Wednesday, March 24, 2010

The Delhi High Court Departs from Samsung Electronics

One of the most pressing issues pending consideration of the Supreme Court is the appeal from the decision of the Karnataka High Court in Samsung Electronics. Earlier posts have considered whether the interpretation of section 195 proposed by the High Court is appropriate, and also the admission of the appeal by the Supreme Court. However, while the hearing before the Apex Court is due only in August this year, the Delhi High Court has delivered a telling blow, though not putting the issue beyond doubt.

The issue in Van Oord ACZ, India v. CIT, decided by the Delhi High Court last week, was whether the assessee, an Indian subsidiary of a foreign company, was required to deduct taxes on amounts paid as reimbursement to its parent company. In the proceedings before the Delhi Bench of the Income-tax Appellate Tribunal, the assessee had contended that the said amount was not taxable, and hence there was no obligation on the assessee to deduct tax at source on the amount. The Tribunal, however, held that it could not examine the chargeability of the amount, and since the assessee had failed to deduct tax at source, it would directly be considered ‘in default’, and would suffer the consequences of non-deduction provided under the Income Tax Act. On appeal, the Delhi High Court reversed this decision of the Tribunal.

The issue concerning non-deduction of tax on payments under section 195 is two-pronged: (i) whether chargeability is essential for deduction; and (ii) whether the assessee can make the determination of chargeability or has to make an application to the Assessing Officer under section 195(2) for making the determination. The Karnataka High Court, in Samsung Electronics, had decided both these questions against the assessee, holding that chargeability was irrelevant to the obligation to deduct, and that there must be an application under section 195(2). While the Delhi High Court has specifically departed from Samsung Electronics on the first issue, the stand taken on the second issue is ambiguous.

To begin with, the Delhi High Court is emphatic that deduction at source under section 195 is required only when the sum paid is chargeable under the Act. Relying on observations in the Supreme Court’s decision in Transmission Corporation, the Court holds that the Act does not impose an obligation to deduct tax on all payments made to a non-resident, irrespective of their chargeability. An earlier post on Samsung Electronics discussed how that decision led to this cumbersome conclusion. By categorically laying down chargeability as a prerequisite for deduction, the Delhi High Court has departed from this highly questionable interpretation of the provision.

However, on the issue of who is to make the determination of chargeability, the Delhi High Court leaves the issue curiously poised. The Court observes,

If the parties feel that either the deduction of tax at source by the payer is required to be at a rate lower than the prescribed rate or no deduction is required to be made they are required to file an application before the ITO for obtaining such certificate. In case no such application is filed before Assessing Officer for obtaining such certificate or such application is rejected by Assessing Officer and direction is issued by the Assessing Officer to deduct such tax at a particular rate the payer is duty bound to deduct tax as per the directions of Assessing Officer and in case no such application for obtaining the certificate was filed before the Assessing Officer then the payer is duty bound to deduct tax as per the prescribed rates in force at the relevant time.

The highlighted parts suggest that the Delhi High Court is in agreement with its counterpart in Karnataka that the appropriate authority to make the determination of chargeability is the Assessing Officer, and if no application is made under section 195(2), the assessee is bound to deduct tax at source. This conclusion is bolstered by the fact that the Court does not categorically disagree with Samsung, choosing instead to distinguish it on facts. The only extent to which it chose to depart from Samsung was on the question of whether chargeability is required for the obligation to deduct. Thus, looking at the cautious approach adopted by the Delhi High Court to Samsung, and the extract reproduced above, it would appear that Samsung remains untouched insofar as the obligation to apply to the Assessing Officer under section 195(2) is concerned.

However, this conclusion seems suspect due to two other observations made by the Delhi High Court:

First, the primary basis on which the Court comes to the conclusion that chargeability is a prerequisite for deduction is the inclusion of the phrase ‘chargeable under the provisions of this Act’ in section 195(1). However, this same phrase is also contained in section 195(2), clearly suggesting that there is no obligation to apply under section 195(2) for a sum which is not chargeable under the Act. This may be the reason why the Court, in the extract reproduced above, speaks of an obligation to apply when ‘no deduction is required to be made’, as opposed to when ‘the sum paid is not chargeable’. This distinction is important, since there may reasons other than chargeability, which result in deduction being unnecessary. For instance, if the entity to which the sum is paid (deductee) is a loss-making entity, there would be no tax levied on that entity even if the amount paid is chargeable. In such a case, the assessee (deductor) could possibly argue that since there is no tax liability on the deductor, there is no obligation to deduct on the Indian assessee. What the Delhi High Court does is to provide that in such a scenario, the assessee must deduct. It does not necessarily mean that there is an obligation to deduct even of the amount is not chargeable.

Secondly, even if the decision is read as meaning that there is always an obligation on an assessee to apply under section 195(2) irrespective of chargeability, the decision of the Court on the requirement of chargeability for deduction under section 195(1) denudes this supposed obligation under section 195(2) of all practical effect. This is because the Court specifically holds that if there is non-deduction, and it is subsequently discovered that the sum paid was not chargeable, the consequences of non-deduction do not attach to the assessee. In the words of the Court,

However, in case in the assessment proceedings relating to the recipient, it is ultimately held that the sum received by the recipient was not chargeable to tax, the effect of that would be that it was no obligation on the assessee to deduct tax at source on the sum paid to the said non-resident and in that eventuality, the assessee will not be treated as in default and would be absolved of any consequences for not deduction the tax at source.

Let us assume that an assessee chooses to take the risk and does not apply to an Assessing Officer under section 195(2), on the firm belief that the sum paid is not chargeable. In such a case, even if it is held that there was an obligation to so apply, a subsequent finding that the sum was not chargeable would absolve him of all liability for non-deduction.

2 comments:

srikanth said...

In light of the seemingly conflicting decisions of the Karnataka and Delhi High Courts, and pending ruling by the Supreme Court, what is the law of the land today? Can it be stated that the Karnataka HC decision applies only in Karnataka and likewise the Delhi HC decision applies only in Delhi? Or is it open for the revenue to insist that Samsung is law of the land across India until such time it is struck down and and any non-deduction will lay one open to penalty?

Mihir Naniwadekar said...

Hello,

Incidentally, there are a few decisions of the Tribunal on the issue after the Karnataka decision, but before the Delhi decision.

For instance, ACIT v. M/s Anchor Health & Beautycare, ITA No. 7164/Mum/2008, ITAT Mumbai Bench - held that chargeability is not essential for application of Section 195. It was held,

"7. In the light of decision of Hon’ble Karnataka High Court and also in the absence of any contrary decision on this issue, I am of the view that the assessee cannot escape from taxation, by virtue of provisions of section 40(a)(i) of the Act, in the event of non-payment of tax at source under section 195 of the Act without obtaining clearance under section 195 (2) of the Act. I, therefore, set aside the Order of the learned CIT(A) and uphold the Order of the Assessing Officer."

With the Delhi decision, the Tribunal's statement that there is no contrary decision is no longer true.