Art 26(3) of India-US DTAA Protects IPLC Payments from TDS Burden: Madras HC Favours Cognizant [Read Order]

The Madras High Court in a recent case, has applied Article 26(3) of the India–US Double Taxation Avoidance Agreement (DTAA) to hold that International Private Leased Circuit (IPLC) payments made by Cognizant Technology Solutions India Pvt. Ltd. to Sprint USA cannot be subjected to harsher tax deduction requirements than similar domestic transactions.

Cognizant Technology Solutions India Pvt. Ltd, a leading software exporter, availed IPLC services from Sprint USA to maintain dedicated international bandwidth connectivity between its Indian operations and overseas clients. For AYs 2003–04 and 2004–05, Cognizant made payments to Sprint USA without deducting tax at source.

The Assessing Officer (AO) disallowed the expenditure under Section 40(a)(i) of the Income Tax Act, treating the payments as “royalty” under Section 9(1)(vi). According to the AO, IPLC charges involved the use of sophisticated equipment and technology, thereby qualifying as royalty. The Commissioner of Income Tax (Appeals) [CIT(A)] upheld the disallowance, and the Income Tax Appellate Tribunal (ITAT) confirmed, holding that IPLC payments constituted royalty under both domestic law and the DTAA.

Cognizant appealed to the Madras High Court, raising multiple substantial questions of law, including whether the non-discrimination clause in Article 26(3) of the India–US DTAA protected IPLC payments from being subjected to tax deduction at source when similar domestic payments were not.

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Counsel for Cognizant argued that IPLC payments are for standard connectivity services and do not constitute royalties. Even assuming arguendo that the payments could be treated as royalty, Article 26(3) of the India–US DTAA prohibits discrimination against US enterprises.

The assessee highlighted that domestic payments for similar connectivity services are not subject to tax deduction at source. Subjecting IPLC payments to TDS would impose a more burdensome requirement on US enterprises, violating the non-discrimination clause

Referring to Article 26(3) of the India-USA DTAA, it was submitted that the language in which it is couched makes it clear that the deduction in the hands of a Resident payer on payment to a US Resident shall be under the same conditions as that of a payment made to an Indian Resident.

The court observed that the provisions contained in Section 40 of the Act along with Article 26(3) of the India-USA DTAA, it was clear that deduction in the hands of the resident on payment to a USA resident shall be on the same conditions as that of a payment made to Indian resident.

It was further noted that in the present case, the disallowance was only in respect of payment made to a non-resident. On this score, the assessee has correctly placed reliance upon the decisions in the Commissioner of Income-tax v. Herbalife International India (P) Ltd, and Commissioner of Income-tax v. Mitsubishi Corporation India (P) Ltd.

It was noted that in the decision in Commissioner of Income-tax v. Herbalife International India (P) Ltd (supra), an identical issue was considered. The relevant extract of the case is,

“…The object of article 26(3) of the Double Taxation Avoidance Agreement was to ensure non-discrimination in the condition of deductibility of the payment in the hands of the payer where the payee is either a resident or a non-resident. That object would get defeated as a result of the discrimination brought about qua nonresident by requiring the tax to be deducted while making payment of fees for technical services in terms of section 40(a)(i) of the Act…”

The Division bench of Chief Justice Manindra Mohan Shrivastava and Justice Sunder ruled in favour of Cognizant, holding that IPLC payments made to Sprint USA are protected under Article 26(3) of the India–US DTAA and cannot be subjected to discriminatory TDS obligations. The Court set aside the disallowance under Section 40(a)(i) and answered the substantial question of law in favour of the assessee.

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