Internationally, most countries require that those who pay interest, dividends and royalties to foreign recipients must withhold the income tax at the time of payment and must deposit the same amount with the treasury. Similarly, under s195 of the Income Tax Act 1961 (the 1961 Act) the Indian domestic tax laws cast a vicarious obligation to withhold tax on payments to non-residents if the same amount can be charged as tax. The provisions of s195 of the 1961 Act are:
- the liability to withhold vests at ‘the person’, whether an individual, a company, a partnership firm, the government or a public sector bank;
- that the payee should be non-resident or a foreign company;
- that payment should constitute either ‘interest’ or ‘any other sum chargeable to tax’ under the provisions of the 1961 Act (excluding the income chargeable under the title ‘salaries’); and
- that tax is required to be withheld at the time of credit or payment of the sum to the non-resident, whichever is earlier.
Section 195(2) of the 1961 Act states that when a person responsible for paying a sum, chargeable to tax to a non-resident, considers that the whole of that sum would not constitute income chargeable to tax, they may make an application to the tax officer to determine, by general or special order, the appropriate portion of the sum that is chargeable. Tax shall be deducted only on that proportion of the sum that is chargeable.
Further, to regularise the outward remittances from India and simultaneously ensuring the collection of tax, the payer of income is required to furnish the chartered accountant certificate to the authorised dealer (Circular No 759 dated 18 November 1997, Circular No 9 and 10 of 2002).
The non-compliance of the above mentioned provisions of withholding taxes may attract the following consequences on the payer:
- levy of simple interest is 1% per month from the date on which the tax was deductible to the date on which the tax is deducted and 1.5% per month from the date on which the tax was deducted to the date on which the tax is paid (s201(1A) of the 1961 Act, as proposed via the Finance Bill 2000);
- levy of penalty ranging from 0% to 300% of the withholding tax amount; and
- in case the payer is regarded as an assessee in default then there may be a levy of simple interest at 1% per month for the period of default and a penalty for an amount not exceeding the amount of withholding tax liability.
Considering the rigorous consequences for not complying with the withholding tax provisions, it is imperative that non-residents evaluate the applicability of the provisions depending on the facts of the case.
The first and main source of litigation, in such deals as cross-border transactions, lies in the interpretation of the word ‘any person’, as used in s195 of the 1961 Act. This term casts an obligation on the person making a payment to withhold tax at the time of remittance to a non-resident. It can be argued that the provocation of Indian tax laws cannot have ‘extra-territorial jurisdiction’ to include non-residents (Star v Deputy Commissioner of Income Tax [2006]). The revenue department challenged this interpretation in many cases pending adjudication at various levels at judiciary.
Section 195 of the 1961 Act also uses the words, ‘any other sum chargeable under the provisions of this Act’. In Transmission Corporation of Andhra Pradesh v Commissioner of Income Tax [1999], the Supreme Court made the following observations:
- The scheme of s195 and s197 leaves no doubt that the expression ‘any other sum chargeable under the provisions of this Act’ would mean the ‘sum’ on which tax is leviable.
- The scheme of withholding tax applies not only to the amount paid that wholly bears ‘income’ character, such as salary and dividends, but also gross sums, the whole of which may not be income.
- The withholding tax provisions for the tentative deduction of income tax, subject to regular assessment and the rights of the parties, are not, in any way, adversely affected.
- In the event that the payer is not certain to whether the payment constitutes an element of income, they can approach the tax authorities under s195(3) and s197.
Recently, Karnataka High Court in Samsung Electronic Co Ltd [2009] interpreted the dicta of the judgment of Transmission Corporation to rule that the withholding tax provisions are applicable on all payments made to non-residents unless the assessing officer has issued a certificate of lower or nil withholding under s195(2) and s197 of the 1961 Act.
This position seems to have been further exasperated by the withdrawal of Circular No 23 of 1969, which had prevented the Income Tax Department from disputing the issue of withholding tax on the payment that was covered within it.
Additionally, Karnataka High Court, in its earlier verdict in Jindal Power [2009], which dealt with engineering procurement construction contracts, categorically ruled that amounts that are not considered to be income are not subject to withholding tax under s195 of the 1961 Act. Jindal Power was not cited during the hearing of Samsung Electronics and therefore the latter may be construed to have been decided per incuriam.
The Supreme Court staged the judgment of Karnataka High Court via its ad-interim order (dated 18 December 2009) in GE India Technology Centre (P) Ltd v Commissioner of Income Tax [2010].
The decision in Samsung caused jitters among the taxpayers on the issue of demons of withholding tax on payments to non-residents. The taxpayers were finding it difficult to comply with the onerous compliance on all cross-border payments until the Delhi High Court took a constructive approach of s195(2) of the 1961 Act, and the dicta of the apex court in Transmission Corporation and Van Oord.
Recently, the Delhi High Court offered some relief on the issue of payments to non-residents in Van Oord. The Court also expressly dissented from the views of Karnataka High Court on the aspect of the applicability of withholding tax provisions on all sums payable to non-residents.
The Delhi High Court made the following observations:
- Where an application is made under s195(2) of the 1961 Act and the Revenue determines that the payment is liable to tax in India, the payer will be obliged to withhold tax on this payment.
- Since the Revenue has refunded the taxes that are withheld by accepting the return filed by the non-resident, the taxpayer will not be obliged to withhold tax in subsequent years.
- The High Court held that Van Oord India was not liable to withhold tax on the reimbursement of mobilisation and demobilisation charges to VOMAC.
Further, very recently, the Chennai Special Bench of Tribunal in ITO v Prasad Production Ltd [2010] held that if the payer is of the bona fide belief that no part of the payment is chargeable to tax, then the provisions of s195 of the 1961 Act are not applicable. The Tribunal has chosen not to follow the judgment of Karnataka High Court in Samsung.
All eyes are now on the the Supreme Court as it hears the appeals against Samsung and other rulings revolving around the issue of withholding tax on payments to non-residents.
The judicial conundrum has created technical impediments in cross-border transactions. The liability to withhold tax becomes imperative in the negotiation process and the liability to withhold, and the consequences for not complying with the withholding tax provisions, must be evaluated on a case-by-case basis.
Comment
With the swelling inflows of foreign exchange and the lure of the Indian market has created, the Indian courts should wipe the dust from the mirror so that the foreign investors can decide their modus operandi while investing in Indian markets.