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Deduction on payments made to non-residents
June, 05th 2008

Deduction of tax at source in relation to payments made to non-residents has been a focal point of long standing tax litigation. In spite of several tax rulings pronounced in this context, the issue has still not attained conclusive finality. The epicentre of this unresolved issue lies in the fact that different courts have been pronouncing contrary rulings on this subject.

Recently, the Delhi Tribunal had the opportunity to revisit this issue in the Millennium Infocom Technologies Ltd (21 SOT 152) case.

Law as of today

Just to briefly touch upon the law as it exists today, Section 195(1) of the Income-Tax (I-T) Act provides that where a person is responsible for paying any sum to a non-resident which is chargeable to tax in India, he is required to withhold tax at the time of such payment or credit of the income to the account of the payee, whichever is earlier.

Further, Section 195(2) provides that where the payer believes that the whole of such sum paid to the non-resident payee is not liable to tax in India, he may make an application to the assessing officer (AO) to determine the appropriate proportion of such sum so chargeable to tax and upon such determination, tax shall be deducted only on that proportion of the sum which is so chargeable.

In continuation to the above, the Central Board of Direct Taxes (CBDT) has issued Circular No. 759 dated November 18, 1997, Circular No. 767 (May 22, 1998), Circular No. 10/2002 (October 9, 2002) and Circular No. 3 (July 19, 2007) in this context.

Circular No. 759 broadly provides that remittances to non-residents would be allowed to be made by the RBI without insisting on a No Objection Certificate from the revenue authorities provided the person making the remittance furnishes an undertaking in duplicate, accompanied by a certificate from an accountant (the RBI regulations currently entail production of accountants certificate in relation to most payments made to non-residents Circular No. 3 of July 19, 2007). Further, Circular No. 10/2002 provides the specific format of such an accountants certificate.

Accordingly, the law seems to be fairly clear to the effect that where a payment made to a non-resident is not chargeable to tax in India, Section 195(1) of the I-T Act would not apply in such a case. Further, to determine whether a particular payment made to a non- resident is chargeable to tax in India or not, the payer may approach an accountant as opposed to approaching the revenue authorities (which generally results in long delays).

Simple as it sounds, the above provisions have been a subject matter of protracted litigation. The revenue authorities have often taken a position that regardless of whether the payment made to a non-resident is chargeable to tax in India or not, the payer is obligated to approach the Revenue under Section 195(2) of the I-T Act and further, in case the payer does not prefer to do so, he is liable to deduct tax on the gross amount paid.

This apart, in most cases, the revenue authorities are not accepting the position adopted in the accountants certificate (though the same is issued only after duly analysing the taxability of the transaction in detail), thus indirectly hinting that the payer should have approached the Revenue instead of adopting the accountant certificate route. As a consequence, the revenue authorities have been disallowing payments made to non-residents under Section 40(a) (i) of the I-T Act.

Reliance on SC decision

While adopting the above stand, the revenue authorities have often placed reliance on the Supreme Court decision in the Transmission Corporation (239 ITR 587) case.

Herein, the Supreme Court broadly held that if no application is filed by the payer under Section 195(2) of the I-T Act (seeking a determination of the appropriate portion of income out of the sum so remitted), income-tax would have to be deducted by the payer on the entire gross sum.

However, somewhat contrary to the above, the Supreme Court in the same ruling also held that the obligation of the payer to deduct tax under Section 195 is limited only to the extent of the appropriate proportion of income chargeable to tax under the I-T Act.

Various courts have discussed and interpreted the above ruling and unfortunately the interpretations made by them have been grossly contrary.

Some time back, the Mumbai Tribunal had also tested this issue in the Maharashtra State Electricity Board (90 ITD 793) case, wherein it was held that Section 195(2) would apply only in a scenario where the payee is chargeable to tax in India on some portion of the income.

Accordingly, in case the entire sum received by the non-resident payee is not liable to tax in India, there is no question of approaching the revenue authorities for a withholding tax certificate in this regard.

Further, the Hyderabad Tribunal in the Sol Pharmaceutical Ltd (83 ITD 72) and A P Power Generation Corporation (11 SOT 221) cases also upheld views similar to those upheld in the Maharashtra State Electricity Board case.

Delhi Tribunal ruling

It is in that context that the recent ruling of the Delhi Tribunal assumes importance as it seems to clear the air of uncertainty on payments made to non-residents based on an accountants certificate after the issuance of the Board circulars.

In the Millennium Infocom (21 SOT 152) case, the Delhi Tribunal held that the law itself has provided an option (through the various Circulars discussed earlier) to the payer to obtain an accountants certificate (instead of approaching the revenue authorities) before making a payment to a non-resident.

Hence, in case a payer is compelled to approach the Revenue (before making payment to a non-resident entity), then the Circulars issued by the Board would be rendered totally meaningless.

Thus, the aforesaid ruling clearly indicates that in case the payer makes payments to non-residents after duly placing on record accountants certificates in relation to such payments, it should amount to sufficient compliance of law.

After pronouncement of this ruling by the Delhi Tribunal, it is hoped that the revenue authorities would readily accept the accountants certificate route adopted by payers and not needlessly burden them with unnecessary questioning in cases where the position adopted in the accountants certificate is correct or where the transaction is not liable to tax in the hands of the recipient in India.

N.C. Hegde
Surojit Ray

(The authors are Partner and Manager, respectively, Deloitte, Haskins & Sells, Mumbai.)

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