Payments To non-residents law and procedure (Withholding Tax provisions under section 195 of the act)

The
subject of “withholding tax provisions (TDS) from payments made to
non-residents” is always mired in controversies.  Being 
part  of  the 
International  Tax Law, the
subject is dynamic. It is a complex subject as it involves computation of
income in the hands of non- residents. Provisions are very harsh and fraught
with severe penalties. Therefore, an attempt has been made in this write-up to
explain the law and procedure of various aspects of withholding taxes from the
payments made to non-residents, in brief, in the simple format of questions and
answers.

1.0  Introduction

Section
195 of the income-tax act, 1961 (the “act”) contains the provisions to deduct
tax at source (worldwide it is popularly known as “Withholding  tax”) from any payment made to a
non-resident.

Section
195(1) provides that, “any person responsible for paying to a non-resident not
being a company, or to a foreign company, any interest (not being interest
referred to in section 194LB  or section
194LC) or section 194LD or any other sum chargeable under the provisions of the
act (not being income chargeable under the head “salaries”) 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. ….”

The
dissection of the above provision reveals that—

(i)  The obligation to deduct tax at source is
cast on every person making payment, be it individual, company, partnership
firm, government or a public sector bank etc. The term ’person’ as defined in
section 2(31) of the act is relevant here.

 (ii)  
The payee may be any type of entity (i.e. individual, company etc.).

(iii)  The payee must be a non-resident under the
act.

(iv)  The payment may be for interest other than
following types of interest:

(a)
Section 194LB – interest from infrastructure debt fund; or

(b)
Section  194LC   – 
interest  income  from 
Indian company before 1st July 2017;

(c)
Section 194LD – interest on certain bonds and government securities.

[In
all above types of interest payments the rate of TDS is 5 %.]

(v)   Payment of salaries is not covered by
section 195 of the act.

(vi)  Tax deduction has to be made at the time of
credit or payment of the sum to the non-resident, whichever is earlier.

(vii)
There is no threshold for deduction of tax at source. It therefore means
payment of even one rupee to a non-resident would attract TDS provisions.

In
the backdrop of above basic provisions, let us proceed to understand in detail
the law and procedure to comply with the provisions of withholding tax at
source u/s 195 of the act.

2.0   Questions and
answers

2.1     What kind of
payments to non-residents would attract withholding tax provisions under the
act? Is there any threshold exemption for deduction of tax at source?

Ans:  Section 195 casts an obligation on the person
who is making any payment to a non-resident to deduct tax at source. The
sweeping language of the section brings almost every payment, made to a
non-resident, which is chargeable to tax, within its ambit. The exclusions here
are in respect of payment of certain types of interest on borrowings (refer
para 1 herein above) and salaries. Section 192 of the act deals with TDS
provisions relating to salary paid to a non-resident, which is chargeable to
tax in India.

There
is no threshold exemption from obligation to deduct tax u/s 195. However, tax
is deductible only if income is chargeable to tax in the hands of  a non-resident and not otherwise.

The
crux of the provisions of section 195 is that the income in the hands of the
recipient must be chargeable to tax. Thus, 
if any income is exempt in the hands of the non-resident, the resident
making payment to such a non-resident need not deduct tax at source u/s 195.
(CBDT Circular no.  786 dated 7th
February, 2000 has clarified this issue).

The  hon’ble Supreme Court in the case of
Transmission Corporation of A.P. Ltd and Another vs. CIT (1999) 239 ITR 587
(SC) has held that the scheme of sub-sections (1), (2) and (3) of section 195
and section 197 leaves no doubt that the expression “any other sum chargeable
under the provisions of this act” would mean “sum” on which income-tax is
leviable. In other words, the said sum is chargeable to tax and could be
assessed to tax under the act. The consideration would be whether payment of
the sum to the non-resident is chargeable to tax under the provisions of the
act or not. That sum may be income or income hidden or otherwise embedded
therein. the  scheme of tax deduction at
source applies not only to the amount paid which wholly bears “income”
character such as salaries, dividend, interest on securities, etc., but also to
gross sums, the whole of which may not be income or profits of the recipient.”

in
this regard, it is important to note that in the subsequent decision in the
case of Ge India technology  (P) ltd (327
itr 456)(SC), the SC has dealt with the above aspect and other aspects relating
to section 195 in detail and has made important observations as follows:

 “7. ……. The most important expression in
section 195(1) consists of the words “chargeable under the provisions of the
act”. A person paying interest or any other sum to a non-resident is not liable
to deduct tax if such sum is not chargeable to tax under the income-tax act.
For instance, where there is no obligation on the part of the payer and no
right to receive the sum by the recipient and that the payment does not arise
out of any contract or obligation between the payer and the recipient but is
made voluntarily, such payments cannot be regarded  as 
income  under  the  income-tax
act. It may be noted that section 195 contemplates not  merely 
amounts,  the  whole 
of  which  are pure income payments, it also covers
composite payments which has 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 section 195(1), namely,
“chargeable under the provisions of the act”. It is for this reason that  vide 
Circular  no.   728 
dated  30-10-1995 that the CBDT
has clarified that the tax deductor can take into consideration the effect of
DTAA in respect of payment of royalties and technical fees while deducting
TAS….

….
While deciding the scope of section 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 section 195. hence, apart from section 9(1), sections 4, 5, 9, 90
and 91 as well as the provisions of DTAA are also relevant, while applying tax
deduction at source provisions. reference to ito(tdS) u/s. 195(2) or 195(3)
either by the non­ resident or by the resident payer is to avoid any future
hassles for both resident as well as non­ resident. in our view, section 195(2)
and 195(3) are safeguards. the  said
provisions are of practical importance. this 
reasoning of ours is based on the decision of this Court in transmission
Corpn. of A.P. ltd.’s  case (supra) in
which this Court has observed that the provision of section 195(2) is a
Safeguard. 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.”

8.
If the contention of the department that the moment there is remittance the
obligation to deduct TAS arises is to be accepted then we are obliterating the
words “chargeable under the provisions of the act” in section 195(1). The said expression
in section 195(1) shows that the remittance has got to be of a trading receipt,
the whole or part of which is liable to tax in India. 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. [See : Vijay Ship Breaking Corpn.
vs. CIT [2009] 314 ITR 309 (SC)].

Applicability  
of   the   judgment  
in   the   case  
of Transmission Corporation (supra)

10.
In transmission Corpn. of A.P. ltd.’s case (supra) ‘a non-resident had entered
into a composite contract with the resident party making the payments. The said
composite contract not only comprised supply of plant, machinery and equipment
in India, but also comprised the installation and commissioning of the same in
India. It was admitted that the erection and 
commissioning  of  plant 
and  machinery  in India gave rise to income-taxable in
India. it was, therefore, clear even to the payer that payments required to be
made by him to the non-resident included an element of income which was
exigible to tax in India. The only issue raised in that case was whetherTDS was
applicable only to pure income payments and not to composite payments which had
an element of income embedded or incorporated in them. The controversy before
us in this batch of cases is, therefore, quite different. In transmission
Corpn. of A.P. ltd.’s  case (supra) it
was held that TAS was liable to be deducted by the payer on the gross amount if
such payment included in it an amount which was exigible to tax in India. it
was held that if the payer wanted to deduct TAS 
not on the gross amount but on the lesser amount, on the footing that
only a portion of the payment made represented “income chargeable to tax in
India”, then it was necessary for him to make an application u/s. 195(2) of the
act to the ito(tdS) and obtain his permission for deducting TAS at lesser
amount. Thus,  it was held by this Court
that if the payer had a doubt as to the amount to be deducted as TAS he could
approach the ito(tdS) to compute the amount which was liable to be deducted at
source. In our view, 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. 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  Corpn. of A.P. ltd.’s  case (supra) which is put in italics has 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 “chargeable to tax in India”, then no TAS is required to be deducted from
such payment. This interpretation of the high Court completely loses sight of
the plain words of section 195(1) which in clear terms lays down that tax at
source is deductible only from “sums chargeable” under the provisions of the income-
tax act, i.e., chargeable under sections 4, 5 and 9 of the income-tax act.”

Thus,  there is no need to deduct tax at source in
respect of all incomes, which are exempt and/or not taxable under the act.

An
illustrative list of income under the act, which is exempt in the hands of
non-residents, is as follows:

(i)   Section 10(4) – interest on NRE account and
notified securities;

(ii)  Section 
10(6BB)  tax  paid 
on  behalf  of  the
non-resident by an Indian Company which is engaged in the business of operation
of aircraft;

(iii)
Section 10(6C) – income by way of royalty or fees arising to a foreign company
in respect of projects connected with security of India;

(iv)
Section  10(8a)  and 
(8B)  —  income 
of  a consultant/individual         out   
of   funds   made available to an international
organization under a technical assistance grant between the agency and the
government of a foreign State/ Government of India;

(v)
Section 10(15)(iv) etc. – income by way of interest and

(vi)
Section 10(15a) – any payment made by an Indian company engaged in the business
of operation of aircraft, to acquire aircraft or an aircraft engine on lease
from the Government of a foreign State or a foreign enterprise.

(vii)
amounts not liable to tax as per the provisions of the respective DTAAs.

Besides
the above income, if any other income of a non-resident is exempt from tax in
India, then there is no necessity to deduct tax at source by the payer.

2.2     Who has to
deduct tax at source u/s. 195 of the act?

Ans:  Section 195 casts an obligation on the person
who is making any payment to a non-resident to deduct tax at source. The only
condition is that the sum payable must be chargeable to tax in the hands of the
non-resident. The only exception is payment of salaries and specified interest
income.

2.3   Can a payer
obtain a “lower” or “nil” deduction certificate from the income tax
authorities? if yes, what is the procedure for the same?

Ans: yes, the
payer can make an application to the Assessing Officer to obtain a certificate
for “lower” or “nil” deduction of tax u/s. 195 (2) of the act. No particular
form has been prescribed for making an application and therefore, the payer can
apply on a plain paper or a letterhead giving all facts and supporting
documents justifying its claim for lower deduction or nil deduction of tax.

Alternatively,  the payer or the payee can make an
application for an advance ruling u/s. 245n of the act. The decision given by
the AAR would be binding on the applicant for the transaction for which the
ruling is sought and on the Commissioner and other income tax authorities
subordinate to him in respect of the applicant and the said transaction.

2.4   Can a payee
obtain a “lower” or “nil” deduction certificate from the income tax
authorities? if yes, what is the procedure for the same?

Ans:  a payee can apply to the AO for lower
deduction or NIL deduction certificates if the income received by him is either
not chargeable to tax or chargeable at the lower rate than what is prescribed
for withholding. Such an application can be made either u/s. 195 (3) or 197 of
the act.

Section
195(3) read with rule 29B provides for application by payee only in a case
where the income in the hands of the non-resident is not chargeable to tax in
Indian and therefore the payment is to be made without deduction of tax at
source i.e. nil tax. Whereas, the application is to be made u/s. 197 r.w. rule
28AA where the deduction is to be made at a lower rate or nil rate. Section197
covers provisions for application of certificate for lower or nil deduction for
host of other sections (e.g. from section 192 to 194 lBC)  along with section 195 of the Act.

Rule
28AA and rule 29B prescribes various conditions that a payee must fulfill in
order to be eligible to get a certificate.

2.5 At what rate tax is required to be deducted u/s. 195 of
the act?

2.5.1
income-tax act vs. double taxation avoidance agreement (DTAA)

Clause
(iii) of the section 2 (37A) of the Act specifies the rates in force for the
purposes of deduction of tax at source u/s. 195. Accordingly,  one has to apply the rate/s prescribed in the
finance  act of the relevant year or the
rates specified in a DTAA entered into by the Central Government, whichever  is 
applicable  by  virtue 
of  provisions of section 90 of
the act. In view of provisions of section 90(2) of the act, in case of a
remittance to a country with which a DTAA is in force, the tax should be
deducted at the rate provided in the finance 
act of the relevant year or at the rate provided in the DTAA, whichever
is more beneficial to the assessee. This position has been clarified by the
CBDT vide Circular no.  728, dated 30^th
October, 1995. However, the provisions of section 90(4) provide that the relief
or benefit from any agreements or DTAA shall be available to a non resident  assessee 
only  on  obtaining 
from  him, a certificate of his
being a resident in a country outside India (TRC), issued by the government of
that country or specified territory.

2.5.2
CBDT Circular no. 333 dated 2-4-1982

Even
before insertion of section 90(2) reproduced above by the finance  (no. 2) act, 1991, with retrospective effect
from 1-4-1972, the CBDT had clarified vide Circular No. 333 dated 2- 4-1982
that where a specific provision is made in the DTAA, the provisions of the DTAA
will prevail over the general provisions contained in the income-tax act and
where there is no specific provision in the DTAA, it is the basic law i.e. the
provisions of the income-tax act, that will govern the taxation of such income.

The
said circular has been accepted and explained by various judicial authorities.
Hence, if a particular payment to non-resident is subject to deduction of tax
at source under the act, but under the relevant DTAA the same is not chargeable
to tax or taxable at a lower rate in India, then such lower/nil rate shall be
applicable.

2.5.3
Levy of Surcharge and the education Cess

The
rates prescribed under the act are to be increased by the Surcharge @ 2 or 5
per cent for foreign companies (as the case may be) and @ 15 per cent for non-residents
other than a company [12% in case of a co-operative society or firm]. Also,
there will be a further levy of the education Cess (@ 3 per cent on the tax and
surcharge amount.

However,  wherever theTDS rate is applied as prescribed
under a DTAA, then the same would be final and the Surcharge and the Education
Cess would not be applicable. Since DTAAs are agreements between the two
sovereign States, the rate prescribed therein is the maximum rate (i.e. the
upper ceiling), regardless of subsequent imposition of surcharge or cess, etc.

In
CIT vs. Srinivasan (K.) [1972] 83 ITR 346 the Supreme Court held that
income-tax includes surcharge. Therefore, 
the term “income tax” as included in tax treaties include surcharge as
well.

In
the following decisions it has been held that in cases where DTAA benefit
applies,TDS cannot be made at a higher rate in terms of section 206AA of the
act:

—
[2015] Serum Institute of India Ltd (68 Sot 254) (ITAT  Pune)

—
[2015] Infosys BPO ltd (154 itd 816)(ITAT 
Bang)

—
[2016]  Wipro  ltd 
(ITA  Nos.   1544 to 1547/ Bang/2013)(ITAT  Bang)

—
[2016] Bharti Airtel Ltd (67 taxmann.com 223) (ITAT  del)

A
contrary decision was earlier rendered in the case of  [2012] 
Bosch  ltd.   (141 
ITD 38)(ITAT  Bang).

2.5.4    Specific Rates prescribed in certain
Sections of the act

2.5.4.1
Section 115A of the act

The
CBDT has, in the context of section 115A [which prescribes special rates of tax
on dividends, interest, income from mutual funds, royalty and fees for
technical services payable to a non-resident (not being a company) or a foreign
company] clarified vide Circular no. 740 dated 17th  April, 1996 that if the DTAA provides for a
lower rate of taxation, the same would be applicable.

2.5.4.2
Presumptive rates of taxes

The  ratio of the above Circular would equally
apply to other special provisions applicable to non-resident such as provisions
contained in sections 44B (Special provisions for computing profits and gains
of shipping business in case of non-residents), 44BBA (Special provisions for
computing profits and gains in connection with the business of operation of
aircraft in case of non-residents), 44BBB (Special provisions for computing
profits and gains of foreign companies engaged 
in  the  business 
of  civil  construction, etc., in certain turnkey power
projects), etc.

Section
44BB prescribes a presumptive rate of 10% in respect of profits and gains in
connection with the business of exploration etc., of mineral oils.
However,  such presumptive rate would not
be applicable, if such income is otherwise covered by section 44D (i.e. Payment
of royalty and FTS  prior to 1-04-2003)
or section 115A (Payment of interest, dividends, royalties or FTS ). [ABC, in
re 234 ITR 37 (AAR)].

Following
the ratio of SC decision in the case of GE India Technology Centre (P.)
Ltd.  (supra), the ITAT  in the case of Frontier Offshore Exploration
(India)  Ltd.  vs. 
DCIT  [2011]  10 
taxmann.com 250 (Chennai) relating to payment to a non­ resident engaged
in the business of prospecting / exploration etc. of mineral oil, covered u/s
44BB of the act, held that obligation to deductTDS is limited to the
appropriate portion of income chargeable to tax.

2.5.4.3 Section 206AA of the act

This
section provides for furnishing of Permanent account number (Pan)  by any person who is entitled to receive any
sum/ income/amount on which tax is to be deducted under Chapter XVII-B  of the income tax act (includes section 195)
to the person responsible for deducting such tax, failing which tax shall be
deducted at higher of any of the following rates;

a)  The rate specified in the relevant provision
of the act,

b)  The rate or rates in force,

c)  The rate of twenty Five Percent.

However,
CBDT has notified a new Rule 37BC in the Income Tax Rules, 1962 vide
Notification no. 53/2016 dated 24th June, 
2016 providing a relaxation from deduction of tax at a higher rate u/s.
206AA in respect of certain payments. The provisions of section 206AA shall not
apply in cases where the deductee does not have a Pan and the payment made to him
is in the nature of interest, royalty, fees for technical services or payments
on transfer of any capital asset and the deductee furnishes the following
details and documents to the deductor:

(i)  Name, E-mail id, contact number;

(ii)
Address  in  the  country  or 
specified  territory outside India
of which the deductee is a resident;

(iii)
A certificate of his being resident in any country or specified territory
outside India from the Government of that country or specified territory if the
law of that country or specified territory provides for issuance of such
certificate;

(iv)
Tax Identification Number of the deductee in the country or specified territory
of his residence and in case no such number is available, then a unique number
on the basis of which the deductee is identified by the Government of that
country or the specified territory of which he claims to be a resident.

2.5.5   No TDS from
payments to foreign shipping companies or agents

The  CBDT, vide Circular no. 723 dated 19th September,
1995 had clarified that there would be no overlapping of section 172 which
provides for recovery of tax from foreign shipping companies and section 194C
& section 195, where payments are made to shipping agents of non-resident
ship owners or charterers of carriage of passengers, etc. shipped at a port in
India. The agent acts on behalf of the non­ resident ship owner or charterers
and therefore he steps into shoes of the principal and accordingly, the
provisions of section 172 shall apply and those of section 194C & 195 will
not apply. Therefore,  a resident making
payment of freight to the foreign shipping companies or their agents will not
be required to deduct TDS u/s. 195 or 194C.

2.6 What is the procedure of claiming tax treaty
benefit  while  remitting 
sum  u/s.  195  of
the act?

Ans:   Sections 90(4) and 90(5) were inserted by
the Finance Act  2012  and 
2013  respectively  to provide that any non-resident assessee who
seeks to obtain the benefit of the relevant DTAA applicable, shall avail so
only if he presents a Tax Residency Certificate (TRC) of the country of which
he is a resident for tax purposes as well 
as  any  other 
prescribed  particulars  as may be notified. Further, by Notification
No. 39/ f.no.142 /13/2012, rule 21AB was inserted which prescribes the
necessary particulars to be submitted along with the TRC u/s. 90(5) for  claiming 
treaty  benefits.  This 
includes  a self declaration by
the assessee in form 10F and it shall contain the Status, nationality, tax
Identification Number of the assessee in the country of which he claims to be a
resident, address of the assessee in that country and the period of residential
status of the assessee as mentioned in the TRC. however,  the Non­ resident shall not be required to
submit form 10F   if  the 
TRC already  contains  all 
such information as specified in form 10F.

2.7 What is the procedure to comply with the provisions of
WHT u/s. 195 of the act?

Section
195(6) of the income-tax act, 1961 provides that a person responsible for paying
any sum to a non-resident shall furnish such information as may be prescribed
under rule 37BB. The said rule 37BB provides that form no. 15CA and/or
form  no. 15CB shall be furnished for the
purpose of payment to a non-resident. Form No. 15CA is to be filed and
submitted online by  the  deductor 
i.e.  payer  and 
form 15CB is to be issued by the practicing Chartered accountant (C.A).
However, form 15CA is required to be filed only when the transaction falls
under reportable category irrespective of chargeability of tax. Form 15CA
contains four parts, A, B, C and D. When a transaction does fall into
reportable category and amount chargeable to tax does not exceed Rs. five lakh,
then part A of the form needs to be filed. But if it is taxable, one needs to
check the amount of the transaction.

If
the  transaction  value 
(payment  to  non­ resident) exceeds Rs. 5 lakh,

(a)
Part B of Form No.15CA needs to be filed after obtaining,­

(i)  A 
certificate  from  the 
Assessing  Officer u/s. 197; or

(ii)
An order from the Assessing Officer under sub-section (2) or sub-section (3) of
section 195;

Or

(b)
Part  C 
of  form   no.15CA 
after  obtaining  a certificate in Form No. 15CB from a
Chartered accountant.

Whereas,
if the transaction is below Rs. 5 lakh, only Part A of form 15CA needs to be
filed. The limit of Rs. 5 lakh is, however, not a threshold limit for
chargeability of tax or deduction of tax at source. In other words, even if
there is an exemption from submission of form 
15CB, the payer needs to deduct tax at source and deposit it with the
Government.

2.8 What are the consequences of failure to deduct tax at
source u/s. 195 of the act?

Ans:  There  
are severe consequences  for  failure 
to deduct tax at source while making payment to a non-resident. Besides
attracting levy of interest and penalty, such payments will not be allowed as
deduction in the hands of the payer while computing the profits and gains from
business and profession under the act [refer provisions of section 40(a)(i)].
Moreover, the payer may be regarded as an ‘agent’ of the non-resident u/s.163
of the act and the tax may be recovered from him. Thus,  one needs to be extremely careful in applying
provisions of the act for deduction of tax at source, from payments made to
non-residents.

Looking
at the serious repercussions of non- deduction of tax at source as a payer one
must always take a conservative view and deduct tax at source.

3.0 Some typical payments to non-residents which attracts
TDS provisions

In
following table some typical payments which are of practical importance are
covered. The idea is to give a bird’s eye view only and not a detailed or
reasoned analysis of provisions or taxability.

4.0 Conclusion

The
subject of withholding tax from payments to non­ resident is faced with many challenges.
The Government’s intention is to protect the tax base of India and collect
revenue from the non-residents at source as it is difficult to catch them once
they are gone or money is transferred to them. As a payer one has to take
conservative view and deduct tax at source as far as possible. Failure to do so
may not only make him an assessee in default, but could also make him a
representative assessee u/s. 164 of the act and the tax may be recovered from
him. Other penal provisions may also follow. Therefore,  it is always advisable to obtain a lower
deduction certificate from the Assessing Officer or go for an advance ruling.