Delhi High Court Quashes Order u/s 197 based on the Draft Order u/s 144C of the Income Tax Act

Back Ground

Lionbridge Technologies LLC ('the Petitioner' or 'Lionbridge US'), a U.S.-based company, approached the Delhi High Court against the rejection of application for Nil Withholding Certificates by the tax authorities under Section 197 of the Income Tax Act, 1961 ('the Act'). The case involves two petitions: one for the financial year ('FY') 2022-23 (W.P.(C) 3403/2023) and the other for FY 2023-24 (W.P.(C) 8192/2023), each challenging the respective orders and certificates issued by the tax authorities.

The Petitioner had multiple User Master Agreements with third parties, such as Microsoft, Adobe, and Dell, for the use of programs and software, including Microsoft Windows, Outlook, MS Office, and others. These software were used internally by various group entities, and the related costs were reimbursed by the user entities to Lionbridge US.

Prior to the financial year (FY) 2022-23, the Indian subsidiary, while making reimbursements for software charges, would withhold tax ('TDS') on a conservative basis. Consequently, Lionbridge US, while filing its income tax return in India, would claim a refund of such TDS. For the assessment year (AY) 2020-21, the petitioner's income tax return was selected for scrutiny. The Assessing Officer concluded the scrutiny by treating the reimbursements received for software charges as income in the nature of 'royalty' in the hands of Lionbridge US and issued a Draft Order as required under the Act. The petitioner filed an objection against the draft order with the Dispute Resolution Panel under section 144C of the Act.

Issue

For the financial years (FY) 2022-23 and 2023-24, instead of withholding tax on reimbursements relating to software charges, the Indian subsidiary filed an application with the tax authority for issuance of Nil Withholding Certificate under Section 197 of the Act. While rejecting the application, the tax authority relied on the findings and conclusions in the draft order and rejected it. Against this rejection, Lionbridge US filed a writ petition with the Delhi High Court.

Observations of the Court

The Delhi High Court allowed the writ petition, quashing the impugned orders and certificates. The court observed that:

• Section 197 of the Act enables a taxpayer to obtain a certificate for withholding tax at a lower rate or no deduction.
• The tax authority is required to examine and undertake a prima facie evaluation of whether the income is chargeable to tax.
• In this case, the tax authority failed to consider aspects of chargeability, relying solely on the draft assessment order, which does not constitute a final determination of chargeability.
• Relying on its own order in EY Global Services Ltd. v. Assistant Commissioner of Income Tax & Anr, which was based on the Apex Court judgment in Engineering Analysis Centre of Excellence Pvt. Ltd. v. CIT, the court quashed the order issued under section 197 by the tax authority
• Further, the court directed the tax authority to examine the application afresh and dispose of it in accordance with the law, bearing in mind the observations made.

[Lionbridge Technologies LLC v. DCIT, W.P.(C) NOS. 3403 OF 2023 & 8192 OF 2023CM Appl. 31414 of 2023]