Law Street - Economic Times (January 2010) - Should all payments to non residents be subject to tax withholding in India?

Dear Readers,

As you will learn on reading this column, Zenobia Aunty thinks she doesn't understand tax anymore. A fall out of a recent High Court decision appears to indicate that tax needs to be withheld at source on all payments made to non-residents, unless a certificate stating otherwise is obtained from the tax authorities. Yes, the tax-men need to meet their revenue targets, but what happened to the good old concept that only income chargeable to tax in India can be subject to tax by India?

Some clarification would be welcome. Read on by clicking here.

Or else, as always, feel free to scroll below.

PS: The next column will be related to pre-budget issues and will be published not on the last Friday of next month but earlier. Zenobia Aunty shall keep you all posted.

Best regards,
Lubna


A tax spanner for international trade

• A recent High Court decision has raised doubts on tax withholding in India
• It appears tax has to be withheld on all imports or payments to non residents
• A clarification is urgently required to resolve doubts

Zenobia Aunty was spotted the other day, staring dismally at the crashing waves off Marine Drive. She just doesn’t seem to understand tax anymore or so she thinks. Her niece; this columnist decided to approach a friendly tax expert to find out the root cause of her Aunt’s gloom. “If you want to pay a non-resident, just deduct tax at source,” he snapped and booted her out.

The cause of this turmoil, faced by everyone in India and everyone who does business with India, appears to be a recent decision of the Karnataka High Court, in the case of Samsung Electronics Ltd. The High Court has held that on import of shrink-wrapped software tax has to be deducted at source in India. Earlier, Tax Tribunals in umpteen cases have held that payments made for import of shrink-wrapped software is akin to purchase of goods (a copyrighted article) and is not ‘royalty’ and no tax is to be withheld in India.

Interestingly, the High Court did not answer the issue of nature of payment for import of shrink-wrapped software question but said that all payments for imports into India are subject to tax deduction at source.

Tax authorities asked for a lemon, but they have got a melon. The judgement has very wide ramifications. The implication of the Karnataka High Court’s decision seems to be, that in all instances of import of any goods, irrespective of its chargeability to tax in India, tax must be withheld and paid to the Indian government and only the balance can be remitted to the foreign supplier.

The only scenario under which the payer (Indian importer in this case) shall be not be under an obligation to withhold tax in India or may withhold tax at a lower rate, is when the payer obtains prior approval from the assessing officer by making an application under section 195(2) of the Income tax Act (Act).

The Karnataka High Court apparently has relied on the Supreme Court decision in the case of Transmission Corporation of A.P. However, tax experts point out that the implications of the Supreme Court decision are quite different.

The tax expert called back to grumpily explain that the Supreme Court in the case of Transmission Corporation had held that: Tax is to be deducted at source only on the sum on which income tax is leviable and which income could be assessed to tax under the Act. Thus, in his view, the payer has to determine whether or not the payment is subject to tax in the hands of the foreign recipient or supplier of goods or services. If income is not chargeable to tax in India, where is the question of deducting tax when making payment to the foreign supplier? There are CBDT circulars which the payer can still rely on and not deduct tax at source, if the income is not taxable in India, he stresses.

However, if one does not wish to take this stand, as suggested by the tax expert, it does appear that in all instances of payments, the tax payer will have to approach the tax authorities for obtaining a dispensation order under section 195(2), an additional administrative burden! If the Indian payer does not do so, the payer will bear the consequences of non-withholding.

For example, an Indian company imports equipment, if tax is not withheld at source, the entire expense will be disallowed, even if in the view of the Indian company, there is no tax to be withheld in India as the foreign supplier does not have a permanent establishment (fixed place of business in India) and such payment is not royalty or fees for technical services, which mandate a tax withholding. Plus, the home country of the foreign supplier may not give a foreign tax credit for taxes ‘wrongfully’ withheld in India. It sure puts a spanner in the wheels of international trade and commerce.

One can also visualize scenarios where the implications of this judgement stretch beyond import of goods. A Mauritius company, sells its shareholding in ABC Ltd, an Indian company to XYZ Ltd, another Indian company. Sale of shares of an Indian company by a Mauritius resident, under the “Capital Gains’ clause of the tax treaty, does not trigger a tax incidence in India.

However, will XYZ Ltd, as per the ‘letter’ of this High Court decision, have to deduct tax at source, before remitting money to the Mauritius seller of shares? If this be the case, global restructuring will get a beating.

Even as Zenobia Aunty was dictating this column, a single member bench of the Mumbai Tax Tribunal has relied on the Samsung decision, however, this was done presumably without considering a favourable view of the Mumbai Tribunal’s Special Bench. Zenobia Aunty learns that a similar issue will now come up before a Special Tribunal Bench in Chennai.

It may be some time before the Supreme Court can clarify this issue. Thus, the MoF must quell the doubts arising in the minds of global players. Else who would want to do business with India?

Source of the photograph