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
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 India 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
. V. Niranjan, in a recent article published in the Journal of Business Law describes the decision in Sonata thus: India
"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,
Of Goods And Taxation”,  8 J.B.L. 799) Sale
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
. 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. India
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
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. India
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.