Nitin Mohan Kashyap and Sharad Goyal 23 December 2009

1. Tax deduction at source under section 195 Nitin Mohan Kashyap and Sharad Goyal 23 December 2009

2. Contents General overview Discussion on section 195 Issues

3. General Overview

4. Statutory obligation on payer Deducting tax at source is mandatory TDS does not substitute the obligation of receiver of income to file return and pay taxes If TDS not done, receiver is finally liable Tax free income to be grossed-up for TDS purposes [Section 195A] Tax deducted is income received [Section 198]

5. Consequences of default Payer is deemed to be ‘assessee-in-default’ [Section 201(1) & 220] Receiver’s tax becomes payer’s tax Payer not to get deduction for expense [Section 40(a)] Interest @ 1% per month [Section 201(1A)] Penalty up to 100% up to tax in arrear [Section 221] Penalty up to 100% up to tax in arrear [Section 271C] Imprisonment for failure to deposit TDS amount (3 months to 7 years) and fine [Section 276B] Madhumilan Syntex Ltd. & Ors. Vs. UOI 2007-TIOL-44-SC-IT (SC)

6. TDS provisions applicable to non-residents Provisions dealing with non-residents only:

7. TDS provisions applicable to non-residents Following provisions also apply to non-residents:

8. Section 195

9. Scope of section 195 Any person responsible for paying Non-resident/foreign company Any interest/any other sum chargeable under the Act At the time of payment or credit, whichever is earlier At the rate in force

10. Scope of section 195 Omnibus and general in nature Does not apply to salary payments Any person making a payment is covered Individual and HUF also covered Literally read, even a non-resident making payment is also covered Recipient should be a foreign company or a non-resident

11. Scope of section 195 Residential status of non-resident is determined as per tests outlined in section 6 Non-resident definition in section 2(30) includes “Not Ordinarily Residents” in some cases Generally, payments to “Not Ordinarily Residents” is outside the purview of section 195 Payment to a resident agent of non-resident is covered Twin conditions for attracting section 195 For payer - credit or payment of income For payee - sum chargeable to tax in India In particular situation, there could be a disconnect between the two

12. Scope of section 195 Section 195 applies if sum chargeable to tax in India Section 5 Total income of a non-resident includes all income from whatever source which - is received or deemed to be received in India; and accrues or arise or deemed to accrue or arise in India Section 9 Defines incomes which are deemed to accrue or arise in India Includes income accruing through business connection, any property/any asset/source of income in India or through the transfer of a capital asset situated in India [Section 9(1)(i)] Dividend paid by Indian company outside India [Section 9(1)(iv)] Interest [Section 9(1)(v)] Royalty [Section 9(1)(vi)] Fees for technical services [Section 9(1)(vii)]

13. Scope of section 195 Treaty provisions, if beneficial may be invoked [Section 90(2)] Tax treaty Agreement entered between two countries with respect to taxes on income and on capital, wherein the countries agree to: avoid double taxation provide relief for taxes paid in the other treaty country Treaty provisions may be beneficial in many ways Rate of tax may be lower Definition may be narrower Exemption may be built in

14. Person responsible for paying Payer himself is the person responsible If payer is a company, the company itself including the principal officer thereof Consideration for transfer of foreign exchange assets (other than short term capital asset) – authorised dealer

15. Time of deduction Payment or credit, whichever is earlier Credit to suspense account or any other account by whatever name called - covered Explanation may not apply even when no income accrues to non-resident although accounting entry incorporating a liability is passed ACIT vs. Motor Industries Co. (2001) 249 ITR 141 (Kar. HC) Karnataka Power Transmission Corpn. Ltd. vs. DCIT 2009-TIOL-739-ITAT-BANG

16. Quantum of deduction At rate in force as defined in section 2(37A) Finance Act or tax treaty Finance Act [Part II of the First Schedule], e.g. Winnings from lotteries, horse races, etc. - 30% Interest - 20% Any other income – 30%/40% Further increased by surcharge and education cess Treaty Some Articles specify the rate at which income is taxable, e.g. Dividends Interest Royalty/FTS Generally, treaty prescribes maximum rate of tax

17. Quantum of deduction Beneficial rate under treaty may be applied Circular No. 728 dated 30.10.1995 Rate of exchange for the purpose of TDS on income payable in foreign exchange - TT buying rate of SBI of the date on which tax is required to be deducted [Rule 26] It is not open to the parties to contract out of statutory obligation If payer agrees to remit sum without deduction of tax, it would be reasonable to construe that payer has undertaken to pay tax thereon Tax has to be grossed-up Section 195A CIT vs. Barium Chemicals Ltd. (1989) 175 ITR 243 (AP HC)

18. Time and mode of payment Time of payment of deducted tax - 7 days from the end of month of deduction [Rule 30] Quarterly payment - possible [Proviso to rule 30(1)] Sum is credited on last day of accounting year - within 2 months TDS return - Quarterly in Form 27Q [Rule 37A] Timeline for issue of TDS certificate in Form 16A - 1 month from the end of the month of deduction Consolidated certificate - possible TDS certificate to be issued even if tax is borne by payer Circular No. 785 dated 24.11.1999

19. Other points No deduction of tax if income does not involve credit or payment, e.g. Transfer pricing adjustments Assessment of income under section 93 Payee cannot furnish declaration in Form 15G/15H for non-deduction of tax at source TDS on cash basis when interest is paid by Government, public sector bank or public financial institution [Proviso to section 195(1)] Exemption from withholding on dividend referred in section 115-O

20. Lower or Nil deduction Application by payer under section 195(2) Application by payee under section 195(3) Application by payee under section 197

21. Lower or Nil deduction On the basis of Chartered Accountant’s certificate Chartered Accountant in his certificate can either certify Nil rate Rate applicable as per Act or treaty Chartered Accountant cannot certify reduced rate of TDS Chartered Accountant’s certificate is not an alternative to section 195(2) Remitter continuous to remain liable for non-deduction or short deduction

22. Lower or Nil deduction No statutory form for application under section 195(2) Order under section 195(2) appealable Amendment to section 248 by Finance Act, 2007 - order when appealable Order under section 195(2) can be revised under section 263 Board of Control for Cricket in India vs. DIT (2005) 96 ITD 263 (Mum. ITAT) Whether application under section 195(2) be made for Nil withholding certificate? Samsung Electronics Co. Ltd. (2009) 185 Taxman 313 (Kar. HC)

23. Lower or Nil deduction Onerous conditions for application under section 195(3) Applicant has filed returns and regularly assessed for all past applicable years He is not in default for tax, advance tax or self assessment tax, interest, penalty, fine or any other sum He is not subject to penalty for concealment of income Non-banking applicants - additional conditions Continuously in business in India for 5 years Value of fixed assets as at the end of preceding previous year > Rs. 50 Lac

24. Issues

25. 1. Time of determination of residential status Residential status crystallizes at year end Section 195 does not refer to status in preceding year On going payments in the interregnum - how to decide residential status?

26. 2. Whole of the income is not taxable Section 195(1): Deduction at the rate in force on the income chargeable under the Act Section 195(2): Where the payer considers that whole of the income is not chargeable to tax Make an application with the Assessing Officer (AO) AO will determine the appropriate proportion of income chargeable to tax AO’s order for a specific period of time Section 197: Such an application (in the prescribed form) can also be made by the payee Transmission Corporation of A.P. Ltd. (1999) 239 ITR 587 (SC)

27. 2. Whole of the income is not taxable Should there still be any withholding? Unfavourable ruling Samsung Electronics Co. Ltd. (2009) 185 Taxman 313 (Kar. HC) Van Oord ACZ India (P) Ltd. 2008-TIOL-60-ITAT-DEL (ITAT Delhi) Favourable rulings Modicon Network Private Limited 14 SOT 204 (ITAT Delhi) ITAT held that reimbursement of expenses cannot be considered as having an income element imbedded therein so as to attract section 195(1) Millennium Infocom Technologies Ltd 21 SOT 152 (ITAT Delhi) “…the payments made on account of rentals for hosting of websites on servers were not in nature of interest or royalties or fee for technical services or other sum chargeable to tax in India. The Central Board of Direct Taxes had revised the procedure for deduction of tax at source on remittances made out of the country. The provisions of DTAA were also in favour of the assessee. Accordingly, the assessee was not required to deduct tax at source under section 195 while making payments outside India. Therefore, the appeal was to be allowed.”

28. 3. Can payer decide the taxability of income? If the payer is not to decide the taxability in the hands of the non-resident recipients, how will he decide the applicable rate of deduction? Section 195 does not prescribe any rate for deduction Should the assessee every time approach the AO for determination of applicable rate? Circular No. 10/2002 dated 09.10.2002 CBDT recognised the fact that deduction under section 195 may be at Nil or lower rate and the payer himself can decide the applicable rate of deduction The Paper Products Ltd. (2002) 257 ITR 1 (Delhi HC)

29. 3. Can payer decide the taxability of income? Unfavorable ruling Samsung Electronics Co. Ltd. (2009) 185 Taxman 313 (Kar. HC) Favourable rulings The Paper Products Ltd. (2002) 257 ITR 1 (Del. HC) Jindal Thermal Power Company Ltd. 2009-TIOL-302-HC-KAR-IT (Kar. HC) Eli Lilly & Co. (India) Pvt. Ltd. (2009) 178 Taxman 505 (SC)

30. 4. Payment by non-resident to non-resident Does the Income-tax Act has extra territorial jurisdiction? P. No. 13 of 1995 (1997) 228 ITR 487 (AAR) Vodafone International Holding B.V. 2008-TIOL-602-HC-MUM-IT (Bom. HC) "The very purpose of entering into agreements between the two foreigners is to acquire the controlling interest which one foreign company held in the Indian company, by other foreign company. This being the dominant purpose of the transaction, the transaction would certainly be subject to municipal laws of India, including the Indian Income Tax Act.” Electronic Corporation of India Limited (2009) 183 ITR 43 (SC)

31. 5. Refund of excess withholding There is no provision under section 195 for refund/adjustment of excess tax or tax erroneously deducted Any claim for excess or erroneous deduction can be made by filing a return of income by the non-resident company CBDT Circular No. 7/2007 dated 23.10.2007 Supersedes all other earlier circulars Lays down the procedure for refund of tax deducted at source to the deductor Prior approval of the Chief Commissioner Income-tax or the Director General of Income-tax No interest under section 244A is admissible Deductor to provide an undertaking to the ITO that no certificate u/s 203 of the Act had been issued to the non-resident

32. 5. Refund of excess withholding CBDT Circular No. 7/2007 dated 23.10.2007 First adjust against any existing tax liability of deductor under the Income-tax Act, 1961, Wealth tax Act, 1957 or any other direct tax law. The balance amount, if any, may be refunded to the person responsible for the deduction Refund only if the deductee has not filed return of income and the time of filing the return has expired AO to ensure that the deductor does not claim the corresponding transaction amount as an expense in the return of income Claim for refund should be made within two years from the end of the financial year in which tax is deducted Where certificate u/s 203 had been issued to the non-resident: - the person making the refund claim should either obtain it back; or - indemnify the Income tax Department from any possible loss on account of any separate claim of refund for the same amount by the non-resident

33. 5. Refund of excess withholding CBDT Circular No. 7/2007 dated 23.10.2007: Circumstances Contract is cancelled, no remittance made to the non-resident Contract cancelled, but remittance made: Remitted amount returned to the deductor Contract cancelled after partial execution, no remittance made to non-resident for non-executed part Contract cancelled after partial execution, remittance related to non-executed part made to the non-resident: Remitted amount has been returned to the deductor or no remittance made but tax was deducted and deposited There occurs exemption of the remitted amount from tax either by amendment in law or by notification under the Act. An order is passed u/s 154/248/264 reducing withholding liability of deductor Deduction of tax made twice from the same income by mistake Payment of tax on account of grossing up which was not required Payment of tax at a higher rate while a lower rate is prescribed in DTAA

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35. Transmission Corporation of A.P. (SC) 239 ITR 387 The Apex Court while discussing the scheme of sections 195 and 197 observed as under: "The scheme of sub-sections (1), (2) and (3) of section 195 and 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. If so, tax is required to be deducted on the said sum, what would be the income is to be computed on the basis of various provisions of the Act including provisions for computation of the business income, if the payment is a trade receipt.” "The purpose of sub-section (1) of section 195 is to see that the sum which is chargeable under section 4 of the Act for levy and collection of income-tax, the payer should deduct income-tax thereon at the rates in force, if the amount is to be paid to a non-resident. The said provision is for tentative deduction of income-tax thereon subject to regular assessment and by the deduction of income-tax, the rights of the parties are not in any manner, adversely effected."

36. Samsung Electronics Co. Ltd. (2009) 185 Taxman 313 (Kar. HC) Karnataka High Court held that Section 195(1) is not a charging section nor a section providing for determination of tax liability of non-resident who is in receipt of payments from a resident Amount deducted u/s 195 is not the same as determining the liability of non-resident for payment of tax under the Act The only scope and manner of reducing the obligation for deduction imposed on a resident payer u/s 195(1) is by invoking the procedure contemplated under sub-section 2 of section 195 Resident payer who has not filed an application under sub-section 2 of section 195 cannot, later, after having failed to deduct contend that no part of payment had resulted in any taxable income in the hands of non-resident recipient and the demand raised in terms of section 201 is not sustainable

37. Motor Industries Co. (2001) 249 ITR 141 (Kar. HC) The resident assessee-company was carrying on its business in collaboration with a non-resident company with which it had a collaboration agreement valid till 31-12-1985 On 10.12.1985, the Government of India granted approval for renewal of the agreement, but the foreign company was not satisfied with it for various reasons Finally, after the Government order dated 12.12.1988, the agreement was formalized and signed on 15.02.1989 with retrospective effect from 01.01.1986 for a period of six years In the meanwhile, the foreign collaborator did not discontinue or snap its ties with the assessee-company but continued its service uninterruptedly On its part, the assessee-company went on crediting the amount payable to it to a suspense account As the assessee did not deduct tax at source as per section 195(1), it was deemed as an assessee-in-default under section 201(1) 1/2

38. Motor Industries Co. (2001) 249 ITR 141 (Kar. HC) Held “The liability under section 195 would begin to operate only with effect from the date when the collaboration agreement was concluded and not earlier. This was so because the foreign collaborator would get a right to enforce its right to receive payment only on conclusion of the collaboration agreement. Therefore, the determination made by the revenue under section 201(1) for the two assessment years, i.e., 1987-88 and 1988-89, was wrong as, by then, the assessee had no liability under section 195 to pay any money to its collaborator. The mere fact that the assessee was crediting a certain amount to the credit of suspense account would not alter this situation in any way.” 2/2

39. Karnataka Power Transmission Corpn. Ltd. 2009-TIOL-739-ITAT-BANG Section 194A Assessee engaged in the business of power purchase Survey conducted to verify the compliance regarding TDS provisions AO finds that Assessee had made provisions for interest on belated payments from power suppliers without deducting tax at source Assessee contended that amounts accounted in earlier year was reversed in subsequent year AO invoked provisions u/s 194A(A) & 201(1) and held the assessee as assessee in default CIT(A) upheld AO's order ITAT held that since the assessee has failed to prove that the tax has been paid by the payee on the sum paid, the CIT(A) order is sustainable Assessee's appeal dismissed

40. Barium Chemicals Ltd. (1989) 175 ITR 243 (AP HC) Held “It was true that under the agreement there were no express words to the effect that the assessee had undertaken the liability to deduct the tax on the income earned by the foreign company in India. But the said words must be deemed to be implicit in the agreement for the reason that section 195 casts a statutory obligation upon every person in the country to deduct tax at the prevailing rates from out of any sum which is remitted to a foreign company. It was not open to the parties to contract out of this statutory obligation….” “When the assessee agreed to remit a particular amount without any deduction for taxes or otherwise, it would be reasonable to construe that the assessee had undertaken to pay taxes thereon by itself.”

41. Van Oord ACZ India (P) Ltd (ITAT Delhi) 2008-TIOL-60-ITAT-DEL Delhi ITAT held that: Neither it is the duty nor it is desirable from the payer/assessee to examine whether any tax is deductible at source from the payments made to the non-resident. It is not for the assessee/payer to decide the taxability of payments made by it in the hands of non-resident recipient as the machinery for this purpose was provided in section 195(2) itself, whereby the concerned AO could have been approached to decide this aspect. The chargeability of income in the hands of recipient non-resident to be taxed in India is a separate issue and in the absence of any certificate obtained from the concerned AO u/s 195(2), it was obligatory on the part of the assessee to deduct tax at source from the payments made to the concerned non-resident.

42. CBDT Circular No. 10/2002 dated 09.10.2002 “….it has recently been observed that often the certificates have been issued prescribing NIL deduction of tax at source in certain cases where tax was liable to be deducted or prescribing deduction of tax at a lower rate than was payable on the basis of the provisions of the Act and the applicable DTAC. The certificate does not provide for necessary details or the reasons for adopting a certain rate for deduction of tax. This results in unnecessary calling of information from the assessees at a later stage and thus gives rise to an avoidable perception of grievance on the part of the tax-payer. Therefore, in order to streamline the procedure as well as to ensure the correct deduction of tax at source, the proforma of the undertaking to be given by the remitter and the certificate to be issued by a chartered accountant have been re-considered and new formats are being prescribed….”

43. Electronic Corporation of India Limited (SC) 183 ITR 43 “But the question is whether a nexus with something in India is necessary. It seems to us that, unless such nexus exists, Parliament will have no competence to make the law. It will be noted that article 245(1) empowers Parliament to enact laws for the whole or any part of the territory of India. The provocation for the law must be found within India itself. Such a law may have extra-territorial operation in order to subserve the object and that object must be related to something in India. It is inconceivable that a law should be made by Parliament in India which has no relationship with anything in India. The only question then is whether the ingredients, in terms of the impugned provision, indicate a nexus. The question is one of substantial importance, specially as it concerns collaboration agreements with foreign companies and other such arrangements for the better development of industry and commerce in India. In view of the great public importance of the question, we think it desirable to refer these cases to a Constitution Bench, and we do so order.”

44. The Paper Products Ltd. (2002) 257 ITR 1 (Del. HC) Delhi High Court held that: “6. Admittedly, the Italians, who had been paid fee for technical services, stayed in India for less than 90 days. The Commissioner (Appeals) held that the amount of remittance of US $ 50,000 was not subject to tax in India and as such, no tax at source was required to be deducted by the assessee. The view which had been taken by the Commissioner (Appeals) had been affirmed by the Tribunal by a well-reasoned order.” “7. The Tribunal correctly observed…. M/s. Rotomac SPA, cannot be held to have a permanent establishment and since the period of stay of their technicians in India was not more than three months in each of the two years and that in view of provisions of article 15 read with article 5(2)(h), the said company was not liable to pay tax in India and the assessee was not liable to deduct tax under section 195(2) on the amounts remitted by it to the foreign company…..” “8. In our considered opinion, no interference is called for. The appeal is dismissed.”

45. Jindal Thermal Power Company Ltd. 2009-TIOL-302-HC-KAR-IT Jindal was issued notice calling up to pay tax in respect of remuneration paid to non-resident Jindal pleaded before the AO that payments made to non-resident does not attract tax liability as such there was no duty on part of Jindal to effect TDS AO rejected the contention and directed Jindal to make payment of tax on account of non-resident Jindal preferred appeal before CIT(A), ITAT and then to the High Court AO challenged the right of Jindal to file appeal contending that it is the non-resident who has the right in law to challenge the order as an assessee, Jindal was only to effect TDS Court held that - If TDS is not effected by payer, the payer would be ultimately responsible to pay tax liability of payee - Conjoint reading of section 195, 201 read with section 246(1)(i) and 248 makes it clear that Jindal as a payee has every right to question tax liability of its payee to avoid the vicarious consequences

46. Eli Lilly & Co. (India) Pvt. Ltd. (2009) 178 Taxman 505 (SC) “36. For the reasons stated hereinabove, the TDS provisions in Chapter XVII-B relating to payment of income chargeable under the head ‘Salaries’ which are in the nature of machinery provisions to enable collection and recovery of tax, form an integrated code with the charging and computation provisions under the Act, which determines the assessability/taxability of ‘salaries’ in the hands of the employee-assessee. Consequently, section 192(1) has to be read with section 9(1)(ii), read with the Explanation thereto. Therefore, if any payment of income chargeable under the head ‘Salaries’ falls within section 9(1)(ii), then TDS provisions would stand attracted…..” Section 192(1) of the Act “(1) Any person responsible for paying any income chargeable under the head “Salaries” shall, at the time of payment, deduct income-tax on the amount payable at the average rate of income-tax computed on the basis of the rates in force for the financial year in which the payment is made, on the estimated income of the assessee under this head for that financial year.”