Section 195 Withholding Tax on Payments made to Non Resident
34195. 35[(1) 36Any person responsible for paying to a non-resident, not being a company, or to a foreign company, any interest 37[***] or any other sum chargeable under the provisions of this Act (not being income chargeable under the head “Salaries” 38[***]) shall, at the time of credit of such income to the account of the payee or at the time of payment thereof in cash or by the issue of a cheque or draft or by any other mode, whichever is earlier, deduct income-tax thereon at the rates in force :
39[Provided that in the case of interest payable by the Government or a public sector bank within the meaning of clause (23D) of section 10 or a public financial institution within the meaning of that clause, deduction of tax shall be made only at the time of payment thereof in cash or by the issue of a cheque or draft or by any other mode :]
Explanation.—For the purposes of this section, where any interest or other sum as aforesaid is credited to any account, whether called “Interest payable account” or “Suspense account” or by any other name, in the books of account of the person liable to pay such income, such crediting shall be deemed to be credit of such income to the account of the payee and the provisions of this section shall apply accordingly.]
(2) Where the person responsible for paying any such sum chargeable under this Act (other than 41[***] 42[***] 43[***] 44[***] salary) to a non-resident considers that the whole of such sum would not be income chargeable in the case of the recipient, he may make an application to the 45[Assessing] Officer to determine, 46[by general or special order], the appropriate proportion of such sum so chargeable, and upon such determination, tax shall be deducted under sub-section (1) only on that proportion of the sum which is so chargeable.
48[(3) Subject to rules49 made under sub-section (5), any person entitled to receive any interest or other sum on which income-tax has to be deducted under sub-section (1) may make an application in the prescribed form to the 45[Assessing] Officer for the grant of a certificate authorising him to receive such interest or other sum without deduction of tax under that sub-section, and where any such certificate is granted, every person responsible for paying such interest or other sum to the person to whom such certificate is granted shall, so long as the certificate is in force, make payment of such interest or other sum without deducting tax thereon under sub-section (1).
(4) A certificate granted under sub-section (3) shall remain in force till the expiry of the period specified therein or, if it is cancelled by the 50[Assessing] Officer before the expiry of such period, till such cancellation.
(5) The Board may, having regard to the convenience of assessees and the interests of revenue, by notification in the Official Gazette, make rules specifying the cases in which, and the circumstances under which, an application may be made for the grant of a certificate under sub-section (3) and the conditions subject to which such certificate may be granted and providing for all other matters connected therewith.]
50a[(6) The person referred to in sub-section (1) shall furnish the information relating to payment of any sum in such form and manner as may be prescribed by the Board.]
Where the person responsible for paying any such sum chargeable under this Act (other than 6[ ] interest on securities, 7[ ] and
2. Substituted by the Finance Act, 1987, w. e. f. 1- 6- 1987. Prior to the substitution, subsection (1), as amended by the Finance Act, 1965, w. e. f. 1- 4- 1965 and the Finance Act, 1975, w. e. f. 1- 4- 1975, read as under:" 195. Other sums.- (1) Any person responsible for paying to a non- resident, not being a company, or to a company which is neither an Indian company nor a company which has made the prescribed arrangements for the declaration and payment of dividends within India any interest, not being" Interest on securities", or any other sum, not being dividends, chargeable under the provisions of this Act, shall, at the time of payment unless he is himself liable to pay any income- tax thereon as an agent, deduct income- tax thereon at the rates in force: Provided that nothing in this sub- section shall apply to any payment made in the course of transactions in respect of which a person responsible for the payments is deemed under the proviso to sub- section (1) of section 163 not to be an agent of the payee."
3. The words" or dividends" omitted by the Finance (No. 2) Act, 1991, w. e. f. 1- 10- 1991
5. Inserted by the Direct Tax Laws (Second Amendment) Act, 1989, w. r. e. f. 1- 6- 1987.
6. The words" or dividends" omitted by the Finance Act, 1976, w.. e. f. 1- 6- 1976.
7. The words", dividend" omitted by the Finance (No. 2) Act, 1991, w. e. f. 1- 10- 1991
salary) to a non- resident considers that the whole of such sum would not be income chargeable in the case of the recipient, he may make an application 1 to the 2[ Assessing] Officer to determine, 3[ by general or special order], the appropriate proportion of such sum so chargeable, and upon such determination, tax shall be deducted under sub- section (1) only on that proportion of the sum which is so chargeable: 4[ Omitted by the Finance (No. 2) Act, 1991 , w. e. f. 1- 10- 1991 ]
(3) 5[ Subject to rules made under sub- section (5), any person entitled to receive any interest or other sum on which income- tax has to be deducted under sub- section (1) may make an application in the prescribed form to the 6[ Assessing] Officer for the grant of a certificate authorising him to receive such interest or other sum without deduction of tax under that subsection, and where any such certificate is granted, every person responsible for paying such interest or other sum to the person to whom such certificate is granted shall, so long as the certificate is in force, make payment of such interest or other sum without deducting tax thereon under sub- section (1).
(4) A certificate granted under sub- section (3) shall remain in force till the expiry of the period specified therein or, if it is cancelled by the 7[ Assessing] Officer before the expiry of such period, till such cancellation.
(5) The Board may, having regard to the convenience of assessees and the interests of revenue, by notification in the Official Gazette, make rules specifying the cases in which, and the circumstances under which, an (3) and the conditions subject to which such certificate may be granted and providing for all other matters connected therewith.
Objective and coverage of Section 195
The objective of section 195 is justifiable as it seeks to avoid a revenue loss as a result of tax liability in the hands of a foreign resident, by deducting the same from payments made to them at source. This will obviate the difficulty in chasing such foreign nationals for recovery of their tax dues subsequently, due to jurisdictional and other operational difficulties. Further most such foreign nationals are likely to have nil or at best very meager assets in India which may be totally inadequate to recover the tax dues.
Section 195 of the Income Tax Act 1961 is an answer to the above difficulty as it not only provides the mechanism for deduction of tax at source but also contains in a large measure the procedures to be followed in the mitigation of the same in genuine cases.
It is very pertinent to note that this section is wider in scope than all the other TDS sections insofar as all payers are covered and there is also no threshold exemption.
Section 195 as regards the payer of any sum chargeable to tax applies to any person unlike certain other sections relating to TDS and covers
As regards the recipient of amounts, the section covers all Non residents in its ambit. Residents and Resident but not ordinarily resident tax status persons are not covered by the section
Some pertinent doubts that may arise in this context are as follows:
a)payment by an Indian Branch of a Foreign Company to its overseas Head Office
In this context CBDT Circulars 649/31.3.1993 and 740 /17.4.1996 give some clarification. Further the landmark Kolkota Tribunal judgment of ABN Amro Bank reported in 280 ITR 117 (Kol) also lays down the law that if a deduction for interest payment by a branch to overseas head office is sought , then it is obligatory to deduct tax , since it presupposes a distinct Payer and Payee with separate identities and makes section 195 applicable.
b) payment by a Resident to an Indian Branch of a Foreign bank
This payment is squarely covered by CBDT Circular 20/3.8.1961 and there is no doubt that TDS has to be effected. the Payee may however apply to the Assessing Officer for Nil/ lower deduction under section 195(3). A precaution which would be advised here is that the payers of such sums like interest,bank charges etc.; (which are more often than not recovered by direct debits to their bank accounts) insist on a copy of the exemption certificate under section 195(3) from the Indian Branch of the Foreign Bank since there are a few foreign Banks which do not have a valid certificate at the time of effecting such debits
c)Payment by a resident to an agent of a non resident
This settled branch of law appears to have been overruled by the withdrawal of CBDT Circular No 23 of 1959. However one may take the help of the decisions in the Morgan Stanley case as well as the Ishikawajima Harima case 2007 158 Taxman 259 SC and come to a conclusion that the settled law in this regard remains the same. However the withdrawal of the above circular 23 of 1969 (which was binding on the department) will certainly foment disputes due to the I T Department taking a stand that all the payments would be subject to withholding unless an application under section section 195(2) is made.
d) Payment by the branch of an Indian Company located offshore to the Offshore branch of an Indian Bank
In this situation even if the amounts are not covered by the exception to section 9(1) when interest is paid on funds for use outside India, the transaction is strictly between two residents (Indian Company and Indian Bank) and merely because it is being carried out on foreign soil will not change its character. Therefore section 195 will have no application and section 194A which specifically exempts such payments from the purview of WHT to Indian Banks will apply.
e)Payment of interest on listed Indian Corporate Bonds held by a Foreign Institutional Investor in dematerialized mode
This is another area where one may fall prey to the misconception that securities held in demat mode do not suffer WHT on their interest payments. This is a fallacy since the exemption on WHT on such interest is covered under section 193 which is applicable only to Indian residents. Thus the FII will have to suffer WHT since the interest paid on demat corporate listed securitiers will be out of the purview of section 193 and will be covered by section 195
This section will have an increased applicability after the Finance Act 2007 due to the proposed modification of the definition of India to cover the airspace above it with retrospective effect from 1976 as well as the non requirement of territorial nexus to constitute a business connection in India for any enterprise being proposed. The two developments listed above will also further enhance its applicability.
f) Non resident in India paying interest to the Indian Branch of a foreign Bank
This payment will be squarely hit by the provisions of 195 and WHT will need to be affected (despite the procedural requirements of PAN,TDS returns etc.;) unless the foreign bank branch in India has obtained an exemption certificate under section 195 (3)
g) Payment to a resident agent of a Non resident Shipping company
It should be noted here that in case of a payment to Agents of a non resident Shipowner it is section 172 that will apply and not section 195 as a special provision will always override a general one . (Generalia specialibus non derogant)
3.Sums Covered under the scope of Section 195(1)
The general rules to be followed in this area may be outlined as follows:
4.Whether TDS needs to be affected on mere reimbursement of expenses
This is a question on which no clear direction is available and keeping in line with the general trend of tax judgments there are conflicting views held by the various courts and Tribunals in the country.
In the case of mere reimbursement of expenses, TDS need not be effected as ruled in the case of reimbursement of out of pocket expenses to a noted Law firm .Clifford Chance 82 ITD 106(Mum). The most important recent Judgement in Mahindra & Mahindra’s case reported in 10 SOT 896 Mumbai ITAT has also held that reimbursement of expenses not having the character of income chargeable to tax under the provisions of the IT Act cannot be subject to WHT
However where the cost of services is charged and recovered by way of reimbursement, even without any profit element TDS will be applicable as ruled in the case of Arthur Andersen & Co by the Mumbai tribunal reported in 94 TTJ 736 (Mum)
There are also judgements which reflect that TDS under Section 195 will be applicable even on mere reimbursement of expenses. This view finds support in the decisions given by Cochin Refineries 222 ITR 354 (Kar) and HNS VSAT Inc 95 ITD 157 (Del ITAT) and also in Hindalco 278ITR 125 (AT)
5.TDS on Royalty and Fees for Technical Services(“FTS”)
At the outset it should be noted that TDS on royalty and FTS will not only be dependent on the particular payment but will also be affected by the provisions of the relevant Double Tax Avoidance Agreement (“DTAA”) which India has with the country to which the payment is being made and the judicial decisions and the Advance rulings on the subject must be interpreted after considering this factor also.
Further the Apex court in the case of Tata Consultancy Services has also distinguished between the assignment of Copyright and the sale of a copyrighted article (ie a book or a CD containing software licenced to the purchaser). While in the former case,the payment will be in the nature of royalty and attract TDS in the latter case it will not being in the nature of the sale of goods.In the following decisions it was held that the transaction in question amounted to a mere sale of a copyrighted article and hence not liable to TDS
Further it was also held that the mere payment of connectivity charges was not royalty or FTS and hence not liable to TDS as held in Skycell Communications Ltd 251 ITR 53 (MP)
Even payment made for an access to a database on an overseas server will not attract TDS as held in Dun & Bradstreet Advance ruling reported in 272 ITR 99 (AAR)
FTS which covers only Fees for Included Services (“FIS”) in the relevant DTAA (eg USA) will attract TDS if the fees paid only fall under the definition of included services and not otherwise as held in the case of Calcutta Electric Supply Corporation Ltd 80 TTJ 806 (Kol). Such treaties usually have a “make available “ clause in the definition of FTS and the relevant treaty will have to be scrutinized in detail along with the nature of payment to determine whether TDS is applicable or not. The old adage that one man’s food is another mans poison may well apply here so that one man’s FTS is not taxable while the other ones may well be.
Payment for any subsidiary/ ancilliary services to sale of Capital equipment will also not attract TDS especially if the services payment is non severable and forms part of the main contract for the supply of Capital Goods (Hindalco Ltd 94 TTJ 944 (Mum). No discussion on this issue will be complete without some discussion on the Samsung case as decided by the Karnataka High Court
6. Samsung Case
In this landmark case, the Karnataka High Court has ruled that TDS u/s 195 is applicable on all payments of “shrink wrapped software” and further gone on to state that all payments to Non residents would need to suffer WHT and the only measure available to the payer of such sums to get out of this obligation would be to apply to the assessing Officer for a certificate of lower WHT under section 195(2).The position seems to have been further exacerbated with the withdrawal of the circular 23 of 1969 which had fettered the IT department from agitating on the issue of WHT on the payments which were covered within it. Transmissions corporation’s case 239ITR 587SC also seems to have been misconstrued by the Hon’ble High Court. This case also overturns the principle of the TCS case (supra) that sale of a shrink wrapped software amounts to the sale of a Copyrighted product and not to license of the copyright
Though the Apex Court has granted a stay of demand on this case, prima facie the payers of amounts to Non residents are a worried lot due to this decision as it has had the McDowell effect in the realm of TDS u/s 195.
Despite this aura of gloom, there are certain defenses which may be available to assesses and these are briefly discussed below
Though the above arguments will be far harder to sustain in areas subject to the jurisdiction of the Karnataka High Court, they do have some substance in cases where the I T department adopts a Procrustean approach (literally) to WHT post Samsung, which they are very likely to do.
Post Samsung, one would have expected the CBDT to issue a clarification (one way or the other) and removed the Damocles sword of TDS from over the assessee’s head.
This they have not done and their wait and watch approach appears to exemplify Mark Antony’s classic line in Shakespeare’s Julius Caesar
“Mischief thou art afoot, Take what course thou wilt”
(upon inciting the plebians of Rome to revolt against Brutus and the other conspirators who assassinated Caesar)
7.Section 195, DTAA and Business Connection
One of the most complex situations may arise if one considers the warp and weft of the interplay of section 195 along with the provisions of a Double Tax Avoidance Agreement with the embroidery of Section 9 , dealing with Business Connection thrown in for good measure.
Initially one must consider the distinction between a legal liability to tax as opposed to a fiscal Liability. Even in this sphere there is no clarity. In Abdul Razzaq’s case 146 Taxman115 (AAR), it was held that a person was not entitled to claim the benefits of the earlier Indo UAE Tax treaty since there was no liability to tax in the UAE , and hence the income would be subject to tax in India. However in another case of Green Emirates Shipping, the exact opposite was decided. Currently there is a new India UAE DTAA in place which addresses this anomaly.
Another issue to be considered in this context is that taxability in the case of an airline and shipping Company is based on the theory of effective control also known as the “head & Brain” theory. The question of residence versus control and management is to be considered, Again a distinction needs to be made for effective management against mere operational management to determine the question of the situs of taxation .
Further the question of a Permanent Establishment (“PE”) as per the relevant DTAA and the attribution of income to it (different under various treaties) also needs to be considered
Taxability , if no DTAA is subsisting, will depend on whether there is a business connection under section 9 of the act, as a business connection is wider in scope than a PE (Western Union’s case). Further the Apex court has held that there needs to be a territorial nexus in order to constitute a PE as held in Ishiwajimakarma Harima industries case 2007 158 Taxman 259 SC. The territorial nexus clause as a necessity for a business connection has been removed from Finance Act 2007 and the definition of India is also sought to be widened with the inclusion of the airspace.
8. Rate of Tax and point of deduction
The wording of section 195 specifies the “rates in force”. This term has been interpreted judicially to mean the lower of the rate between the Finance Act and the relevant DTAA . Further if the DTAA rate is applied and the term “income tax” is employed in the DTAA, it does not need to be augmented with any surcharge or Education cess as held in Srinivasan’s case reported in 83 ITR 346 SC.
In the case of a conflict in the intervening period between an old finance Act and a new Finance Bill , the rate more beneficial to the payee must be applied.
The next question which arises is the point at which the TDS has to be effected. The law states that TDS has to be effected at the earlier of actual payment or credit. This would be tempered by the decision in IDBI’s case which makes the ascertainment of a definite payee a precondition for effecting TDS. Thus mere credit to a general suspense account would not attract TDS. Certain decisions have held that TDS needs to be deducted only in the year of RBI approval Pfizer Ltd 259 ITR 391 (Mum)
9. Application for Exemption/ Mitigation of WHT
Section 195 is a self contained section and there are two different provisions for mitigation viz by the payer u/s 195 (2) and the payee u/s 195 (3)/section 197
The payer can make an application to his respective Assessing Officer seeking permission to effect nil or lower deduction on a certain payment with cogent reasoning for the same in the application.
Under Section 195 (3) there is also a provision for the payee making an application to its Assessing Officer for lesser rate of TDS or nil TDS . However this is limited by the conditions set out in rule 29B.
TDS wrongly deducted may be refunded in certain limited cases and after certain setoffs and CBDT Circular No 769/16.8.1998 deals with the conditions and procedure
An alternative mechanism has been provided by the CBDT in exercise of its powers conferred by section 195(6) which calls for uploading Form 15CA electronically and then submitting the electronic uploading acknowledgement along with Form 15CB duly certified by a Chartered Accountant for all offshore remittances. In case the C A certifying Form 15CB feels that no WHT is to be affected on the payment, provision for the same is also inbuilt (notwithstanding the Samsung ruling).The CBDT has further clarified that Form 15CB need not be certified by a CA in case of diplomatic/consular channel payments
10. Consequences for Non Deduction
As with other TDS defaults the consequences for Non deduction may be broadly classified as follows
a) Disallowances of the amounts paid under Section 40 (a) (i). It should be noted that the scope of the section dealing with payments to non residents is wider than that of 40 (a) (ia) which deals with residents. However there is no disallowance of any salary due to non deduction if the employee concerned pays the tax., but interest on the delayed period may be chargeable
b) Simple Interest at 12 % p a u/s 201A (which is on a month to month basis after the Finance Act 2007)
c) Penalties for non deduction (u/s 271C) and failure to pay the deducted tax to the government (u/s 221)
d)Prosecution u/s 276B
Section 195 A provides for the grossing up of payments in case of Net Of Tax Payments. This is not applicable in case of Non monetary perquisites which are subject to TDS under section 192(1A). Further there is no gross up on Presumptive tax as held in ONGC’s case in 264 ITR 340 (Uttaranchal)
Thus it is imperative for a payer to ensure that the provisions of section 195 are strictly followed in all payments to Non residents and the following rules would be helpful
If the amount of income embedded in a payment cannot be ascertained it is better to deduct based on the gross amount
In case of doubt, an application for mitigation of TDS under Section 195 (2) to the Payers assessing Officer must be made. The alternative route of the C A Certificate in form 15CB must be used in the same way as one gets into bed with a 900 pound gorilla i.e. with great care and caution. Only where there is strong justification and judicial support in the respective jurisdiction should this alternative be used. In Karnataka even if the payer is certain that no income element is embedded in the proposed payment it is advisable to use the 195(2) route until the Apex Court takes a view on the Samsung case.
The exact rate as determined by the application of a DTAA or the Act needs to be carefully determined
A point in note in this very important branch of law is that articles on the subject are ever increasing and interpretations multiplying with each passing decision.
The impending Direct Taxes Code will redraw the landscape in this important branch of law and in its present form is expected to foment litigation even more.
The following immortal words of LJ Denning in Seaford Court Estates v Asher may be referred to with profit while interpreting the scope of section 195(1)
“The English language is not an instrument of mathematical precision. …………….. It would certainly save the judges trouble if Acts of Parliament were drafted with divine prescience and perfect clarity. In the absence of it, when a defect appears a judge cannot simply fold his hands and blame the draftsman. He must set to work on the constructive task of finding the intention of Parliament, and he must do this not only from the language of the statute, but also from a consideration of the social conditions which gave rise to it, and of the mischief which it was passed to remedy, and then he must supplement the written word so as to give "force and life" to the intention of the legislature………. A judge must not alter the material of which it (Section 195)is woven, but he can and should iron out the creases.”(emphasis supplied )
Ruling of the Supreme Court in the case of GE India Technology that in effect overrules the Karnataka High Court’s Samsung decision - provides a reprieve from the obligatory TDS payment and deduction on foreign remittances with no India nexus.
The Supreme Court of India has held that any payments made to non-residents will be subject to withholding tax only when such payments are chargeable to tax in India in its 9 September 2010 judgment pronounced in the case of GE India Technology Centre Private Ltd Vs CIT.
Meanwhile, it may be recalled that the Karnataka High Court in the Samsung case had earlier stated that any person making a payment for the import of shrink wrap software was under a statutory obligation to deduct tax at source.
Hence, by implication all payments for the import of any goods, irrespective of their chargeability to tax in India, became subject to withholding tax to the detriment of the foreign party.
The only way to avoid the tax withholding was to make an application to the Indian tax authorities and obtain a written permission that the payer need not deduct taxes at source.
In the Samsung case, the appellants imported pre-packaged shrink wrapped standardised software from Microsoft and other suppliers outside India by making payments for such imports.
The Indian tax authorities contended that the payments for supply of software being akin to license fees were in the nature of royalty and the appellants were liable to withholding tax as such royalty payments deemed to accrue or arise in India.
On this contention, the appellant preferred an appeal to the Income Tax Appellate Tribunal which held that the amount paid to the foreign software suppliers was not in the nature of royalty payments that would give rise to taxable income in India. Accordingly, the appellants were not liable to withhold tax at source on payments made to the offshore suppliers.
The tax authorities appealed against the tribunal’s order to the Karnataka High Court with an additional ground of appeal to make the payer statutorily liable for filing a nil withholding tax certificate. Further, the tax authorities contended that unless permission for non-deduction of tax was granted by them, the payer was required to deduct tax at source. However, the high court did not address the question of taxability of the payments, but accepted the additional contention of the tax authorities and ruled in their favour. The Karnataka High Court’s ruling necessitated the appellants to prefer an appeal to the Supreme Court.
Questions before the Supreme Court in the GE India Technology Centre Private Ltd Vs Commissioner of Income Tax Case
The following two questions were placed before the Apex Court:
1. Whether the Karnataka High Court was right in holding that the obligation to withhold tax arose the moment there was a remittance?
2. Whether merely on account of such remittance to a non-resident, could it be said that such a remittance was income chargeable to tax under the Act?
1. The Supreme Court held that the expression “sums chargeable under the provisions of the Act” in Section 195(1) of the Income Tax Act 1961 (Act) is the crucial determining factor.
2. The phrase “sums chargeable” under the provisions of the Act refers to the amounts that have an element of income in them as required under the provisions of the Act and the treaty provisions.
3. The Supreme Court rejected the contention of the tax authorities that the assessees have to make an application in every case of remittance even when the income has no territorial nexus with India or is not chargeable in India.
4. The Supreme Court also observed that accepting the contention of the tax authorities would lead to the obliteration of the expression “sum chargeable under the provisions of the Act” as given under Section 195(1) of the Act.
5. The Supreme Court held that any person paying any sum to a non-resident is not liable to deduct tax if such sum is not chargeable to tax under the Act.
Majmudar & Co views that the Supreme Court judgment will put an end to the controversy created by the Karnataka High Court on the need to withhold taxes even when the underlying payment was not chargeable to tax in India.
This decision will also result in avoiding unnecessary litigation on the applicability of withholding tax obligations in India.
The Samsung case touches upon the topic of extra-territorial operation of the Income Tax Act (highlighted in the Vodafone judgment of the Bombay High Court). It relates to the obligation of the payer to deduct and deposit TDS in relation to remittances made to foreign parties who do not have any permanent establishment in India and, therefore, are not taxable under the Income Tax Act.
Why this judgment is important is because a large number of remittances are made to foreign parties from India, on which the tax department has imposed interest and penalty for the payer not having deducted TDS.
In this case, the companies argued that no part of the payees’ incomes arose in India nor did they have a permanent establishment in the country. Furthermore, the income was exempt under double taxation avoidance agreements. In view of the foregoing, the Supreme Court reversed the judgment of the Karnataka High Court holding that it was not correct to say the moment a remittance was made to a foreign party, tax became deductible under the provisions of Section 195 of the Income Tax Act.
1 of 3
GE INDIA TECHNOLOGY CENTRE PRIVATE LTD. VS COMMISSIONER OF INCOME TAX & ANR
(2010) 10 SCC 29
SUPREME COURT JUDGMENT
Decided on: 09.09.2010
Payments to a non-resident or foreign company will be subject to deduction of Tax at Source under section 195 (1) of the Income Tax Act, 1961 only if the sum payable is "chargeable to tax" in India in the hands of the non-resident or foreign company.
Supreme Court in this matter clubbed various other petiitons on the same issue and proceeded on the basis of facts of the leading case of Sonata Information Technology limited. The appellants were the distributors of imported prepackaged shrink wrapped standardized software from Microsoft and other Suppliers outside India. GE made payments to the aforesaid software Suppliers. The ITO (TDS) held that since the sale of software included a license to use the same, payments made by the GE to the foreign Suppliers constituted royalty, which was deemed to accrue or arise in India. Therefore, Tax at Source (TAS) was liable to be deducted under Section 195 of the Income Tax Act, 1961 (Act). The finding of the ITO (TDS) was upheld by the Commissioner (A).
In second appeal, the Income Tax Appellate Tribunal (ITAT), however, held that the amount paid by GE to the foreign software Suppliers was not "royalty" and the same did not give rise to any income taxable in India, and therefore, the GE is not liable to deduct Tax at Source (TAS). Revenue appealed to the High Court of Karnataka and raised the Page
2 of 3
contention that unless the payer makes an aplication to ITO (TDS) under Section 195 (2) and obtain permission for non-deduction of TAS, payer cannot contend that the income is not chargaeable to tax. Karnataka High Court accepted this contention of department and relying on the Supreme Court decision in
Transmission Corporation’s case held tha any payment in the nature of income to a non-resident or a foreign company would require TAS deduction under section 195 (1) of the Act.
Whether under the Income Tax Act, 1961, the obligation to deduct tax at source (TAS) arises the moment there is remittance to non-residents?
OBSERVATIONS AND DECISSION OF THE SUPREME COURT
1. The most important expression in Section 195 (1) consists of the words "chargeable under the provisions of the Act". If the contention of the Department that the moment there is remittance the obligation to deduct TAS (TDS) arises is to be accepted then we are obliterating the words "chargeable under the provisions of the Act" in Section 195 (1). The payer is bound to deduct TAS only if the tax is assessable in India. If tax is not so assessable, there is no question of TAS being deducted.
2. That Section 195 (2) provides a remedy by which a person may seek a determination of the "appropriate proportion of such sum so chargeable" where a proportion of the sum so chargeable is liable to tax. Section 195 (2) is based on the "principle of proportionality". The said Sub-section gets attracted only in cases where the payment made is a composite payment in which a certain proportion of payment has an element of "income" chargeable to tax in India.
3. The facts of the
Transmission Corporation’s case were different and the reliance of Karnataka High Court on the same is misplaced.
3 of 3
4. The Supreme Court overruled the Karnataka High Court ruling and held that Payment to a non-resident will be subject to withholding of the tax under section 195 (1) of the Act, only if the sum payable is "chargeable to tax" in India in the hands of the non-resident.
The issue of Tax Deduction at Source, when the payment is being made by resident to a non-resident has long been a controversial issue with the various High Courts being of divergent opinions. This ruling of Supreme Court has finally settled the position of law in case of payments to non-residents by stating that if payments in not chargeable to tax in India in the hands of the non-resident then there is no liability to deduct Tax at Source.
No requirement to approach the Tax Officer for nil withholding certificate under section 195(2) where the non-resident is not liable to tax
Bench of the Income-tax Appellate Tribunal
Facts:-The assessee was engaged in the business of executing a turnkey project of water/waste water treatment and sewerage treatment plants. For the Assessment Year ("AY") 2002-03, the Assessing Officer ("AO") disallowed the fees for technical services amounting to Rs. 11,536,306 by invoking the provisions of section 40(a)(i) of the Act since the assessee had not deducted tax at source under section 195 of the Act while making the payment to the foreign company. On appeal, the Commissioner of Income-tax (Appeals) ("CIT(A)") upheld the action of the AO.
Issue:-The assessee contested the action of the CIT(A) before the Tribunal on the ground that it was not liable to deduct tax.
Assessee's contentions:-The assessee contended that under Article 7 of the old tax treaty between India and Austria, which was applicable for the year under consideration, the fees for technical services would be taxable in India only if the services were rendered in India. As the services were rendered in Austria, the amount paid by the assessee to the Austrian company was not liable to tax in India and consequently, no tax was liable to be deducted and no disallowance under section 40(a)(i) of the Act was called for.
Revenue's contentions:-The Revenue argued that the applicability of section 195(2) of the Act was mandatory and if the assessee did not want to deduct TDS on the payment to the non-resident, it was incumbent upon the assessee to make an application under section 195(2) of the Act. Further, as per the provisions of section 40(a)(i) of the Act, the expenditure claimed was liable to be disallowed.
The Revenue placed reliance on the decision of the Karnataka High Court in the case of CIT v. Samsung Electronics Ltd  320 ITR 209 (Kar).
Under the provisions of the tax treaty, the payment made by the assessee would not be subject to tax in India.
A perusal of the provisions of section 195 of the Act clearly showed that if any sum chargeable under the provisions of the Act was paid to a non-resident then tax was liable to be deducted. Here, what is important is the sum chargeable under the provisions of the Act.
It is undisputed that the provisions of sections 90 and 91 of the Act would override the other provisions of the Act. Thus, when the transaction is covered under the provisions of the tax treaty, it is to be first shown that the tax treaty does not apply or that the particular income is taxable in India under the provisions of the Act if the provisions of section 195 of the Act are to be invoked.
As the income of the Austrian enterprise was not taxable in India, the provisions of section 195 of the Act would not be applicable for the year under consideration.
As the provisions of section 195(1) of the Act were not applicable, the requirement of the assessee to obtain a nil withholding certificate under section 195(2) of the Act also did not survive and on that count, no disallowance under section 40(a)(i) of the Act could be made.
There have been various decisions (See note 1 below for list) to the effect to the effect that section 195(2) of the Act is applicable only where income is chargeable to tax in India. Further, one may note that as per information received from the Supreme Court today, the Karnataka High Court in the case of Samsung Electronics Ltd. (above) is reversed by the Supreme Court.
VODAFONE CASE LAW
The Supreme Court judgment in the Vodafone case will put to bed several controversies in taxation. Our judicial system normally takes several years to close a case beyond final appeal. The fact that Vodafone got their judgement in about five years and in a manner that upholds several international principles in law reposes faith in India's judiciary.
Vodafone was, as described by the revenue department, a test case where Revenue wanted to stretch interpretation of the Income-Tax Act to hold overseas transfers with an underlying value in India liable to tax in India, if the 'intent' of the transacting parties was transfer of the underlying value. Revenue contended that the transaction sought to avoid tax and that Vodafone ought to have withheld tax on the consideration it paid Hutch.
On the other hand, it was Vodafone's contention that the true legal effect of the transaction was to transfer the shares of an overseas company. The fact that there were statements made commercially to say that the sale/acquisition was of an Indian telecom business was not relevant.
The Supreme Court has upheld that the legal implications of a transaction cannot be disregarded and, inthis case, the legal effect was to transfer the shares of an overseas company. One could not 'look through' and pierce the corporate veil of a legitimate holding company that was used as an investment vehicle and thereby try and tax the underlying value of the subsidiaries.
The observations of the Chief Justice of India that foreign direct investment flows towards locations with a strong governance infrastructure - good laws, efficacious enforcement of laws by the legal system - and that certainty is integral to the rule of law is remarkable and noteworthy. Hopefully, they will set the tone for the future.
The judgement has several long-term implications. First, and foremost, it provides a basis for interpretation, namely, that one has to 'look at' a transaction rather than 'look through' a transaction unless one is concerned about fraud or a similar situation.
The tax authorities cannot dissect a transaction and treat a transaction as a sum of its constituents instead of the way the transaction has been entered into by the parties. This principle is indeed critical. The Supreme Court has built caveats to cover artificial devices and frauds, but barring that, the form of the transaction would prevail.
Second, the issue of tax avoidance versus tax evasion gets clarity. The Supreme Court has held that tax avoidance within the legal parameters continues to prevail and the principle laid down in this regard earlier in the case of Azadi Bachao Andolan continue to hold fort. Importantly, the Supreme Court has held that one cannot impose form over substance in statute or impose limitation of benefits in a tax treaty. This indeed is very welcome.
Third, the international principles of jurisprudence of respecting holding company structures, particularly those that have been in place for a length of time and have not been created merely for the purposes of exit, have been blessed. This, again, is very welcome and will do away, with significant certainty, with the Revenue authorities' desire to pierce the corporate veil and look at the substance of the transaction in several cases.
Fourth, the concurring but separate judgement of Justice Radhakrishnan also lays down some very interesting principles. It deals at length with the issue of India-Mauritius Tax Treaty (although that was not the issue in the present case) and holds that India-Mauritius Tax Treaty would be respected where a Mauritius company holds a Tax Residence Certificate, unless a Mauritius entity has been interposed at the time of disposal of shares solely with a view to avoiding taxes.
This separate judgment also upholds that payments made by one non-resident to another would not be subject to withholding tax in India, particularly where there is no tax presence in India. This, indeed, would provide a sigh of relief to several assessees who make offshore payments on which the Indian Tax Office seeks to impose withholding obligations.
Finally, this judgment will help close out the pending litigation on similar issues in the case of General Electric, AT&T and the like. There are significant stakes involved in such litigation.
The strong statement by Justice Radhakrishnan that capital gains tax demand on Vodafone constitutes imposing capital punishment for capital investments and lacks authority of law indeed sends out a very strong signal. It will reaffirm the faith of foreign investors in the Indian judicial system.
Rather than view the judgement as a defeat for Revenue, one should view it as a victory for the Indian judicial system. This will promote inflow of foreign funds to India and ultimately benefit revenue much more than the immediate loss to the exchequer. The stakes involved matter more than Vodafone.
Vodafone won a five-year legal battle against the Indian tax authorities in January as the apex court dismissed a $2.2 billion tax demand raised over the British mobile phone giant's acquisition of Indian mobile assets in 2007.
The tax office last month filed a petition seeking a review of that judgment.
The tax demand was over Vodafone's $11 billion deal to buy Hutchison Whampoa Ltd's Indian mobile business.
Vodafone, the world's largest mobile operator by revenue and the biggest overseas corporate investor in India, had argued that the Indian authorities had no right to tax the transaction between two foreign entities.
Even if tax was due, the company had argued, it should be paid by the seller and not the buyer.
Speaking to ET Now, renowned lawyer Harish Salve expressed happiness over the Supreme Court's decision but added that he wasn't surprised by the dismissal of review petition.
Commenting on the Supreme Court's decision, Dinesh Kanabar, CEO (tax), KPMG told ET Now, "Government will have to take a hard look at the provisions of the Finance Bill. It is very rare for SC to reverse its judgement on a review petition."
The union budget presented last week amended the income tax act retrospectively from 1962, giving the taxman powers to scrutinise offshore merger and acquisition deals. Finance Minister Pranab Mukherjee later assured investors that deals more than six years old will not be reopoened. This still leaves the sword hanging over the Vodafone case.
The government in its review petition had said that the apex court ruling had error in its findings that the offshore transaction which gave Vodafone holding company a 67% stake in Hutch-Essar was bona fide structured FDI in India.
The Centre said there was no investment or inflow of the funds into the country through such transactions. It said that the amount was admittedly paid outside India by VIH, a British Virgin Island company, to Hutchison Telecommunications International (Cayman) Holdings Ltd, a Cayman Island company, and was, therefore, not a case of FDI into India at all.
"We hold, that the Offshore Transaction herein is a bona fide structured FDI investment into India which fell outside India's territorial tax jurisdiction, hence not taxable. The said Offshore Transaction evidences participative investment and not a sham or tax avoidant preordained transaction," Chief Justice SH Kapadia had said writing the lead judgement in the case.
The government further said that the SC ruling has the effect of legitimising transactions through the tax havens and preventing the income-tax department from looking at the substance of such transactions.
By creating an interposed holding or operating company, the foreign investors would be able to avoid lengthy approval or registration process which would have far reaching consequences, the Centre said seeking recall of the order.