An Indian company making a payment to an overseas entity is obliged to deduct tax only if the income of the foreign firm is liable to tax in India.

This was the sum and substance of a recent Delhi High Court ruling which provides substantial relief to several companies making regular cross-border payments. Interestingly, the Delhi High Court ruling differs from a Karnataka High Court judgement in the case of Samsung Electronics last October, in which the HC held that tax has to be deducted in India from all payments made to overseas entities.

The latest ruling centred around costs reimbursed by the Indian subsidiary of the Netherlands-based Van Oord ACZ Marine Contractors. The income-tax department directed Van Oord ACZ India to withhold the tax before paying its parent company.

However, the amount withheld was refunded to the Dutch company after it filed an application with the Indian I-T authorities. Thereafter, when the Indian subsidiary made a subsequent reimbursement to the Dutch company, it did so without withholding tax. The I-T department, however, disallowed this reimbursement and initiated action against the subsidiary for having defaulted by not withholding tax.

The Delhi High Court pointed out that this was a case in which the income-tax department had already allowed a refund of the amount withheld from a similar reimbursement in the past. Therefore, prima facie, the Dutch company was not liable to pay tax in India and hence it was not obligatory on the part of its Indian subsidiary to withold tax. However, the court added that if, at a later stage, the income of the Dutch company became liable to tax in India, the I-T was vested with powers to initiate proceedings against the Indian subsidiary for not withholding tax.

The rationale of the Karnataka High Courts order last December that tax had to be deducted from all cross-border payments was based on the premise that the taxpayer did not have the expertise to decide whether any particular income was taxable or not in India. Such a decision would have to be left to the tax authorities. The Supreme Court in its order in November 2009, however, had stayed the Karnataka High Courts ruling till further notice.

This is an important ruling as the High Court has reiterated the principle that obligation to withhold tax would arise only if the income is liable to tax in India, said a statement from accounting firm BMR Advisory.

Sanjay Sanghvi, tax partner, Khaitan & Co added, When two high courts give contradictory judgments, one can rely on the judgement favourable to the assessee. The Delhi High Court judgement comes as a big relief to taxpayers.