TDS liability in payments to foreign collaborators
October, 07th 2006
TDS applies not only to the amount paid, which wholly bears income character, but also to gross amounts, the whole of which may or may not be income or profits of the recipient.
Collaboration agreements between Indian and foreign companies often give rise to a plethora of problems concerning tax liability. Before remittances are made to the foreign collaborator, the Indian company has to decide on the taxes to be deducted at source.
Section 195 of the Income-Tax Act, 1961 requires that any person responsible for paying a non-resident any sum chargeable under Indian tax law shall deduct income-tax thereon at the rates in force at the time of credit of such sum to the account of the payee or at the time of actual payment thereof, whichever is earlier.
The question to be considered is whether payment of the sum to the non-resident is chargeable to tax. The sum may or may not be income. Income may be hidden or otherwise embedded therein. The scheme of tax deduction at source applies not only to the amount paid, which wholly bears income character, but also gross amounts, the whole of which may or may not be income or profits of the recipient.
Way back in 1959, the Calcutta High Court pointed out that "if chargeable under the provisions of this Act" means actually liable to be assessed to tax, in other words, if the sum contemplated is taxable income, a difficulty is undoubtedly created as to complying with the provisions of the section.
The section contemplated not merely amounts, the whole of which was taxable without deduction, but amounts of a mixed composition, a part of which only might turn out to be taxable income, as well; and the disbursements, which were of the nature of gross revenue receipts, were yet sums chargeable under the provisions of the Income-tax Act.
The Headstart case
In this case (285 ITR 530 AAR), an Indian company, Headstart Business Solutions (P) Ltd, entered into a Solution Provider Agreement with Microsoft Regional Sales Corporation, Singapore, in July 2005 for supplying packaged business software solutions.
The product is meant to be delivered in physical form through a compact disc accompanied by a software licence key which is delivered electronically through e-mail over the Net. The software licence key bears the name of the client to whom the software is to be delivered.
The Indian company approached the Authority for Advanced Ruling (AAR) to find out whether there was any legal obligation to withhold taxes while making payment for the software purchased from the Singapore firm. It was argued that the agreement was in the nature of one for purchase of software without copyright.
The Indian company obtained only a right to provide licence to software directly to the customers, with no additional distributorship rights being granted. The agreement expressly prohibited assignment of any of the intellectual right vested with the Singapore company to the Indian company. The latter did not get any right to exploit the product commercially.
The buyer of a software is liable to pay loyalty only when the copyright is transferred. The Revenue pointed out that as per the agreement, the Indian company can make copies of the software purchased from the Singapore firm by taking permission. The Indian company can also customise the software for its clients according to their need.
The Singapore company can thus be said to be providing technical knowhow by providing licence to software and other assistance. The payments will also include an element of royalty and, therefore, tax will be deductible from such payment.
The AAR held that the expression "any other sum chargeable under the provisions of this Act" in Section 195(1) contemplates not only amounts, the whole of which is taxable without deduction, but also amounts of a mixed composition, a part of which only might turn out to be taxable income, as well as other disbursements which are of the nature of gross revenue receipts, are yet sums chargeable under the provisions of the Act and come within the ambit of Section 195(1) of the Act.
It held that there was a legal obligation on the part of the Indian company to withhold taxes while making payments for the software purchased from Singapore.
The Supreme Court had pointed out that the way out in all such cases is for the company concerned to file an application before the assessing officer (AO) for determination that no part of the remittance would be chargeable to tax. In the alternative, a prayer can be made for determination of the appropriate proportion of the sum chargeable. The AO is bound to Act on such request and issue a certificate for tax deduction at nil or lower rate. If no such application is made, the entire amount will be subjected to TDS. There is also provision for appeal against the order of the AO declining to issue a certificate, as required by the Indian company.
T. C. A. Ramanujam
(The author is a former Chief Commissioner of Income-Tax.)