Sunday, November 22, 2009

When are TDS provisions applicable?

In a decision which may lead to grave practical difficulties in international commercial transactions, the Karnataka High Court has recently ruled in effect that ‘tax’ must be deducted at source in respect of all payments made to non-residents, irrespective of whether or not the sums paid are chargeable to tax in India. The case, CIT v. Samsung Electronics, can be accessed here.

In the facts of the case, the assessee made some payments to a non-resident for the purchase of shrink-wrapped software. No deduction of tax at source was made in terms of Section 195. The AO held that the payments were chargeable to tax in India u/s 9(1)(vi) of the Income Tax Act, 1961 as ‘royalty’, and treated the assessee as an assessee-in-default u/s 201 of the Act for non-deduction of tax at source. The CIT(A) upheld this view. On appeal, the Tribunal held that the payments were for shrink-wrapped software, which is ‘goods’ following the decision of the Supreme Court in Tata Consultancy Services.

The judgment in TCS as also the subsequent decision of the ITAT in Sonata, (2007) 106 T.T.J. (ITAT) 797, make it abundantly clear that payments for shrink-wrapped software would not be chargeable to tax in India. V. Niranjan, in a recent article published in the Journal of Business Law describes the decision in Sonata thus:

"The leading case is Sonata Information Technology v Additional Commissioner of Income Tax, International Taxation. The Income Tax Assessing Officer considered that the payment for software import constituted "royalty" under s.9(1)(vi) of the Income Tax Act 1961, on the reasoning that there was no sale of software as there was no transfer of ownership rights and sale, if any, was only restricted to the CDs in which the software is transacted… Royalty is payable only if the copyright itself is transferred, and Sonata correctly observed only a copy of the copyrighted software is licensed to the user. However, Sonata then followed Tata Consultancy Services to hold that it is a sale of goods, which by definition does not attract royalty." [Footnotes omitted]

(See: V. Niranjan, “A Software Transfer Agreement And Its Implications For Contract, Sale Of Goods And Taxation”, [2009] 8 J.B.L. 799)

Thus, it is clear that the AO in the facts of the Karnataka decision got it wrong – the payment was not chargeable to tax in India. This would have been sufficient to dispose of the appeal – but the High Court’s view was that this evident non-chargeability was completely irrelevant. The Court held that the moment there is a payment made to a non-resident, the provisions of Section 195 are attracted. Non-chargeability is no excuse to avoid deduction of tax at source. The only situation when tax need not be deducted is if the payee files an application before the AO for the grant of a certificate authorizing him to receive the sum without deduction.

The effect of such a reading is quite incongruous. For example, one might consider this position along with the stance of the Revenue in the Vodafone case that Section 195 applies even to payments where both the payer and the payee are non-residents. If both these propositions are to be accepted (i.e. chargeability is irrelevant and situs of payment/payer is irrelevant) the conclusion is that an English company paying a sum of money to another English company for reasons entirely unconnected with India, would be an assessee-in-default under the Indian Income Tax Act unless it gets a certificate from the Indian AO! For, the question of whether that payment is susceptible to tax in India is entirely irrelevant. I had discussed the law on the extraterritoriality of Section 195 here. For the moment leaving aside the issue of extraterritoriality, even assuming that the payment is made by a resident, this position is likely to cause grave commercial hardship. Even assuming that a payment is specifically exempted by the Act or by a treaty, a withholding liability u/s 195 will subsist. The only remedy is for the non-resident to file an application – something that is only likely to increase delays and promote uncertainty in commercial transactions.

Does the plain language of the provision support the Court’s stance? Section 195 says, “Any person responsible for paying to a non-resident, not being a company, or to a foreign company, any interest (not being interest on securities) or any other sum chargeable under the provisions of this Act (not being income chargeable under the head "Salaries" shall, at the time of credit of such income to the account of the payee or at the time of payment thereof in cash or by the issue of a cheque or draft or by any other mode, whichever is earlier, deduct income-tax thereon at the rates in force…”

On its plain reading, the applicability of Section 195 turns on whether the sum is chargeable or not. Perhaps realizing this difficulty, the Karnataka High Court sought to place reliance on the Supreme Court judgment in Transmission. The Court’s reasoning effectively consisted of reproducing a few paragraphs in Transmission, and concluding that the issue was a settled one.

The facts in Transmission, seen from the Supreme Court judgment, were that appeals were filed by the assessee against an order of the AO treating the assessee as an assessee-in-default. These appeals were allowed by the CIT(A), who stated that the words “any other sum chargeable under the provisions of this Act” in Section 195 do not contemplate trade receipts within their ambit, and Section 195 applies only to cases where the sums paid are ‘pure income profits’. The ITAT was of the same view. On further appeal, the High Court stated that two fundamental questions arose for consideration, which were: (a) whether the provisions of Section 195 are applicable to cases where the sum paid to the non-resident does not wholly represent income; and (b) if Section 195 is applicable in such cases, whether the AO could enforce deduction of tax at source on the gross amount of trading receipts or only in respect of that portion of the trading receipts which may be chargeable as income under the Act.

Before the Supreme Court, the same two issues were raised in appeal. The Supreme Court held, “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.

Undoubtedly, the Court went on reject the assessee’s first contention; saying, “there is no substance in the contention of the learned Counsel for the Appellant that the expression “any other sum chargeable under the provisions of this Act” would not include cases where any sum payable to the non-resident is a trading receipt which may or may not include ‘pure income’. At the same time, the Court clarified, “the answer given by the High Court that (i) the assessee who made the payments to the three non-residents was under obligation to deduct tax at source under Section 195 of the Act in respect of the sums paid to them under the contracts entered into; and (ii) the obligation of the respondent-assessee to deduct tax under Section 195 is limited only to appropriate proportion of income chargeable under the Act, are correct.

The portions of the judgment underlined above would clearly indicate that the controversy before the Karnataka High Court was not a settled one – if anything, arguably, the issue was settled in favour of the assessee insofar as chargeability being a precondition for application of TDS provisions. It is perhaps time for the Supreme Court to step in and set the record right. 


Kodur_Sathya said...

I believe high court looked in more narrow on this issue. and also hope that it would be addressed at supreme court. My only concern is why would issues like this keep coming up and wastes time of the tax payers or deductors. lets hope for the best.

Anonymous said...

If anything, it justifies the National Tax Tribunal all the more

Mihir Naniwadekar said...


Thanks for the comments. On the point made by anonymous, the National Tax Tribunal in its present form does have several separation of powers concerns (quite similar to those also faced by the National Company Law Tribunal). The Supreme Court heard arguments in this a long time ago -hopefully there will be some clarity on this soon. Also, I wonder whether this decision - one which deserves reconsideration, no doubt - justifies a total institutional change? Would that not ignore several other instances where Courts have been appreciative of commercial reality and the principles of taxation law?

Shreya said...

Also, while the language used in s.195 is 'any other SUM chargeable under the provisions of this act', the authorising prov is section 4 which allows for deduction of tax at source on total INCOME. Section 4(2) says tax shall be deducted at source 'in respect of INCOME chargeable under sub-section(1)'. Income chargeable under sub-section (1) is chargeable in accordance with and subject to the provisions of the Act, including any applicable deductions etc. Irrespective of policy considerations, even a bare reading of the provisions doesnt seem to support the view that WHT should attach to the payment of any 'sum'.

Also, the Transmission Corp parallel between WHT on interest payments to residents and WHT under 195 - it doesnt seem sound because of the difference in 1) nature of payee AND 2) payment. Residents whose total income consists of interest would pay tax at 30%, even though the withholding may only be 10%. However WHT on interest to non-residents is at 20%, which is equal to the presumptive tax rate of 20% applicable under 115A - the WHT in this case subsumes all further liability. This kind of presumptive tax and the lower rate of presumptive tax indicates the stand the ITA takes on what should be the income component of that interest receipt received by the NR. In a business income context it is just not possible to presume the income component because it is so fact specific.

Anonymous said...

Mihir.... the point is how long you can leave something like taxation to generalists, and you also have to consider that there is a sizable percentage of tax decisions by the higher courts is not in consonance with the first principles. Just because some of the decisions by these courts are excellent, status quo cannot be justified. Quality has to be by design not by serendipity. Anyway, no one can dispute that one of the greatest assets of Indian system is an independent and strong judiciary, but that does not mean we donot think about improving our efficiency further.

When I think of NTT, I think of a specialist court. If not NTT, one can at least think of specialization of judges in certain fields. I am sure one can do excellent work, even without specialization background, but it will surely help having some background in taxation and business situations. Considering that many of the decisions toady have far reaching implications, one must have specialist judges with good understanding of the business laws they are required to deal with.

I donot know whether it is realistic to expect any major and radical departure but perhaps the need for radical changes does exist.

Mihir Naniwadekar said...


Thanks for the comments- I realise the difficulty you are highlighting. My greater concern insofar as separation of powers is concerned was pertaining to issues of the powers of the High Court; but I assume that by a specialist "tax court" these concerns would anyway be addressed if those Courts are created in the same manner as say, High Courts. The problems with the NTT are not something which cannot be remedied.

"When I think of NTT, I think of a specialist court. If not NTT, one can at least think of specialization of judges in certain fields"

I believe that some High Courts do have judges sitting predominantly on tax appeals and writs arising out of tax matters or on the tax Bench, so to say. I wonder if this is a system which is followed across High Courts; and if so, whether this in itself would be sufficient to tackle 'specialization' concerns?

Raghav Sharma said...

Mihir, it seems that the plain language of Section 195 supports the view of the High Court. The question is not whether section 195 would apply even in case of sum not chargeable to income tax under the Act. The question is : who will determine whether the sum is chargeable to tax or not. It appears that your view is that the payer is entitled to judge the chargeability of the sum and decide to deduct or not accordingly in case the sum is evidently non-chargeable (on basis of certain decisions etc.). I disagree for the simple reason that section 195(2) exists. Though the text of section 195(2) suggests that it is applicable only in case where a proportion of the sum paid is chargeable, it is only a logical consequence that it can apply even to cases where no sum is chargeable and the AO can record it in his order. The payer does not seem to be the judge of non-chargeability of a sum. I know difficulty would arise from the stand taken in Vodafone case but that has nothing to do with the interpretation taken in Samsumg case as the court could only be guided by principles of interpretation and not result of pending litigation.

Mihir Naniwadekar said...

Apologies for the delays in replying.

I would say that the idea of a separate tax court does indeed make sense, as an adequate compromise between maintaining the balance of separation of powers and ensuring specialization. There are indications that commercial wings are being proposed in the High Courts:

@Shreya -
the Section 4(2) argument seems to be a strong one. I don't think either Transmission or Samsung considers that aspect. Thanks for highlighting this. Also, on your second point - I agree with it. I will respond on the interest parallel (the second point you made) in a bit more detail later.

@Raghav Sharma -
I agree that the result of a pending litigation is not something which should influence legal interpretation. I mentioned Vodafone simply to highlight the absurdity which would result in case the Revenue's interpretation of 195 is accepted in its entirety.

However, I do think that commercial realities are relevant in legal interpretation; particularly in relation to statutes which affect international commerce. 195 itself uses the words "chargeable" - added to that is the 4(2) argument made by Shreya. 195(2)and (3) can be read as provisions of convenience: they give an option to the assessee. This reading is (a) a reasonable interpretation of the text; (b) will result in much less hardship to assessees; and (c) does not go against the rationale of TDS provisions. Hence, in my view, this reading must be preferred.

I do not believe that Transmission forecloses the argument in its entirety - particularly when the whole of the "sum" is not chargeable. There are, I must admit, a few decisions which go against this view: the decision of the Hyderabad Bench of the ITAT in Cheminor - for instance - specifically states that 195(2) is not a provision of convenience. Yet, that decision seems to have been watered down by the same Bench in a subsequent decision - Hyderabad Industries.

Mihir Naniwadekar said...

The Supreme Court has stayed recovery of tax in an ad-interim order against the Karnataka High Court judgment. The SC order can be downloaded at the following link: