Tax Hotline December 28, 2009

Supreme Court provides a breather for withholding tax obligations on payments made to non-residents

The Supreme Court of India has in a special leave petition filed before it, stayed recovery proceedings in relation to the Karnataka High Court’s order in the case of CIT v/s. Samsung Electronics Co. Ltd. Recently, in a judgment that shook the software industry, the Karnataka High Court held that every person making a payment for import of shrink wrap software is under an obligation to deduct tax at source. Though the core issue in the case was regarding the characterization of payments to foreign suppliers for the purchase of shrink wrapped software, the High Court in fact did not delve into the issue regarding software taxation, instead dealt with a broader framework with respect to withholding tax obligations arising out of payments being made to non-residents from India.

The High Court held that it was an obligation on the part of every resident payer making a payment, being in the nature of income in the hands of a non-resident, to withhold tax under section 195(1) of the Income Tax Act, 1961 (“ITA”). It further observed that section 195(1) of the ITA is not a charging provision and the assessing officer cannot embark on an exercise to determine the actual nature of the income or the tax liability of the non-resident assessee. It concluded that the resident payer’s liability to withhold tax arises the moment there is a payment to be made to a non-resident, if such a payment is income per se in the hands of the recipient. The resident payer can be relieved from his obligation to withhold tax either wholly or partially, only upon making an application to the assessing officer for a nil or lower rate of tax withholding certificate, by demonstrating that the entire payment does not partake or only partially partakes the character of income.

The principle laid down by the High Court has significant implications and could bring every payment which is in the nature of income per se, under the purview of withholding tax provisions of the ITA.

The letter of the law in India is very clear that only when an income is chargeable to tax, withholding provisions would trigger. An application to the assessing officer under section 195(2) should only be required in a case where the whole or part of the payment is not subject to withholding tax. However, where a payment is not chargeable to tax in the first place, no application to the assessing officer should be required. Hopefully, the Supreme Court will now address this much debated issue and provide certainty with respect to withholding obligations for payments to be made to non-residents.


Shreyas Jhaveri & Parul Jain



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