaged in trading of certain products. The assessee procured the products from suppliers in India and exported the same to foreign customers. The assessee had entered into export contracts with a M company (M Co) and a UK company (UK Co).

The Assessee did not fulfil the contract with M Co, as the price in the Indian market was substantially higher and the assessee could not procure the products. M Co claimed compensation towards the losses suffered because of default by the assessee. To maintain its business reputation and relationship with the M Co, the assessee paid the compensation. In respect of its contract with the UK Co, there were certain quality issues and the assessee agreed to price rebate.

The AO completed the assessment u/s 143(3) of the Act. Subsequently, CIT opened the case for revision u/s 263 and held that as payment was made to a foreign company and no tax was deducted u/s 195 of the Act, the order was erroneous and prejudicial to the interest of the Revenue. The CIT directed the AO to examine disallowance u/s 40(a)(i) of the Act. The AO proposed disallowance, which the DRP upheld.


Compensation for contractual default

The transaction of export was a business transaction. Compensation was paid because of failure of the assessee to supply the products. Thus, the payment was to compensate the M Co for the loss suffered by it because of non-fulfilment of contract by the assessee.

The ITAT held that the receipt was business income in the hands of the M Co and M Co did not have a PE in India. Applying Article 7 of the India-Malaysia DTAA, the ITAT held that business income of M Co would be taxable only in Malaysia unless it had a PE in India. The ITAT held that since M Co did not have a PE in India, the business income was not chargeable to tax in India and the question of disallowance u/s 40(a)(i) of the Act does not arise.

Quality rebate

The ITAT observed that Quality rebate was given because of certain quality issues and it was like discount in sale price. Thus, question of TDS does not arise. The ITAT further observed that the quality rebate was in the nature of business profit for the UK Co. Since UK Co does not have a PE in India, the business income was not chargeable to tax in India by virtue of Article 7 of the India-UK DTAA. Therefore, the question of disallowance u/s 40(a)(i) of the Act did not arise.

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