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Facts

The Supreme Court took into consideration the facts presented in the lead suit, which was called Sonata Information Technology Ltd. The respondent is a distributor of pre-packaged, shrink-wrapped, imported standardized software that comes from Microsoft and other providers located outside of India.

Assessee has satisfied their financial obligations to the vendors by making the payment that corresponds to the software’s purchase price. The Assessing Officer (AO) concluded that the money paid to the vendors should be considered a royalty because the sale of the software included a license to use it, and this license was presumed to accrue or arise in India. The AO also concluded that tax should be withheld at the source following section 195 of the Act.

The judgment made by the AO was maintained by the CIT(A). However, the tribunal decided that the amount that the assessee paid to the foreign suppliers was not of the nature of royalties and did not result in any income that was taxable in India. As a result, the assessee was not required to deduct tax at the source because there was no obligation to do so.

The High Court agreed to hear the department’s appeal and based its decision on Transmission Corp. of A. P. Ltd v. CIT [1999] 239 ITR 587 (SC). In that case, the Supreme Court stated that unless the payer made an application to the AO under section 195(2) of the Income Tax Act, 1961, and obtained permission for non-deduction of tax, it would not be permissible for the payer to contend that the payment made to the non-resident did not result in “income”

Issue

Is it necessary for an Indian company to make a tax deduction at the source if the company makes a remittance to a non-resident abroad, regardless of whether or not the payment is taxable following the Act?

Legal

1. Section 195 of the Income Tax Act,1961
2. Section 192 of the Income Tax Act,1961
3. Section 194E of the Income Tax Act, 1961
4. Section 18(3B) of the Income Tax Act, 1961
5. Sections 4, 5, 9, 90, and 91 of the Income Tax Act,1961
6. Section 237 of R.W.S. 199

Views

The decision that was made in the case CIT v. Cooper Engg. Ltd. [1968] 68 ITR 457 (Bom HC) stated that if the payment made to a non-resident is not chargeable to tax in India, then no tax is deductible at the source. This is the case even if the assessee did not make an application under section 18(3B) [i.e., section 195(2)] of the Income Tax Act.

In the case of Vijay Ship Breaking Corpn. v. CIT [2008] 314 ITR 309 (SC), the Supreme Court decided that the assessee was not required to deduct tax at source after Explanation 2 to section 10(15)(iv)(c) was added. The reasoning behind this decision was that tax deduction at source is only required if the tax is assessable in India.

In the case of Eli Lilly & Co. (India) (P.) Ltd. [2009] 312 ITR 225 (SC), the Supreme Court of India considered the question of whether or not provisions regarding tax deducted at the source constitute machinery provisions that enable the collection and recovery of tax and that form an integrated code with the charging and computation provisions that determine taxability in the hands of the assessee.

The decision of PILCOM v. CIT [2020] 271 Taxman 200 (SC) held that the obligation to deduct tax at source under section 194E is not affected by the DTAA. If the taxability is disputed by the assessee, the benefit of the DTAA can be pleaded, and based on the case made out, the amount will be refunded with interest; however, this would not by itself absolve the liability under section 194E of the Income Tax Act.

Held

The Supreme Court, after analyzing the provisions of section 195 of the Income Tax Act, concluded that the clause imposes a tax withholding obligation on any person responsible for paying to a non-resident any interest or other amount that is taxable following the terms of the Act.

The word “chargeable under the provisions of the Act” may be found in section 195(1) of the Act and has the utmost weight due to its prominent placement. So, a person who pays interest or any other payment to a non-resident is not obliged to deduct tax if the Act specifies that such an amount is free from taxes. This is because the Act provides an exemption for such a sum.

In addition, section 195 of the Act contemplates not only payments of pure income but also composite payments that include an element of income, and the payer is responsible for withholding tax at the source on such composite payments. This provision does not apply to payments of pure dividends or interest.

In addition, the Central Board of Direct Taxes Circular No. 728 dated October 30, 1995, emphasized that the person responsible for deducting tax may consider the impact of the DTAA on payments of royalties and technical fees while deducting tax at the source. This provision was included in the circular.

The wording of sections 195(1) of the Act and 18(3B) of the 1922 Act is quite comparable to one another. The Supreme Court made note of the fact that the application made under section 195(2) of the Act presupposes that the person responsible for making a payment to a non-resident is certain that tax is payable on some portion of the amount that is to be remitted to the non-resident but is uncertain as to what portion of the amount should be subject to tax withholding. This was something that was brought up in the case that was heard by the Supreme Court. In situations like these, an application must be submitted to the AO/ITO(TDS) following the provisions of section 195(2) of the Act to ascertain the amount of tax that must be withheld.

For evaluating whether or not section 195(2) of the Act applies, the tax that is required to be withheld at the source may be deducted simply from the amount that is considered to be owed. Hence, the provisions of sections 4, 5, 9, 90, and 91 of the Act, in addition to the prerequisites of the DTAA, apply to the application of tax deductions at the source.

Based on the judgment in Transmission Corp. of A.P. Ltd., the Supreme Court concluded that Sections 195(2) and 195(3) constitute protective measures (supra). So, a person responsible for deductions can decide on their own whether or not taxes may be deducted at the source, as well as the amount of taxes that should be deducted. This is the case if the person is reasonably certain.

The Supreme Court observed that Section 195 of the Act pertained to Chapter XVII of the Act, which addressed collection and recovery, while Chapter XVII-B of the Act addressed tax withholding at the source. In addition, the terminology used in Chapter XVII is distinct, and the only place in the Act where the phrase “amount paid following the requirements of the Act” appears is in section 195.

Similar provisions of the Act, sections 194C, 194EE, and 194F, make it possible to deduct tax from “any amount,” but they do not contain the language that is used in section 195. As a result of this, the United States Supreme Court was compelled to define the phrase “amount taxable following the requirements of the Act.”

The Supreme Court of the United States decided that Section 195 should be interpreted in conformity with the charging requirements, which are found in Sections 4, 5, and 9. So, the need to deduct tax at the source is something that emerges only when there is a taxable amount according to the Act. It is not possible to have a wide interpretation of section 195 based on the fact that the revenue department has not received any information. This would allow for the demand for tax deductions at the source even though a payment is not taxable in India.

The Supreme Court further rejected the department’s position that the need to deduct tax should begin as soon as a remittance is received. The court reasoned that this would indicate that income is presumed to exist or accrue in India upon simple payment, something the court did not want to imply. Because of this, the language “chargeable under the provisions of the Act” that is now included in section 195(1) of the Act would be removed as a consequence.

When one is attempting to understand a portion, one must pay careful regard to each word inside that area. The charge provisions of the Act cannot be read in isolation from the machinery sections to properly grasp the meaning of the Act; rather, the Act must be understood as an integrated code. Therefore, the language in section 195(1) of the Act indicates that the remittance must be of a trade receipt where the entire or a portion of the amount is taxable in India, and the payer is only required to deduct tax at source if the entire amount is assessable in India. This is because the language indicates that the payer is only required to deduct tax at source if the entire amount is taxable in India. If the amount is not subject to taxation in India, then there is no need for that tax to be withheld at the point of origin.

The Supreme Court observed that sections 192 and 195 of the Act are quite similar to one another. The department’s contention that a payer making a payment to a nonresident was required to deduct tax would have absurd consequences. The department would be able to appropriate the money deposited by the payer even if the sum is not subject to tax, because the Act contains no provision that allows the payer to obtain a refund. Furthermore, the absurd consequences would be caused by the department’s contention that a payer making a payment to a nonresident was required to deduct tax. In addition, the recipient of the amount is the only person who may file a return according to the provisions of section 237 of R.W.S. 199.

The Supreme Court made notice of the fact that the High Court did not discuss the merits of the case and instead merely determined that the obligation to deduct tax at source arose when the money was remitted. This decision made by the High Court was reversed, and the High Court’s order was vacated so that it might be reconsidered based on the merits of the case.

Judgement Reviewed By Jay Kumar Gupta