April 2010. ORAL JUDGMENT (Per Dr. D.Y Chandrachud, J.)

1. Rule. With the consent of the learned counsel appearing on behalf of the petitioner and the learned counsel appearing on behalf of the Revenue, the petition is taken up for hearing and final disposal. Counsel for the respondents waives service.

2. The petitioner is a non-resident company incorporated under the laws of the United States. The petitioner forms part of the McKinsey Group and provides international management consultancy services. The parent of the petitioner is McKinsey and Company Inc. McKinsey and Company Inc. has a branch in India — McKinsey India. Broadly speaking, the petitioner provides two kinds of services to the Indian Branch : (i) Borrowed services which are services rendered by the petitioner to McKinsey India as part of the consultancy services, which the latter provides to its clients; (ii) Firm function services, which constitute a central support function that is dedicated to provide a range of administrative and support services for the worldwide offices of McKinsey Group, including the Indian branches of

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McKinsey Inc. The firm function services comprehend administrative support provided worldwide on legal issues, taxation and administration. In so far as the borrowed services are concerned, the consistent view of the Assessing Officer's was that such services amounted to technical fees for included services under the Indo-US Treaty and were chargeable in India at the rate of 15% on a gross basis.

3. The Income Tax Appellate Tribunal by its decision dated 26 April 2006 came to the conclusion that the payments made to the petitioner for borrowed services would have to be regarded as normal business income and not as fees for included services. In arriving at this conclusion, the Tribunal placed reliance on the Memorandum of Understanding concerning fees for included services entered into on 15 May 1989 between the Governments of India and United States. The MoU inter alia clarifies that under article 12(4b) of the us india Tax Treaty, consultancy services which are not of a technical nature could not be regarded as included services.

4. The subject matter of the present proceedings relates to the imposition of a withholding of tax or of tax deducted at source in respect of payments made to the petitioner for firm function services. As noted earlier, the case of the petitioner is that the firm function services are an umbrella of administrative and support services centrally provided by the petitioner to various offices in the group. In providing these services, the petitioner incurs

4 certain costs which are charged as firm function charges to its offices worldwide through an allocation mechanism. The allocation, according to the petitioner, is computed on the basis of the total costs incurred by the petitioner in providing these services together with an agreed mark up of three per cent.

5. On 27 January 2005, an MoU for providing firm function services was entered into by the petitioner and the Indian branches of McKinsey & Company Inc. with effect from 1 April 2005. The MoU records the consideration for the services provided by the petitioner to the group companies as 103 per cent of the firm function's cost pool multiplied by the company's allocation fraction.

6. The petitioner made an application under Section 197 for assessment year 2010-2011 on 8 January 2010 to the Deputy Director of Income Tax (International Taxation) — 4(1), Mumbai (the second respondent) seeking a Nil Tax Withholding Certificate in respect of payments received for firm function services rendered by the petitioner to the Indian branches of the McKinsey & Company Inc. for financial year 2009-2010. The petitioner informed the second respondent that in the meantime, orders have been passed under Section 264 by the Commissioner and under Section 197 by the Assessing Officer for assessment years 2007-2008 to 2009-2010, specifying tax withholding rates at 1.5 per cent and 1.30 per cent on similar gross

5 payments made to the petitioner for earlier years. By the impugned order dated 29 March 2010, the application filed by the petitioner for a Nil Tax Withholding Certificate for assessment year 2010-2011 has been rejected on the ground that for assessment year 2006-2007 the schedules to the preparation of the consolidated accounts, indicating the financials of the petitioner were not made available and hence the claim of the petitioner that these receipts are in the nature of business receipts was unverifiable. Consequently, the receipts were held to be taxable in India as fees for technical services under Section 9(i)(vii) of the Act and taxable as fees for included services under Article 12 of the Indo-US Treaty, liable to be taxed at the rate of 15 per cent. Consequently, it has been directed that the taxes would be withheld at the rate of 15% on the gross amount to be paid or payable to the petitioner for financial year 2009-2010.

7. The application that was made by the petitioner was under Section 197(1), which provides that subject to the Rules made under subsection (2A), where, in the case of any income of any person or sum payable to any person, income-tax is required to be deducted at the time of credit or, as the case may be, at the time of payment at the rates in force under the diverse provisions of the Act and the Assessing Officer is satisfied that the total income of the recipient justifies the deduction of income tax at any lower rates or no deduction of income-tax, as the case may be, the Assessing Officer shall, on an application made by the assessee in that behalf, give to

6 him such certificate as may be appropriate. Where such a certificate is given, the person responsible for paying the income shall, until such certificate is cancelled by the Assessing Officer, deduct income-tax at the rates specified in such certificate, or deduct no tax, as the case may be.

8. The submissions which have been urged on behalf of the petitioner are (i) the payments received by the petitioner from the Indian branch of McKinsey & Company Inc. are not chargeable to tax in India because they are not fees received for technical services; (ii) In so far as the administrative support services are concerned, the payments made form part of the normal business income under Article 7 of the Indo-US Tax Treaty and the amount which is received is not chargeable to tax in the absence of a permanent establishment of the petitioner in India; (iii) Under the agreement that was entered into between the petitioner and the Indian branches of McKinsey & company Inc., the Petitioner is to be reimbursed for the firm function services rendered on a cost plus basis with a mark up of three per cent. The income of the petitioner, relatable to the services which are provided, can be no higher than three per cent. Consequently without prejudice to its submission as noted earlier, the petitioner is willing to submit itself to a deduction of tax at source to the extent of the income element involved in the payments received by it, which can be no higher than three per cent; (iv) The Transfer Pricing Officer, in the course of a determination made under Section 92CA for assessment year 2006-2007 has accepted the

7 consideration involved in the transaction between the petitioner and the Indian branches of McKinsey & Company Inc. as being reflective of an arms length price and that determination would be binding on the Assessing Officer; (v) The Commissioner, in the exercise of powers under Section 264 has for assessment years 2008-2009 directed that tax should be deducted at

1.5 per cent of the gross receipts of McKinsey & Company Inc., from India for firm function services; (vi) The Assessing Officer for assessment year 2009-2010 has also passed an order under Section 197 to the effect that taxes are to be withheld on gross payments made to the petitioner computed at 1.30 per cent, placing reliance on the agreement between the petitioner and the Indian branches. In the present case, there was absolutely no justification for the Assessing Officer not to follow the order passed by the Commissioner for assessment year 2008-2009.

9. On the other hand, it has been urged on behalf of the Revenue that the Assessing Officer has while directing a deduction computed at 15 per cent on the gross amount that is paid or payable to the petitioner relied on a draft assessment order for assessment year 2006-2007 issued on 27 November 2009 and in doing so the Assessing Officer has followed a consistency of approach. In the draft assessment order, it was held that the amount received by the petitioner while rendering firm function services would be taxable in India as fees for technical services within the meaning of Section 9(i)(vii) of the Act and would be taxable as fees for included services

8 under Article 12 of the Indo-US Tax Treaty.

10. For the purposes of these proceedings and having regard to the limited nature of the issue which falls for consideration of the Court, it is not necessary to expand upon the ambit of the controversy. The material on record indicates that for assessment year 2008-2009 the Assessing Officer had while ruling on an application made by the petitioner under Section 197 decided that tax should be deducted at 1.5 per cent of the gross payments to be received by the petitioner for firm function services provided to the Indian branches of McKinsey & Co. Inc. The correctness of the order was questioned in proceedings under Section 264. By an order dated 3 June 2008, the Director of Income Tax (International Taxation) noted that the services were rendered by the petitioner as a common function to all offices of McKinsey & company Inc., worldwide. The order passed by the Director of Income Tax (International Taxation) holds that as provided in the agreement for firm function services, the income component of these services would be about three per cent and this income would be liable to tax at the rate of 42.23 per cent in accordance with the provisions of the Act. Consequently, it has been held that the income would be taxable on a net basis on a mark up of three per cent. Tax was directed to be deducted at 1.5 per cent of the gross receipts of McKinsey & company Inc., from India for firm function services rendered for assessment year 2008-2009.

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11. A similar line of approach has been taken in an order passed on 26 February 2009 by the Assessing Officer under Section 197 for assessment year 2009-2010. The contention of the petitioner that the agreement with the Indian branches of McKinsey & company Inc. involved a net profit element of three per cent was considered. While estimating the net profit provisionally at three per cent, the Assessing Officer directed that tax be withheld on the gross payments made to the petitioner at 1.30 per cent. At this stage, it would also be necessary to note that during the course of assessment year 2006-2007, the Transfer Pricing Officer passed an order on 29 October 2009 accepting the consideration reflected in the agreement entered into by the petitioner as being reflective of an arms length price under Section 92CA.

12. The impugned order that has been passed by the Assessing Officer, directing the withholding of tax computed at 15 per cent on the gross amount for assessment year 2010-2011 is not founded on any logical or cogent basis. The submission of counsel for the Revenue that the Assessing Officer has relied upon his own order for assessment year 2006-2007 dated 27 November 2009 cannot prima facie be accepted since admittedly that order is a draft assessment order, pending the conclusion of the Dispute Resolution Procedure. The Assessing Officer has furnished no basis whatsoever, for making a departure from the position adopted in the order passed by the Director of Income Tax (International Taxation) under Section

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264, for assessment year 2008-2009. There was no valid basis for the Assessing Officer to determine that tax be withheld at the rate of 15 per cent on gross payments received by the petitioner from the Indian branches.

13. The Assessing Officer in the impugned order has stated that the petitioner had during the course of proceedings for assessment year 2006-2007 not made available the schedules to the preparation of consolidated accounts, indicating the financials of the assessee. At this stage, even if the statement which has been made in Para 4 of the impugned order to this effect were to be accepted, though counsel appearing on behalf of the assessee has seriously contested its correctness, that by itself would not furnish any justification for the Assessing Officer to depart from the order passed by the Director of Income Tax (International Taxation) for assessment year 2008-2009. Unless there was a valid and acceptable basis for making a departure from the order passed by the Director of Income Tax (International Taxation) and cogent material was available before the Assessing Officer to do so, the exercise of discretion would become arbitrary and vulnerable to challenge.

13. Counsel appearing on behalf of the Revenue submitted that against the determination that has been made under Section 197(1), it is open to the petitioner to seek recourse to revisional proceedings under Section 264. Section 264 provides that in the case of any order other than an

11 order to which Section 263 applies, passed by an Authority subordinate to him, the Commissioner on his own motion or on an application by the assessee for revision, may call for the record of any proceedings under the Act in which any such order has been passed and may make such inquiry, and may pass such order thereon, not being an order prejudicial to the assessee, as he thinks fit.

14. In disposing of an application filed by the assessee under Section 197(1) for the grant of a certificate, the Assessing Officer has to make a determination which would constitute an order for the purposes of Section 264. That a petitioner should exhaust the alternate remedies available is a self-imposed restraint which does not bar the exercise of the writ jurisdiction under Article 226. In a case such as the present where the Assessing Officer has chosen to act in complete departure from a duly considered determination made by a superior officer, it is necessary for this Court to step in to ensure that the discipline of the hierarchy imposed by fiscal legislation is duly observed. Unless a sense of hierarchical discipline is observed, while implementing fiscal legislation, the exercise of powers would be rendered arbitrary and subject to the whim and caprice of Assessing Officers. This would be impermissible and contrary to the norm of fairness which Article 14 of the Constitution embodies. The prescriptions of Article 14 must at all times infuse statutory interpretation and must rigorously apply to the exercise of statutory discretion. It is in these circumstances, that this Court

12 has been constrained to exercise its writ jurisdiction under Article 226 to correct a manifest failure of justice. The Assessing Officer is correct in adopting the position that Section 197(2) will not preclude a departure or a contrary view being taken in assessment proceedings, in view of the judgments of this Court in Tata Engineering & Locomotive Company Limited, 245 ITR 823 (Bom) and Commissioner Of Income-Tax v. Elbee Services P. Ltd., 247 ITR 109 (Bom). But the Assessing Officer must also bear in mind that a departure has to be made on the basis of valid and cogent reasons where there is material on record which would justify such a departure. There is an absence of material on record which would have justify a departure in the facts of the present case.

16. In the circumstances, the impugned order passed by the Deputy Director of Income Tax (International Taxation) — 4(1), Mumbai on 29 March 2010 is set aside. There shall be a direction to the Second respondent to issue a certificate under the provisions of Section 197(1) in accordance with the order passed by the Director of Income Tax (International Taxation), Mumbai on 3 June 2008 for assessment year 2008-2009.

17. Rule is made absolute in the aforesaid terms. There shall be no order as to costs.

(J.P Devadhar, J.) (Dr. D.Y Chandrachud, J.)