Payment to Non-Resident in Respect of Income Not Chargable to Tax — Obligation of TDS u/s.195

1.8.2 In particular, the following findings of the High Court read with other observations made in Samsung’s case created a situation referred to in para 1.8.1. (pages 245-246):

“If one is allowed the liberty of giving a rough and crude comparison to the manner in which the provisions of S. 195 of the Act operate on a resident payer who makes payment to a non-resident recipient and if the payment bears the character of semblance of an income receipt in the hands of the non -resident recipient, then the obligation on the part of the resident payer who makes such a payment to the non-resident recipient is like a guided missile which gets itself attached to the target, the moment the resident -assessee makes payment to the non-resident recipient and there is no way of the resident payer avoiding the guided missile zeroing in on the resident payer whether by way of contending that the amount does not necessarily result in the receipt of an amount taxable as income in the hands of the non-resident recipient under the Act or even by contending that the non-resident recipient could have possibly avoided any liability for payment of tax under the Act by the overall operation of different provisions of the Act or even by the combined operation of the provisions of a Double Taxation Avoidance Agreement and the Act as is sought to be contended by the respondents in the present appeals.

The only limited way of either avoiding or warding off the guided missile is by the resident payer invoking the provisions of S. 195(2) of the Act and even here to the very limited extent of correcting an incorrect identification, an incorrect computation or to call in aid the actual determination of the tax liability of the non-resident which is in fact had been determined as part of the process of assessing the income of the non-resident and by using that as the basis for claiming a proportionate reduction in the rate at which the deduction is required to be made on the payment to the non-resident. Except for this method, there is no other way of the resident payer avoiding the obligations cast on it by the provisions of S. 195(1) of the Act and as a consequence of such default when is served with a demand notice in terms of S. 201 of the Act.

This position is the clear legal position that emerges on analysing the full effect of the provisions of S. 195 of the Act in the light of the law declared by the Supreme Court in Transmission Corporation of A.P. Ltd.’s case (1999) 239 ITR 587.”

1.8.3 Subsequently, it was expected that the CBDT will come out with some clarification to relieve the Payers from the abnormal hardship created by the above judgment but that never happened. Fortunately, the Delhi High Court in the case of Van Oord ACZ India (189 Taxman 232) and Special Bench of ITAT (Chennai) in the case of M/s. Prasad Production (125 ITD 263) took a different view on the major issue and explained the correct effect of the judgment of the Apex Court in Transmission Corporation’s case. These gave some relief to the Payers, but the issues survived due to the judgment of the Karnataka High Court in Samsung’s case.

G. E. India Technology Centre P. Ltd. v. CIT, 327 ITR 456 (SC):

2.1 The above-referred judgment of the Karnataka High Court in Samsung’s case came up for consideration before the Apex Court (in a batch of appeals filed by various assessees — reported as GE India Technology Centre P. Ltd). For the purpose of deciding the issue, the Court noted the facts of the leading case of Sonata Information Technology Ltd. In that case, the assessee was distributors of imported pre- packaged shrink-wrapped standardised software from Microsoft and other suppliers outside India. The assessee made payments for such softwares to suppliers without making TDS on the ground that such payments represent purchase price of the goods. The Income-tax Officer (TDS) (ITO), however, took the view that such payments are in the nature of royalty, as the sale of software included a licence to use the same and accordingly, the same represents income deemed to accrue or arise in India. The first Appellate Authority upheld the view of the ITO. However, the Appellate Tribunal accepted the contention of the assessee and held that such payment did not give rise to any taxable income in India and therefore, the assessee was not liable to deduct Tax At Source (TAS). When the matter came up before the Karnataka High Court at the instance of the Revenue, the contention was raised for the first time on behalf of the Revenue that unless the Payer makes an application to the ITO u/s.195(2) and has obtained permission to make for non-deduction of the TAS, it was not permissible for making payment without making deduction of TAS. This contention was accepted by the High Court for which a strong reliance was placed on the judgment of the Apex Court in Transmission Corporation’s case.

2.2 At the outset, the Court noted that the short question which arises for determination in this batch of cases, is as follows (page 458):

“whether the High Court was right in holding that the moment there is remittance the obligation to deduct tax at source (TAS) arises? Whether merely on account of such remittance to the non-resident abroad by an Indian company per se, could it be said that income chargeable to tax under the Income-tax Act, 1961 (for short ‘I.T. Act’) arises in India”

2.3 To decide the issue on hand, the Court referred to the provisions of S. 195 and in particular, also noted the New Procedure for Remittance contained in S. 195(6). The Court, then, explained the scheme of S. 195 and other relevant provisions under which the statutory obligation is imposed on the Payer to deduct tax while making payment to non-resident and the consequences of the default, if any, committed by the Payer in that respect. The Court, then, stated that the most important expression contained in S. 195 (1) is ‘chargeable under the provisions of the Act’. Therefore, a person making payment to a non-resident is not obliged to deduct tax if, such sum is not chargeable to tax under the Act. While explaining the effect of this expression, the Court further stated as under (pages 460/461):

“….It may be noted that S. 195 contemplates not merely amounts, the whole of which are pure income payments, it also covers composite payments which have an element of income embedded or incorporated in them. Thus, where an amount is payable to a non-resident, the payer is under an obligation to deduct TAS in respect of such composite payments. The obligation to deduct TAS is, however, limited to the appropriate proportion of income chargeable under the Act forming part of the gross sum of money payable to the non-resident. This obligation being limited to the appropriate proportion of income flows from the words used in S. 195(1), namely, ‘chargeable under the provisions of the Act.’ It is for this reason that vide Circular No. 728, dated October 30, 1995 the Central Board of Direct Taxes has clarified that the tax deductor can take into consideration the effect of the DTAA in respect of payment of royalties and technical fees while deducting TAS….”

2.4 Proceeding further, the Court noted that S. 195(1) is in identical terms with S. 18(3B) of the 1922 Act. Under those provisions, in the case of Cooper Engg. Ltd. (68 ITR 457 — Bom.), it was pointed out that if the payment made by the resident to the non-resident does not represent taxable income in India, then no tax is required to be deducted, even if the Payer has not made any application u/s.18(3C) [similar to S. 195(2) of the Act], the Court, then, explained effect of S. 195(2) as under (page 461])?:

“….The application of S. 195(2) pre-supposes that the person responsible for making the payment to the non -resident is in no doubt that tax is payable in respect of some part of the amount to be remitted to a non-resident, but is not sure as to what should be the portion so taxable or is not sure as to the amount of tax to be deducted. In such a situation, he is required to make an application to the Income-tax Officer (TDS) for determining the amount. It is only when these conditions are satisfied and an application is made to the Income- tax Officer (TDS) that the question of making an order u/s.195(2) will arise. In fact, at one point of time, there was a provision in the Income-tax Act to obtain a NOC from the Department that no tax was due. That certificate was required to be given to the RBI for making remittance. It was held in the case of Czechoslovak Ocean Shipping International Joint Stock Company v. ITO, (1971) 81 ITR 162 (Cal.) that an application for NOC cannot be said to be an application u/s.195(2) of the Act. While deciding the scope of S. 195(2) it is important to note that the tax which is required to be deducted at source is deductible only out of the chargeable sum. This is the underlying principle of S. 195. Hence, apart from S. 9(1), S. 4, S. 5, S. 9, S. 90, S. 91 as well as the provisions of the DTAA are also relevant, while applying tax deduction at source provisions…..”

2.5 The Court, then, stated that the application to the ITO u/s.195(2) or u/s.195(3) is to avoid any further hassles for both residents as well as non-residents. The said provisions are of practical importance. Referring to the judgment in Transmission Corporation’s case, the Court pointed out that in that case the Apex Court has observed that the provisions of S. 195(2) is a safeguard. Based on this, the Court, then, further stated as under (pages 461/462):

“From this it follows that where a person responsible for deduction is fairly certain, then he can make his own determination as to whether the tax was deductible at source and, if so, what should be the amount thereof.”

2.6 Dealing with the contention raised on behalf of the Revenue that the moment there is remittance, the obligation to deduct TAS arises, the Court stated that if this is accepted, then we are obliterating the words ‘chargeable under the provisions of the Act’ in S. 195(1). Referring to the judgment of the Apex Court in the case of Vijay Ship Breaking Corpn. (314 ITR 309), the Court stated that 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. Referring to the scheme of deduction of TAS contained in Chapter XVII-B, the Court stated that on analysis of various provisions contained therein, one finds the use of different expressions, however, the expression ‘sum chargeable under the provisions of the Act’ is used only in S. 195. In no other provision this expression is found. Therefore, the Court is required to give meaning and effect to the said expression. Therefore, it follows that the obligation to deduct TAS arises only when there is a sum chargeable under the Act. S. 195 is to be read in conformity with charging provision (S. 4, S. 5 and S. 9). The Court stated that we cannot treat S. 195 to mean that the moment there is remittance, the obligation to deduct TAS arises. If such a contention is accepted, it would mean that on mere remittance income would be said to arise or accrue in India. While interpreting a Section, one has to give weightage to every word used in the Section. Again, the Act is to be read as an integrated code and one cannot read the charging Section of the Act de hors the machinery provision as held by the Apex Court in the case the Eli Lilly (312 ITR 325).

2.6.1 Explaining further, the effect of the above referred contention of the Revenue, the Court stated as under (page 463):

“….If the contention of the Department that any person making payment to a non-resident is necessarily required to deduct TAS, then the consequence would be that the Department would be entitled to appropriate the monies deposited by the payer even if the sum paid is not chargeable to tax because there is no provision in the Income- tax Act by which a payer can obtain refund. S. 237 read with S. 199 implies that only the recipient of the sum, i.e., the payee could seek a refund. It must therefore follow if the Department is right, that the law requires tax to be deducted on all payments, the payer, therefore, has to deduct and pay tax, even if the so-called deduction comes out of his own pocket and he has no remedy whatsoever, even where the sum paid by him is not a sum chargeable under the Act. The interpretation of the Department, therefore, not only requires the words ‘chargeable under the provisions of the Act’ to be omitted, it also leads to an absurd consequence. The interpretation placed by the Department would result in a situation where even when the income has no territorial nexus with India or is not chargeable in India, the Government would nonetheless collect tax….”

2.7 Dealing with another argument of the Revenue that huge seepage of the revenue can take place if the Payers are free to decide to deduct or not to deduct TAS, the Court stated that according to the Revenue, S. 195(2) is a provision requiring the Payer to give information so that the Revenue is able to keep track of the remittances made to non-residents outside India. The Court did not find any merit in this contention. For this, the Court noted that the Payer when he makes remittance, he claims a deduction or allowance of sum as an expenditure and if there is default in making TAS, such expenditure will get disallowed as provided in S. 40(a)(i). This provision ensures effective compliance of S.

195.    The Court also noted the New Procedure for Remittance introduced in the form of 195(6) with effect from 1-4-2008 and stated that it will not apply for the period under consideration. Finally, the Court took the view that there are adequate safeguards created in the Act, which would prevent the revenue leakages.

2.8 The Court, then, considered the effect of the judgment of the Apex Court in Transmission Corporation’s case and stated that the only issue raised in that case was whether TDS was applicable only to pure income payments and not to composite payments, which had an element of income embedded therein. The controversy before the Court in the present cases is, therefore, quite different. In that case, it was held by the Court that if the Payer had a doubt as to the amount to be deducted as TAS, he could approach to the ITO to compute the amount on which deduction of TAS has to be made. Explaining the effect of the said judgment, as well as the effect of S. 195(2), the Court concluded as under (pages 465/466):

“…..In our view, S. 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. It is in this context that the Supreme Court stated, “If no such application is filed, income-tax on such sum is to be deducted and it is the statutory obligation of the person responsible for paying such ‘sum’ to deduct tax thereon before making payment. He has to discharge the obligation to TDS”. If one reads the observation of the Supreme Court, the words ‘such sum’ clearly indicate that the observation refers to a case of composite payment where the payer has a doubt regarding the inclusion of an amount in such payment which is exigible to tax in India. In our view, the above observations of this Court in Transmission Corporation case (1999) 239 ITR 587 (SC) which are put in italics have been completely, with respect, misunderstood by the Karnataka High Court to mean that it is not open for the payer to contend that if the amount paid by him to the non-resident is not at all ‘charge-able to tax in India’, then no TAS is required to be deducted from such payment….”

2.9 On merits of the cases on hand, the Court noted that the ITO and the First Appellate Authority have taken a view that the payment for supply of software constituted royalty, whereas the Appellate Tribunal has held otherwise and accepted the contention of the Appellant(s). However, the High Court did not go into merits of the cases. Therefore, the cases are remitted to the High Court for de novo consideration on merits.

Conclusion:

3.1 In view of the above judgment of the Apex Court, now it is the settled that if the payment is made to a non-resident, which is not a taxable income in India, then no tax is required to be deducted u/s.195.

3.2 For the above purpose, it is open to the Payer to decide whether such payment is at all chargeable to tax in India as the income of the Payee. For this purpose, the Payer can take into account the relevant provisions of the Act as well as applicable Double Tax Avoidance Agreement (DTAA). If, in the process, the Payer is fairly certain about the non-taxability, he need not deduct TAS.

3.3 In view of the above judgment of the Apex Court, for the purpose of determination taxability of the remittance being made to non-resident, it is also open to the Payer to determine the character of income in the hands of non-resident Payee.

3.4 There are adequate safeguard in the Act to prevent revenue leakages, notwithstanding the above view of the Apex Court on the provisions of S. 195.