CA CHANDRA PRAKASH HASSANI (CA) (33 Points)
13 February 2010Whether payment to Non Resident Company for professional services rendered in India attracts to TDS u/s 195, the deductee is not having a PE in India as per Artcle 5 of DTAA between India & USA and are the tax residet of USA. Please clear me whether to deduct TDS as per Article 12 of DTAA between India & USA @ 20% plus surcharge 2.5% or not to deduct TDS as they are the TAX RESIDENTS of USA
Ratan Deep Saxena
(Asstt Manager (Accounts & Finance))
(2998 Points)
Replied 13 February 2010
Recently a Karnataka High Court judgment[1] ruled that an assessee is liable to deduct tax at source on ‘sums’ chargeable to income tax under Section 195 (1) of the Income Tax Act, 1961, (the ‘Act’) the moment the resident payer makes a payment to a non-resident resulting in some possible income in the hands of the non-resident recipient. The Karnataka HC relied on a Supreme Court judgment in Transmission Corporation of A.P. Ltd & Anr. v. Commissioner of Income Tax[2], wherein the honourable SC while interpreting Section 195 of the Act, held that if the assessee or the non-resident recipient had not applied to the AO under Section 195 (2) & (3) for its opinion on as to whether the whole ‘income’ in the form of ‘sums’ chargeable is liable to a TDS deduction or only that portion of such ‘sums’ that fall under ‘income’ is eligiblefor TDS deduction, then, it is the statutory obligation of the assessee under Section 195 (1) to deduct TDS on such ‘sums’ chargeable to income tax.
This article takes a critical look at the above judgment of the Karnataka HC in the light of what was pronounced by the honourable SC inTransmission Corporation case. First part of the article will discuss the cases in point and the relevant issue/s involved. Second part will critically analyze the Karnataka HC judgment in the light of the SC’s judgment in Transmission Corporation. Third part will conclude by discussing the repercussions of such a judicial pronouncement.
Part II
In the case under consideration, the division bench of Karnataka HC has held that persons making payment for purchase of software from non-resident vendors are legally obliged to withhold tax from such payments irrespective of the fact that the recipient is/is not obliged to pay tax in India.
Facts:
The assessee, Samsung Electronics Co. Ltd., India, a branch of Samsung Electronics Company Limited, Korea, was engaged in the development, manufacture and export of software for use by its parent company. During the relevant assessment years, assessee made certain payments to non-resident companies towards purchase of ‘shrink-wrapped’ (ready to sell) software without deduction of tax at source under section under section 195(1) of the Act.
For non-deduction of withholding tax, assessee contended that the purchased software, being shrink-wrapped software, is readily available in the market. Hence, payment made to the non-resident companies is a mere payment towards purchase of “good”, which is excluded from withholding tax under the provisions of Double Taxation Avoidance Agreement (DTAA) between India and the concerned countries in the absence of Permanent Establishment of the non-resident recipients in India. While rejecting assessee’s contention, Assessing Officer (AO) held that the payments were chargeable to tax in the hands of the foreign company as ‘royalty’, under section 9(1)(vi), paid towards getting a licence to use the software and not mere payment towards purchase of a good. Therefore, AO declared assessee liable under section 201 for non-deduction of tax and interest thereon. On appeal, the Commissioner of Appeals affirmed the view taken by AO, however, the Tribunal held that the payments for software, being a purchase of a “copyrighted article’’ and “goods” as held by in Tata Consultancy Services v. State of A.P.[4], were not liable to be taxed in India. Consequently, there was no obligation on the assessee to deduct tax at source under section 195 (1).
The Issues:
On appeal by the tax authorities against the order of the Tribunal, the High Court dealt, inter alia, with the following issues:
1. Whether the Tribunal was correct in holding that the payments made by the assessee for purchase of software from non-resident vendors was not liable to income tax in India and consequently, no TDS needs to have been deducted?
2. Whether the Tribunal was correct in holding that the assessee is not liable to deduct TDS in respect of payments made for purchase of software as the same cannot be treated as income liable to tax in India?
The Judgment:
The High Court, while reversing the findings of the Tribunal, held that the person making payment to non-resident is under obligation to deduct tax at source under section 195(1) unless such person makes application to AO under section 195(2) for the determination of that portion of the entire sum paid, which is chargeable under the provisions of Income Tax Act as ‘income’. The High Court observed that section 195 of the Act is not at all a provision wherein the AO is required to indulge in an exercise of determination of the income of a non-resident and that can be done only on a review of return of income filed by the non-resident and, therefore, the Tribunal erred in law in examining the question of the actual tax liability of a non-resident recipient as there was no scope for it to embark on an exercise for determination of the tax liability of the non-resident recipient, in a proceeding under Section 195 of the Act.
The Hon’ble Bench opined that if AO is allowed to examine the tax liability of the non-resident recipient, prematurely under section 195, there may arise different versions of the tax liability of the non-resident recipient as the revenue authorities might take a different view on the basis of the return of income filed later by the non-resident assessee. The bench, however, did not venture into the question whether purchase of software amounted to royalty payment or not.
For coming to the aforesaid conclusions, the High Court placed a strong reliance upon the above judgment delivered by the Supreme Court, where a division bench of the Supreme Court was considering the liability of Andhra Pradesh State Electricity Board (APSEB) to deduct tax at source from the payments made to non-residents against the purchase of machinery and equipment and also against the work executed by the non-residents in India of erecting and commissioning the machinery and equipment. On an analysis of the scheme of collection and recovery of tax under the Act, the Supreme Court made some relevant observations:
1. 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;
2. The scheme of tax deduction at source applies not only to the amount paid which wholly bears “income” character such as salaries, dividends, interest of securities etc., but also to gross sums, the whole of which may not be income or profits of the recipient;
3. 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 payee should deduct income tax thereon at the rates in force, if the amount is to be paid to a nonresident. The said provision is for tentative deduction of income-tax thereon subject to regular assessment and by the deduction of income-tax, rights of the parties are not, in any manner, adversely affected;
4. The rights of payee or recipient are fully safeguarded under sections 195(2), 195(3) and 197. Only thing which is required to be done by them is to file an application for determination by the AO that such sum would not be chargeable to tax in the case of recipient, or for determination of appropriate proportion of such sum so chargeable, or for grant of certificate authorising recipient to receive the amount without deduction of tax, or deduction of income-tax at any lower rates or no deduction. On such determination, tax at appropriate rate could be deducted at the source. 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;
5. The obligation of the respondent-assessee to deduct tax under section 195 is limited only to appropriate proportion of income chargeable under the Act.
In view of the above, the Court held that APSEB was under statutory obligation to deduct tax under section 195 of the Act in respect of the sums paid under the contracts entered into with non-resident companies.
The above two judgments clearly are on different points, the Karnataka HC pronounced its judgment on an issue where the whole component of the ‘sum’ payable to the non-resident comprised of ‘income’, there was no mixed payments – wherein a part of it may be attributed to count as an ‘income’ chargeable under Section 195 read with Section 9 (1) (vi) as a royalty payment and other part may be a ‘trading receipt’. However, the honourable SC in Transmission Corporation case was concerned with a situation wherein a mixed payment was made by the assessee – partly a payment for the machinery & equipment imported from foreign countries and partly it involved a payment against the some of the work executed by the non-residents in India. Therefore, the SC was dealing with case involving the issue of apportionment of such ‘sums’ that required the assessee to invoke Section 195 (2) & (3).
What Karnataka HC seemed to have done was that it totally relied on the SC’s decision in Transmission Corporation case assuming that the interpretation put by the Honourable SC on Section 195 of the Act is the law of the land and they are ought to follow the same. But it failed to appreciate the fact that interpretation as put forth by the SC was in a different factual situation that involved more going in to the question of interpreting Section 195 partially. We would say partially because even in Transmission Corporation the SC did not go into the question of deciding as to – whether in the first instance the said ‘payments’/’sums’ fall in to the category of ‘income’ (other than salaries) to make the same exigible to income tax or to deduct TDS on that ‘income’? This is the primary question that would need to be decided first under Section 195 (1) of the Act. To decide – whether any ‘sums’ paid by a resident to a non-resident (not falling under the head ‘salaries’) is chargeable under the provisions of the Act, one needs to go back to the charging provisions contained under the Act that is Sections 4 and if at all the payments, as held by the Karnataka HC that such payments fall under royalty payments, they need to be read with Section 9 (1) (vi).
Section 4 is a charging section that provides that a resident is taxed on his/her total income of the previous year. Sub-section (2) provides that in respect of income chargeable under sub-section (1), income-tax shall be deducted at the source or paid in advance, where it is so deductible or payable under any provision of this Act. Therefore, TDS gets deducted in advance, before any actual receipt of the income. For non-residents, the Act creates a fiction under Section 9 (1) of the Act that imposes a tax liability on the assessee, if the income to the non-resident accrues or deemed to accrue or is received or deemed to have been received in India. Section 9 deals with ‘income deemed to accrue or arise in India’. Sub-clause (vi) of sub-section (1) of Section 9 deals with income in the nature of ‘royalty payments’ and sub-clause (vii) deals with ‘fee for technical services’. Before, dealing with the specific provision of Section 9, let’s see how the Karnataka HC has reached the conclusion regarding Section 195 (1) of the Act.
The Karnataka HC, after relying on the interpretation put forth by the SC on Section 195, observed:
‘In this background, the picture that emerges is that while under Section 195[1] of the Act, there is an obligation on the part of the person responsible for paying to a non-resident does arise if and only if the payment partakes the character of income payment, in the sense that, if an amount is not in the nature of income payment at all then Section 195[1] of the Act does not operate, we cannot lose sight of the fact that Section 195[1] of the Act is not a provision for assessing the tax liability of a nonresident nor as to whether under Section 9 of the Act, any income is deemed to have resulted in the accrual or arisal of income to the non-resident in India, but by simply accepting the operation of the mandate under Section 195(1) on every resident payer making a payment to a non-resident recipient in respect of any goods/service supplied by the non-resident, which the resident payer is making use of in the running of its business or any other activity indulged in as part of the business/professional activity of the resident assessee as in such a situation, the payment to the resident recipient prima-facie bears the character of an income recipient and therefore the obligation under Sub-section (1) of Section 195 springs up.’[6]
Therefore, the above observation makes it amply clear that the Karnataka HC admitted the fact that until unless the payment partakes the character of an income payment (if the amount is in the nature of income payment), Section 195 (1) does not and can not be put into operation. If that being the case, the HC should have gone into the question of – whether the payment/s so made by the resident assessee to a non-resident partakes the character of an ‘income payment’ or not? Once this question is answered in the affirmative and then only an obligation to deduct TDS comes in to picture on the part of the assessee making such payment. But the Honourable HC seem to have erred when it relied on Sections 195 (2) & (3), which sub-sections can be sprung in to action only when the entire payment made to a non-resident does not partake the character of income but only a portion of that payment falls under ‘income payment’. Section 195 (2) provides that, when the resident assessee while paying such ‘sum’ chargeable under the Act to a non-resident, considers that the whole of such amount would not be income chargeable in the case of the recipient, he may make an application to the assessing officer for the appropriate determination of such sum so chargeable and consequent upon such determination, tax shall be deducted at source under sub-section (1) only on that proportion of the sum which is so chargeable. Therefore, a bare reading of sub-section makes it clear that it is only when the resident assessee considers or thinks that the whole of such ‘sum’ shall not be an income for the purposes of sub-section (1), it is only then the assessee will be making an application under sub-section (2).
On the contrary, the HC took the following view:
‘We are of the opinion that Section 195 of the Act is not at all a provision wherein the assessing officer is required to indulge in an exercise of determination of the income of a non-resident and that can be done only on the basis of a return of income filed by the non-resident who can definitely put forth the various contentions as have been urged in the present appeal by the learned senior counsel appearing on behalf of the respondents, i.e., the resident payers and even much more on the authority of the law declared by the supreme court in TRANSMISSION CORPORATION OF A.P. LTD., ’s case [supra], the only scope and the manner of reducing the obligation for deduction imposed on a resident payer in terms of Section 195[1] of the Act is by the method of invoking the procedure contemplated under Sub-section [2] of Section 195 of the Act i.e., only when the person responsible for paying any such sum chargeable under this Act on a non-resident, considers that the whole of such sum would not be income chargeable in the case of the recipient, by 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 obligation cast under Sub-section [1] of Section 195 of the Act.’[7]
Therefore, what follows from the above view of the HC is that under Section 195, the AO is not to go in to the question of determining the ‘income payment’ as made to non-resident by the resident. This view seems to be fallacious as – how can assessee deduct TDS on each and every payment made to a non-resident without determining the nature of such ‘sums’ payable? He first needs to determine – whether such ‘sums’ at all fall under the category of ‘income payment’ in order to deduct TDS. The entire discussion of the honourable Karnataka HC seems to have tilted on the issue of apportionability of such ‘sums’ that was not at all the issue, as in the case before the HC the payment that was made was only against the import of software products and for nothing else. Therefore, there was no question of apportionability involved here. The only litmus test here would be – whether the payments made are in the nature of ‘income payment’ so as to be eligible for a TDS deduction? Astonishingly, the HC did not go into the question of examining the nature of payment, rather it accepted the fact that it was a ‘royalty payment’ (as was the stand taken by the revenue and so affirmed by the appellate authority) and, therefore, would require the resident assessee to deduct TDS. In fact it had gone to the extent of saying that:
‘There being no dispute nor can there be any dispute regarding the payments made by the resident payers, bearing the character of an income receipt in the hands of the non-residents as the payments whether are in respect of a merchandise i.e., a payment for buying/purchasing/acquiring a packaged software product and is a commercial transaction or even be in the nature of a royalty payment, as was opined by the assessing officers and affirmed in appeals by the first appellate authorities, nevertheless, the payment definitely being in the nature of a payment resulting in some possible income in the hands of the non-resident recipient, the obligation imposed on the resident payers in terms of Section 195[1] of the Act springs into action, the moment, there is to be a payment to the non-resident and admittedly in all these appeals, the payers who are the respondents in all these appeals, having not taken any steps or not having invoked the relieving provisions of Sub-section [2] of Section 195 of the Act, such obligation on the resident payer remaining in tact…’[8]
If one were to look at the above observation, what HC seems to have done is that it has equated even the ‘business income’ of a non-resident within the scope of the total income. However, as per the provisions of the applicable tax treaties, if the non-resident does not have a Permananent Establishment (PE) in India, then such business income will not form part of the total income of the non-resident. In the case before the HC, the foreign suppliers, like Tektronix Inc and Telelogic Tau TTCN Suite, do not have a presence in India or a PE in India. Therefore, even on this basis it would be wrong to include such income in the ‘total income’ of a non-resident assessee.
As observed in the above paragraphs, what was decided by the Honourable SC in Transmission Corporation was the outcome of specific fact situation in that particular case before the SC. But even the implications of Transmission Corporation can be disastrous, if Section 195 (1) was to be interpreted the way it was interpreted in Transmission Corporation. The Honourable SC specifically recognized the fact that for the applicability of TDS under Section 195 (1), one needs to go back to the charging provision of Section 4 to determine – whether the income is so chargeable to income tax for the purposes of deducting TDS? In this regard the Honourable SC observed:
‘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. Consideration would be whether payment of sum to 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 trade receipt. However, what is to be deducted is income-tax payable thereon at the rates in force. Under the Act, total income for the previous year would become chargeable to tax under section 4. Sub-section (2) of section 4 inter alia, provides that in respect of income chargeable under sub-section (1), income-tax shall be deducted at source where it is so deductible under any provision of the Act. If the sum that is to be paid to the non-resident is chargeable to tax, tax is required to be deducted.’[9]
What can be discerned from the above observation of the SC is the clear acknowledgment of the fact that a TDS under Section 195 is to be deducted only when the said ‘sums’ is so chargeable to income-tax under the Act. Therefore, depending upon the nature of the income that is – whether it’s a ‘business income’ in the form of ‘trade receipts’ or a ‘royalty income’ or ‘fee for technical services’ would first need to be determined then only the resident assessee can deduct TDS at the applicable rate/s. But then the Honourable SC latter came to the conclusion that if the resident assessee has not made an application before the AO under sub-section (2) & (3) of the Act, the assessee is statutorily required to deduct TDS on such ‘sums’. This is evident from the following observation of the SC:
‘The said provision is for tentative deduction of income-tax thereon subject to regular assessment and by the deduction of income-tax, rights of the parties are not, in any manner, adversely affected. Further, the rights of payee or recipient are fully safeguarded under sections 195(2), 195(3) and 197. Only thing which is required to be done by them is to file an application for determination by. the assessing officer that such sum would not be chargeable to tax in the case of recipient, or for determination of appropriate proportion of such sum so chargeable, or for grant of certificate authorizing recipient to receive the amount without deduction of tax, or deduction of income tax at any lower rates or no deduction. On such determination, tax at appropriate rate would be deducted at the source. 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 of tax deduction at source’[10]
Therefore, one can clearly discern the contradiction in the view taken by the Honourable SC.
The implications of the above Karnataka HC and the Supreme Court’s judgment in Transmission Corporation can be profound especially in term of its implications on all the persons engaged in import of products like machinery and equipments. Even the SC seems to have taken the view that a resident assessee is liable to deduct TDS on every payment made to a non-resident supplier under Section 195 (1) of the Act. However, the said Section can be sprung into action only once such ‘sums’ are falling under the nature of ‘income payments’, without determining the nature of ‘payment’, even sub-sections (2) & (3) can not be brought into operation.
At present, the issue is before the Honourable SC, which has stayed the operation of the judgment passed by the Karnataka HC vide its ad-interim order dated December 18, 2009. Now, it needs to be seen as to how SC re-looks at the entire controversy – whether it will rely upon its earlier decision of Transmission Corporation or will give section 195 its true interpretation, only time will tell.
regards,
ratan
Amir
(Learner)
(4016 Points)
Replied 14 February 2010
Dear Chandra Prakash Sir,
TDS will be deducted u/s 195...
TDS rate under Article 12 of DTAA with USA is 15%.....20% rate was applicable only for the first 5 years from the sigining of DTAA..
Further, On TDS rates mentioned in DTAA, surcharge & education cess are NOT applicable...Flat 15%...
CA OP Gupta
(Chartered Accountant)
(23 Points)
Replied 15 February 2010
SANDEEP SOLANKI
(ARTICLESHIP)
(36 Points)
Replied 09 August 2013
Is tds liabilty arises when payment made to spain resident for purchase of images (in soft copy)???
gauravpatel00750
(Sr.Account Executive)
(36 Points)
Replied 12 June 2019
Hi,
Can Any one Say that, When TDS Applicable u/s 195?
Is it applicable on Purchase or Payment to NRI?
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