Tax Hotline April 21, 2010

Relief comes the way of Indian importers: Chargeability a must for withholding of taxes

Much to the relief of Indian importers, the Special Bench of the Income Tax Appellate Tribunal, Chennai (“ITAT”) has, in the case of ITO v. M/s Prasad Production Limited1 ruled that a resident is not required to deduct tax at source while making payments to a non-resident, if he is of the bona fide belief that such payment is not chargeable to tax in India. The order, passed by the ITAT, Chennai is in line with the Delhi High Court ruling in the case of Van Oord Acz India (P) Ltd.2, marking a clear departure from the controversial judgment of the Karnataka High Court in CIT v. Samsung Electronics Co. Ltd3.

The ITAT in the instant case was faced with the question of whether, a Taxpayer who has not applied to the Assessing Officer (“AO”) for a determination for deduction of tax at a lower or NIL rate of tax under Section 195(2)4, is under a statutory obligation to deduct tax at source on the entire payment. The ITAT found the answer to be in the negative, and held that if a taxpayer does not apply for a determination, based on a bona fide belief that no part of the payment is chargeable to tax, he will be relieved from his statutory obligation to deduct tax at source on any part of the payment.

Background

Pursuant to a contract awarded by the Tourism Department of the Government of Andhra Pradesh to establish an IMAX theatre in Hyderabad, M/s Prasad Production Limited (herein, the “Taxpayer”) entered into an agreement with IMAX Limited, Canada for purchase of equipment, maintenance and installation against lump sum consideration. The payment of the consideration aforesaid was made by the Taxpayer without deducting tax at source. Consequently, during the course of assessment proceedings instituted against the Taxpayer, the AO found these remittances to be in the nature of fees for technical services, chargeable in accordance with the Income Tax Act, 1961 (“Act”). In the absence of an order under Section 195(2), the AO raised a demand of tax, and concluded that the entire sum remitted was liable to tax. However, the Commissioner of Income Tax cancelled the demand, and the matter was referred to a Special Bench of the ITAT.

Before the ITAT, the Department of Revenue (“Revenue”) argued that the remittances by the Taxpayer were made towards fees for technical services, and chargeable under the provisions of the Act. Relying on the Supreme Court’s decision in Transmission Corporation of A.P Ltd. V. CIT5, the Revenue contended that if a taxpayer does not obtain an order from the AO for a reduced or NIL withholding of tax, the taxpayer would be required to deduct tax at source on the entire payment. According to the Revenue, the Taxpayer had no discretion in determining whether it should deduct tax or not; if such discretion is allowed, the very purpose of Section 195 would be defeated.

The Taxpayer, on the other hand, contended that while the obligation of deducting tax at source under Section 195 was that of a taxpayer, this liability attaches only when the payment made to the non-resident qualifies as income, chargeable in accordance with the Act. Consequently, if the income is not chargeable, whether under the Act, or by virtue of a double taxation avoidance agreement, the taxpayer will be under no obligation to deduct any taxes. In the instant case, the payment to IMAX, Canada was not in the nature of fees for technical services rendered, as concluded by the AO, but was a technology transfer fee that was inextricably linked with the sale of the equipment. Moreover, under the terms of the India-Canada double tax avoidance agreement, supervision of installation work does not amount to a permanent establishment, and therefore, the withholding provisions under Section 195 would not be attracted in the instant case. Since no part of the payment was chargeable to tax, the ratio laid down in Transmission Corporation is not applicable.

Decision of the ITAT

The ITAT, after undertaking a detailed analysis of various judgments including that of the Supreme Court in Transmission Corporation, stated that the taxpayer is under an obligation to deduct tax from the entire payment remitted to a non-resident, if he has failed to make an application under Section 195 (2) for lower withholding of taxes. However, the ITAT reasoned that this principle would apply only when the entire payment or a part thereof bears an income character. Thus, if the taxpayer is under a bona fide belief that no part of the payment bears an income character, then Section 195 will not apply, and the taxpayer is entitled to make the payment without deducting any taxes.

On the issue of who would be primarily responsible for whether a deduction should be made, the ITAT held that the responsibility of this determination would devolve on the taxpayer first. This is further corroborated by a plain reading of Section 195(2), which provides that the person responsible for making the payment may make an application to the AO, if such person considers that the whole of the payment would not be income chargeable in the hands of the recipient. In any event, the determination by the Taxpayer is tentative, and may be corrected by a demand for tax in accordance with the provisions of Section 201 of the Act.

Analysis

The ratio laid down by the ITAT is a breather in more ways than one; first, the Delhi High Court, in the case of Van Oord, and the ITAT in the present case, have ruled against the interpretation of Section 195, as adopted by the Karnataka High Court in the Samsung case, and have laid down the correct position of law. However, it will be interesting to see how the currently pending appeal from the Samsung case unfolds, given the repercussions that an adverse ruling is likely to have on Indian software companies. Second, the ITAT’s interpretation of the Transmission Corporation is particularly significant, as it settles the position that chargeability is the sine qua non for a deduction to apply. Third, the flexibility provided to a taxpayer to assess a deduction in the first place is a welcome relief, especially in situations where the taxpayer is confident that no deductions are necessary. However, at the same time it has to be noted that if it is determined that the transaction is chargeable to tax in India, in such case the taxpayer would be subjected to proceedings under section 201 of the Act for failure to withhold taxes.

 

Rohini Agarwal & Rajesh Simhan

 

 

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1 [2010] TIOL 182 Mad SB

2 ITA No. 439/2008

3 ITA No. 2808 to 2810 of 2005 and others

4 Section 195(2) of the ITA provides that if any person responsible for making a payment chargeable under the ITA to any non-resident or a foreign company, considers that the whole of such sum would not be income chargeable in the case of the recipient, may make an application to the assessing officer to determine the appropriate proportion of the income so chargeable and thereafter tax is required to be deducted at source on such appropriate income.

5 [1999] 239 ITR 587 (SC)


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