Source: http://www.filereturn.com/tds-on-payments-made-to-non-resident-section-195-read-with-section-90-90a-dtaa
Timestamp: 2019-04-25 00:45:39+00:00

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(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.
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."
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.
(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.
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.
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.
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.
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.
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.
All sums in which income can reasonably be expected to be embedded are covered.This rule follows the judgement in Transmissions corporation’s case 239ITR 587SC where the apex court has categorically ruled that a payer cannot sit in judgement as to what proportion of the amount paid to the payee constitutes the income of the payee.
There is no clear ruling on TDS in respect of Capital gains and one must take it up on a case to case basis.If no mitigation is available even after application by either the payer or the payee , after disclosing the quantum of Capital gains likely to be embedded in the payment , then TDS on the gross amount is advisable on the principle of ex abundant Cautela ie by way of abundant caution to mitigate the consequences of non deduction to the payer.
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.
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.
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.
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.
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.
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 .
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.
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 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.
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.
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.
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.
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.
1.1 S. 195 of the Income-tax Act provides for tax deduction at source from payment of interest or any other sum chargeable under the provisions of the Income-tax Act (other than salaries or dividend specified in S190) to a non-resident or a foreign company at the prescribed time at the rates in force.
1.2 U/s.195(2), where the payer considers that the whole of such sum so payable to a non-resident would not be income chargeable of the recipient, he can make an application to the Assessing Officer to determine the appropriate proportion of such sum chargeable to tax, and thereupon shall deduct tax u/s.195(1) only on that proportion of the sum chargeable to tax. Similarly, sections 195(3) and 197 provide for the payee making an application to the Assessing Officer for issue of a certificate that income-tax may be deducted at lower rates of tax or not deducted on payment to be received by him, where such lower rate or non-deduction is justified.
1.3 The issue has arisen before the courts as to whether, in a case where the payment to the nonresident or a foreign company does not comprise any income chargeable to tax in India at all (for example, in case of payment for purchase of goods imported from the non-resident), whether the payer has necessarily to apply to the tax authorities for a certificate u/s.195(2) or whether the payment can be made to such non-resident or foreign company without any deduction of tax at source, and without obtaining any such certificate u/s.195(2) or u/s.195(3) or u/s.197.
1.4 While the Karnataka High Court has taken the view that it is mandatory to obtain such a certificate from the tax authorities, the Delhi High Court has taken a contrary view that in such cases, the payer can make the payment without the need for such certificate.
2.1 The issue came up before the Karnataka High Court in the case of CIT v. Samsung Electronics Co. Ltd., 320 ITR 209. Various other appeals of different resident payers were also decided vide this judgment.
2.2 In this case, the assessee payer was a branch of a Korean company engaged in the development, manufacture and export of software for use by its parent company. The software developed by it was for in-house use by the parent company. During the relevant years, the assessee imported ready-made software products from US and French companies for its own use. It did not deduct tax at source from payments made to the US and French companies on the ground that the payment to the foreign companies was for purchase of products, and was not in the nature of royalty, and was not chargeable to tax in India.
2.3 The Assessing Officer held that the payment was in the nature of royalty, that the assessee was bound to deduct tax at source on the payments, and accordingly treated the assessee as an assessee in default u/s.201(1), and also levied interest u/s.201(1A). The Commissioner (Appeals) dismissed the assessee’s appeals against this order.
2.4 The Tribunal held that the payment was not in the nature of royalty in terms of the relevant provisions of the Double Taxation Avoidance Agreements. It also held that it was not incumbent on the assessee to deduct any amount u/s.195.
2.5 Before the Karnataka High Court, it was argued on behalf of the Department that the payment was in the nature of royalty on which tax was required to be deducted at source u/s.195. It was argued that the transaction was a licence and was therefore in the nature of royalty. It was further claimed that the assessee was bound to deduct tax u/s.195 and that it could not contend that it was not the income of the recipient. Reliance was placed on the decision of the Supreme Court in the case of Transmission Corporation of A.P. Ltd. v. CIT, 239 ITR 587.
2.6 It was argued by the assessee that the nature of payment was not royalty even u/s.9(1)(vi), on account of the fact that the non-resident supplier had merely sold a copyrighted article and not the copyright itself, relying on the decision of the Supreme Court in the case of Tata Consultancy Services v. State of Andhra Pradesh, 271 ITR 401. It was therefore claimed that the payment was for purchase of articles/goods in connection with the business carried on by the assessee. It was further claimed that under the Double Taxation Avoidance Agreements, since the non-resident recipients had no permanent establishments in India, the entire income of the non-residents attributable to the payments was not taxable in India. It was therefore claimed that there was no obligation on the part of the payer to deduct any amount.
2.7 It was also contended by the other assessees that there was no obligation on their part to deduct any amount from the payments, as they were fully and bona fide satisfied that the amount was not taxable in the hands of the non-resident in India. They had therefore not chosen to apply for any relief or concession in terms of S. 195(2) and (3). It was further argued that the words used in S. 195 are ‘chargeable to tax’ and hence a person deducting tax u/s.195 would have to necessarily first see whether the same was chargeable to tax and then only, if it was so chargeable, he was to deduct tax. It was contended that if a person was not liable to be charged to tax, then the payer could not be held to be a person in default u/s.201.
2.8 The Karnataka High Court considered the decision of the Supreme Court in Transmission Corporation of AP’s case (supra) and of the Calcutta High Court in P. C. Ray & Co. (India) Private Limited v. ITO, 36 ITR 365, wherein the Calcutta High Court had held that if the term ‘chargeable under the provisions of this Act’ means actually liable to be assessed to tax, in other words, if the sum contemplated was taxable income, a difficulty is undoubtedly created as to complying with the provisions of the Section.’ The High Court in that case had held that what was contemplated was not merely amounts, the whole of which were taxable without deduction, but amounts of a mixed composition, a part of which only might turn out to be taxable income as well; and the disbursements, which were of the nature of gross revenue receipts, were yet sums chargeable under the provisions of the Income-tax Act and came within the ambit of the Section.
2.9 The Karnataka High Court therefore rejected the arguments of the assessees that the expression ‘any other sum chargeable under the provisions of this Act’ would not include cases where any sum payable to non-resident was trading receipts, which may or may not include ‘pure income’. According to the Karnataka High Court, the language of S. 195(1) was clear and unambiguous and cast an obligation to deduct appropriate tax at the rates in force.
2.10 The Karnataka High Court observed that S. 195 was not a charging Section, nor a Section providing for determination of the tax liability of the nonresident receiving the payments from the resident. The amount deducted by the resident was only a provisional tentative amount, which was kept as a buffer for adjusting this amount against the possible tax liability of the non-resident. Deduction of the amount u/s.195 was not the same as determination of the liability of the non-resident, who may be or may not be liable to pay any tax. Determination of tax liability could only be on the basis of the return of income filed by the non-resident. According to the Karnataka High Court, the only scope and manner of reducing the obligation for deduction imposed on a resident payer in terms of S. 195(1) was by the method of invoking the procedure u/s.195(2) of making an application to the Assessing Officer to determine by general or special order the appropriate proportion of such sum so chargeable, and upon such determination alone, being allowed the liberty of deducting the proportionate sum so chargeable to tax to fulfil the obligations u/s.195(1).
2.11 The Karnataka High Court therefore held that in the absence of an application u/s.195(2), the payer was obliged to deduct tax at source u/s. 195(1), even though the payment did not contain any element of income of the non-resident chargeable to tax in India.
3.1 The issue again recently came up before the Delhi High Court in the case of Van Oord ACZ India (P) Ltd. v. CIT, (unreported — ITA No. 439 of 2008 dated 15th March 2010, available on www.itatonline.org).
3.2 In this case, the assessee was an Indian subsidiary of a Netherlands company, and was engaged in the business of dredging, contracting, reclamation and marine activities. During the relevant year, the assessee reimbursed mobilisation and demobilisation cost to its parent company. This cost related essentially to transportation of dredger, survey equipment and other plant and machinery from countries outside India to the site in India and the transportation of such plant and machinery on completion of the contract, including fuel cost incurred on transportation. These services were contacted by the parent company and were provided by various non-resident entities. The assessee reimbursed such cost to the parent company on the basis of invoices received by the parent company from the non-resident entities.
3.3 The assessee filed an application to the Assessing Officer for issue of nil tax withholding certificate in respect of reimbursement of various costs to the parent company. The Assessing Officer issued a certificate of deduction of tax at source at 11%, and the assessee deducted tax at source accordingly on Rs.6.98 crore. In the course of assessment proceedings, the Assessing Officer disallowed payments of Rs.8.66 crore made to the parent company u/s.40(a) (i), on the ground that the assessee had defaulted in deducting tax at source u/s.195.
3.4 The Commissioner (Appeals) upheld the disallowance made by the Assessing Officer. The Tribunal confirmed the addition, stating that the assessee was mandatorily liable to deduct tax at source u/s.195, and that it was not necessary to determine whether such payment was chargeable to tax in India in the hands of the non-resident. The Tribunal further held that the assessee was a dependent agent permanent establishment of the parent foreign company and therefore the reimbursement of expenses to the foreign parent company was to be subjected to tax.
3.5 Before the Delhi High Court, it was argued on behalf of the assessee that the amount reimbursed to the parent company was not chargeable to tax in India in the hands of the parent company, and that the assessee was consequently not liable to deduct tax at source u/s.195. It was argued that the obligation to deduct tax at source u/s.195 was predicated on the condition that tax was payable by the non-resident on the payments received by it, and once it was established that no such tax was payable by the non-resident, the assessee could not be treated to be in breach of its obligations.
3.6 It was pointed out that the reason for fastening the obligation to deduct tax at source of the payment to non-resident only in a situation where such payment was chargeable to tax in India was that it was not the intention of the law to fasten an absolute liability on the remitter to deduct tax at source from the payment to the non-resident, and then subject the non-resident to the rigorous process of filing return and seeking refund and assessment on the basis of such return. Where the remitter was of the opinion that some part of the income may be chargeable to tax in India, the remitter could approach the Assessing Officer to determine the appropriate portion of the income that would be subject to tax in India and the rate on which tax was to be deducted at source. Reliance was placed on the observations of the Supreme Court in the case of Transmission Corporation of AP Ltd. (supra) and various other cases for the proposition that the obligation to deduct tax at source is triggered only when the payment to be made to the non-resident is chargeable to tax in India in the hands of the nonresident recipient.
3.7 On behalf of the Department, it was argued that S. 195 only determines the proportion of liability and presupposes the existence of liability. It was pointed out that the assessee itself had applied for determination of extent of liability. The statutory obligation of the assessee with regard to deduct tax at source was fully crystallised, and therefore there was no justification on the part of the assessee not to deduct tax at source, particularly when the order passed u/s.195(2) had attained finality.
3.8 The Delhi High Court noted that the issue before the Supreme Court in the case of Transmission Corporation of AP (supra) was whether tax at source was to be deducted by the payee on the entire amount paid by it to the recipient or whether it was to be deducted only on the component of pure income profits. It was therefore in the context of whether tax deductible was to be on the gross sum of trading receipts paid to non-residents or whether only on the income component. It was in that context that the Supreme Court held that “any other sum chargeable under the provision of this Act” would include the entire amount paid by the assessee to non-residents. The observations of the Supreme Court therefore needed to be read in that context. The Delhi High Court noted that the Supreme Court was not concerned in that case with a situation where no tax in the hands of the recipient was payable at all. The Delhi High Court noted that certain observations in the judgment clearly depicted the mind of the Supreme Court that liability to deduct tax at source arose only when the sum paid to the non-resident was chargeable to tax. Once that is chargeable to tax, it was not for the assessee to find out how much of the amount of the receipts was chargeable to tax, but it was its obligation to deduct tax at source on the entire sum paid by the assessee to the recipient.
3.9 The Delhi High Court relied on certain other decisions of the High Courts, including that of the Delhi High Court in the case of CIT v. Estel Communications (P) Ltd., 217 CTR 102 and the Karnataka High Court in the case of Jindal Thermal Power Company Limited v. Dy. CIT, 182 Taxman 252, where Courts had taken the view that there was no obligation to deduct tax at source since there was no tax liability of the non-resident in India. The Delhi High Court noted the decision of the Karnataka High Court in the case of Samsung Electronic Co. Ltd. (supra), and observed that the context in that case was different. The Delhi High Court expressed its disagreement with some of the observations made in that judgment of the Karnataka High Court.
3.10 The Delhi High Court therefore held that the obligation to deduct tax at source arises only when the payment was chargeable under the provisions of the Income-tax Act. The Delhi High Court noted that in the case before it, the income-tax authorities had accepted that the foreign company was not liable to pay any tax in India by accepting the foreign company’s tax return u/s.143(1) and refunding the tax deducted at source. Therefore, the assessee could not be regarded as having defaulted in deduction of TDS u/s.195.
4.1 This issue was also again very recently considered by the Special Bench of the Income-tax Appellate Tribunal at Chennai, in the case of ITO v. Prasad Production Ltd., (ITA No. 663/Mds/2003, dated 9th April 2010 — unreported, available on www.itatonline.org).
4.4 From these two decisions of the Supreme Court, the Tribunal concluded that it was abundantly clear that the charging provisions could not be divorced from the TDS provisions, and that S. 195 would be applicable only if the payment made to the non-resident was chargeable to tax.
4.5 The Tribunal also noted the material difference between the provisions of Ss.(2) and Ss.(3) of S. 195. U/ss.(2), the payer made the application for deduction of tax at lower rates. U/ss.(3), the payee could make an application for deduction of tax at lower rate or without deduction of tax. According to the Tribunal, the reason for such difference was that where the payer had a bona fide belief that no part of the payment bore income character, S. 195(1) itself would be inapplicable and hence there would be no question of going into the procedure prescribed in S. 195(2). Ss.(3) deals with a situation where the payer wants to deduct tax from the payment, but the payee believed that he was not chargeable to tax in respect of that payment. Hence the payee was given an opportunity to seek approval of the Assessing Officer to receive the payment without deduction of tax.
4.6 The Tribunal interestingly observed that by deciding whether the payment bore any income character or not, the payer was not determining the tax liability of the total income of the payee, but merely considering the chargeability in respect of the payment that he was making to the payee.
4.7 The tribunal also considered the fact that for the purposes of remittances to non-residents, a chartered accountant’s certificate was prescribed as an alternative to the procedure u/s.195(2). This was evident from the CBDT Circular 767, dated 22-5-1998. It noted that the certification covered all types of payment, whether purely capital or revenue in nature, but exempt either under the act or the relevant Double Taxation Avoidance Agreement or payments bearing pure income character. The Tribunal held that the new format of the CA certificate clearly established the legal position of S. 195 that the payer need not undergo the procedure of S. 195 at all if he was of the bona fide belief that no part of the payment was chargeable to tax in India.
4.8 The Tribunal therefore held that if the assessee had not applied to the Assessing Officer u/s. 195(2) for deduction of tax at a lower or nil rate of tax under a bona fide belief that no part of the payment made to the non-resident was chargeable to tax, then he was not under any statutory obligation to deduct tax at source on any part of the payment.
4.9 When one looks at the provisions of S. 195(1), the language is clear that it applies only to income chargeable to tax, and not to other items at all. As analysed by the Special Bench of the Tribunal, the Karnataka High Court seems to have misapplied the ratio of the decision of the Supreme Court in Transmission Corporation of AP. The better view seems to be that of the Delhi High Court and that of the Special Bench of the Tribunal that if the income is not chargeable to tax in India in the hands of the nonresident recipient, the payer need not obtain a certificate u/s.195(2) for not deducting tax at source.
4.10 In any case, an appeal to the Supreme Court against the decision of the Karnataka High Court has been admitted by the Supreme Court and has been fixed for hearing on 18th August 2010, on which date one hopes that this controversy will ultimately be laid to rest.
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).
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?
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.
Transmission Corporation’s case were different and the reliance of Karnataka High Court on the same is misplaced.
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.
The Supreme Court ("SC") has delivered a landmark ruling that the withholding tax obligation on payment to non-residents would arise only if there was income chargeable to tax in India. The SC has reversed the ruling of the Karnataka High Court in the lead case of Samsung Electronics (which also included several other companies).
The SC was examining a batch of appeals filed by certain companies that had made payments to overseas vendors of off-the-shelf software. These companies had made a determination that the payments for the purchase of the software were not chargeable to tax in India for the non-residents, and hence, had not withheld tax under section 195 of the Income-tax Act, 1961 ("Act"). The Revenue had alleged that the payments were in the nature of royalties and hence, tax ought to have been withheld. The Tribunal had decided in favour of the companies, and on appeal, the matter came before the Karnataka High Court ("KHC"). The KHC held that the payers were at fault for unilaterally determining that the payments were not chargeable to tax in India and in concluding that there was no tax deduction at source ("TDS") obligation on them. The KHC also held that the proper procedure for the payers would have been to approach the Revenue seeking a determination of their TDS liability and having failed to do so, the companies were liable to pay the necessary taxes to the Revenue. The KHC did not rule on merits as to whether the payments to the non-residents for the purchase of software were liable to tax in India.
for BMR analysis of KHC decision in Samsung Electronics.
Against the judgment of the HC, the aggrieved parties preferred appeals before the SC, which heard this matter on August 18 and 19, 2010 and reserved its judgment.
for BMR’s summary on the proceedings before the SC.
Brief : No requirement to approach the Tax Officer for nil withholding certificate under section 195(2) where the non-resident is not liable to tax and further no disallowance can be made under section 40(a)(i) of the Income-tax Act, 1961 In a recent decision, the Chennai Bench of the Income-tax Appellate Tribunal in the case of VA Tech Wabag Ltd. v. ACIT [2010-TII-109-ITAT-MAD-INTL] held that in a case where the payment for services was not taxable in India under the provisions of a Double Tax Avoidance Agreement ("the tax treaty"), there was no requirement for applying to the tax officer for a nil withholding certificate under section 195(2) of the Income-tax Act, 1961 ("the Act"). It was also held that as section 195 of the Act was not applicable, the amount paid for services could not be disallowed under section 40(a)(i) of the Act.
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.
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.

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