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Contents

Objective of Section 195

Overview of Section 195

Section 195A – Grossing Up

Refund of tax withheld under section 195

Section 195 and Section 197

Non compliance consequences

Case Study – Vodafone

Case Study – Others

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Objective of Section 195

• Section 195 deals with deduction of tax at source from payments to Non-residents and Foreign Companies

• Objective– to ensure tax liability is recovered through deduction at source itself

– Tax Department is not troubled to recover tax from a non-resident whose India connection may be transient or whose assets in India may not insufficient

• No threshold limit prescribed – tax deductible even on a negligible amount of credit / payment

• Tax on the gross amount / income element – no finality

• Deductor has option to approach the Assessing Officer (‘AO’) to determine the income element

• Does not apply to salaries, interest on securities and exempt dividends

• Section 2(37A)(iii)– Benefit of Tax Treaty Available

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Overview of Section 195

Section Provisions

195(1) Scope and conditions for applicability

195(2) Application by the “Payer” for lower or Nil withholding to the Tax Authorities

195(3) Application by the “Payee” for lower or Nil withholding to the Tax Authorities

195(4) Validity of certificate issued by the Tax Authorities

195(5) Powers of the CBDT to issue Notifications

195A Grossing up of tax ~ when payment is on “net of tax”195A basis

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Section 195(1)

‘Any person responsible for paying to a non-resident, not being a company,

or to a foreign company, any interest or any other sum chargeable under

the provisions of this Act (not being income chargeable under the head

“Salaries”) shall, at the time of credit of such income to the account of the

payee or at the time of payment thereof in cash or by the issue of a cheque

or draft or by any other mode, whichever is earlier, deduct income-tax

thereon at the rates in force…”

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Section 195(1) – Persons covered• Payment by “any person”

– Includes Individuals and HUFs

– Includes Non-residents and Foreign Companies

– Includes a person having no taxable income or income not taxable in India

• Payments to non-residents– Includes all Non-residents having presence in India or not

– It does not include RNOR

• Any sum chargeable to tax– Does not apply to any and every payments

– Does not apply to salary payments and exempt dividends

• Payment by non-resident to another non-resident? – Highly controversial– Section 1 extends to the whole of India

– Theory of “Extra Territorial Jurisdiction” gets invoked

– Circular No. 726 of 18 October 1995

– Practically Tax Authorities insist upon tax withholding relying on various judgments

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Section 195(1) – Sum chargeable to tax• Payments to Non-residents (other than salaries), which are chargeable to tax

under the Act, are covered under Section 195

• Chargeability under the Act – Scope of Total Income: Sec 5 & Sec 9– Received or deemed to be received in India

– Accrue or arises or deemed to accrue or arise in India

• Income deemed to accrue or arise – Section 9: Some instances– Income through or from any business connection in India or from any property in India

or from any asset or source of income from

– India [Section 9(1)(i)]

– Salary Income [Section 9(1)(ii)]

– Interest Income [Section 9(1)(v)]

– Royalty Income [Section 9(1)(vi)]

– Fees for technical services [Section 9(1)(vii)]

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Section 195(1) – Sum chargeable to tax

• If payment is not chargeable to tax, the provisions are not attracted:– Circular No. 786 dated 7 Feb. 2000 (taxability of export commission payable to non-

resident agents rendering services abroad)

• Illustrations payments to Non-residents not chargeable under the Act:– Payments on capital account, for example, gifts, loans, repayment of loans, etc.

– Sums which are on revenue account and which are not chargeable to tax at all under the Act in the hands of the recipient

– Sums which fall within the scope of Section 5 of the Act, but which are expressly exempt under the Act. for example, dividend income

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Section 195(1) – Rates in Force

• S 2(37A)(iii)– Rates of income-tax specified in the Finance Act or the rates specified in the DTAA,

whichever is applicable by virtue of S 90 or S 90A

– The beneficial rates to be applied• CBDT Cir. No. 333 in 1982 and Cir. No. 728 in 1995

• Does rates prescribed under DTAA to be increased by surcharge and Education Cess?

Lower of the two rates:– Relevant rates in force prescribed by the Finance Act; or

– Rates under Tax Treaty [rate prescribed is the maximum rate including Surcharge and Education Cess]

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Section 195(1) – Treaty Override

• Beneficial provisions of the ITA or tax treaty can be applied by the non-resident– Section 90(2) of the ITA

– CBDT Circular No. 333 of 1982

– CBDT Circular No. 728 of 30 October 1995

• Difference in scope of taxation between ITA and tax treaty– Royalty

– Fees for Technical Services

– Business Income, etc.

– Income from international shipping and Aircraft business

– Interest, etc.

• Difference in rates of tax between ITA and tax treaty

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Section 195(2)

• Compliance under Section 195(2):– Application to be made to AO when payer considers whole of sum is not income

chargeable to tax– AO to determine the portion of payment chargeable to tax and issue a certificate

accordingly– The payment to non resident also permitted by obtaining CA certificate

• Remedy for Non-Resident payee:– Section 195(3) / Section 197– Application to be made by payee– Application to AO for grant of certificate for receipt of income without deduction of tax at

source

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Section 195(2) – Certificate of CA

• Certificate of a Chartered Accountant certifying the tax withholding amount– Circular by the RBI– Circular No. 759 of 18 November 1997; Circular No. 767 of 22 May 1998 and Circular

No. 10/2002 of 9 October 2002

– Form of Undertaking and Certificate substantially revised

• Specific aspects of the Certificate– Clause 1 ~ Name and address of the beneficiary of remittance

• Beneficiary of income v. beneficial owner– Clause 7 ~ Answer to four specific questions supported by reasoning

• Nature of payment, existence of a PE, Attribution of income to such PE– Advisable that the certificate should be properly reasoned to mitigate penal exposures

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Section 195(3) & 195(4) - Reference to AO for No deduction

• Payee satisfying certain conditions can make an application for receipt of any amount without deduction of tax at source

• Prescribed conditions include (Rule 29B):– Has been regularly and assessed to Income-tax– Not in default or deemed to be in default in respect of Tax, interest, fine or any sum

payable under the Act– Has not been subjected to penalty for concealment of particulars of income.– Where not a banking company:

• Has been carrying on business or profession in India continuously for at least 5 years

• Value of Fixed Assets in India exceeds Rs. 50 Lacs

• Certificate issued by the AO valid for the Financial Year mentioned therein

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Section 195A – Grossing Up

• Applicable to all agreements entered into with non-resident from June 2002

• For the purpose of deduction of tax, income to grossed-up (proportionately increased) when tax chargeable on that particular income is to be borne by the payer of the income

• The proportionate increase in the income should be such an amount as would, after deduction of tax thereon at the rates in force be equal to the net amount payable under such agreement or arrangement.

• Section 195A not applicable to:– income referred to in Section 192(1A)– when profits are computed under presumptive Sections – Section 44B, Section 44BB,

Section 44BBA and Section 44BBB

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Refund of Tax Withheld under Section 195

• Person making payment is entitled to claim refund in prescribed cases

• Circular No. 769 of 6 August 1998 revoked and replaced by Circular No. 790 of 2 April 2000

• Circular No. 7/2007 on 23 October 2007 widens the scope– Contract is cancelled and no remittance is made to the nonresident– Remittance is made to the non-resident but the contract is cancelled – Remitted

amount should have been returned – the contract is cancelled after partial execution and no remittance is made non-

executed part– there occurs exemption of the remitted amount from tax either by amendment in law or

by notification under the provisions of ITA– An order is passed under section 154 or 248 or 264 reducing the tax deduction liability

of a deductor under section 195– Deduction of tax twice from the same income by mistake– Payment of tax on account of grossing up which was not required– Payment of tax at a higher rate under the domestic law while a lower rate is prescribed

in the relevant double taxation avoidance treaty entered into by India

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Refund of Tax Withheld under Section 195

• Refund can be granted to the payer with the approval of the Chief Commissioner or the Director General

• Refund is first adjusted against any income-tax or wealth tax or any direct tax liability

• Interest under Section 244A is not payable on such refunds

• Undertaking to be given by the payer that TDS certificate has not been issued

• Corresponding amount payable to non-resident is disallowed

• Claim should be made within 2 years from the end of the FY in which tax has been deducted

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Section 195 and Section 197

Section 195• 195(2) provides that if a payer of

any sums considers that any portion would not be liable to tax, he can make an application to AO to determine the proportion liable

• Section 195 determines the portion of income liable to tax withholding

• Application under section 195(2) is to be made by the payer, and under section 195(3) by the payee

• Order under section 195(2) can be appealed under section 248, provided the payer is liable to bear the taxes and have paid such taxes

Section 197• Section 197 provides that a

payee( non-resident), if he considers that tax withholding can be at the ‘nil’ or lower rate, can approach the AO to determine the rate

• Section 197 determines the rate for tax withholding

• Application under section 197 is to be made by the nonresident payee

• Application to be made before the payment/ credit, whichever is earlier

• There is no provision under Chapter XX of the Act, to appeal against the order under section 197

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Non Compliance

• Refund can be granted to the payer with the approval of the Chief Commissioner or the Director General

• Disallowance of payments to non-residents under Section 40(a)(i)– Tax deductible but not deducted or after deduction not paid before the due dates– Allowable in the year of payment

• Disallowance of salary payments to a person outside India or a non-resident under Section 40(a)(iii)– Tax is not paid thereon nor deducted there from

• Disallowance of interest and salary to non-residents under Section 58(1)(a)(ii) and Section 58(1)(a)(iii)

• Levy of interest under Section 201(1A) - simple interest @ 1% p.m. or part thereof

• Levy of penalty– Section 221 - Failure to pay tax

– Section 271C - Failure to deduct tax

• Invoking of prosecution under Section 276B

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Vodafone International Holding B.V., 2008-TIOL-602-HC-MUM - Key Arguments

• Section 201 – Vodafone is not an ‘Assessee in Default’ as:– It had not failed to Deduct and failed pay the tax deducted– HTIL was not called upon to pay tax– The 2008 retrospective amendment to Act was Unconstitutional

• Section 195 – Territorial Operations– Does not apply to non-residents having no presence in India

• Section 9(1)(i) – No income chargeable to tax in India– The transfer is between two Non-residents of a Foreign Company’s shares with

payment received / settled outside India– No transfer of capital asset situated in India– Share capital is situated at the registered office i.e. overseas– Controlling interest is not distinct from shares but incidental

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Vodafone - Tax Authorities’ Key arguments

• Writ Petition Not maintainable at the stage of SCN as:– SCN was not totally non-est– Withholding tax is provisional and does not infringe the right of Vodafone– Writ was pre-mature since Vodafone had an efficacious remedy

• Section 201– Vodafone is an ‘Assessee in default’ as the conditions of deduction and payment are

not cumulative

• Section 195– Not invoked extra-territorially in this case as the transaction has a clear nexus to

income or property or asset in India– Agreement dated 11 Feb 2007 not produced – essential facts undisclosed

• Section 9(1)(i) – There is income chargeable to tax in India– The subject matter of the transaction is not shares of a shell overseas company but

transfer of interests, tangible and intangible in an Indian company– There is no need to pierce the corporate veil as Vodafone itself has not disputed the

above fact before various authorities and now could not take a separate stand for income-tax purposes

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Vodafone Bombay High Court Ruling

• Writ was pre-mature since Vodafone had an efficacious remedy Strong prima facie case that :– Transaction was one of transfer of capital asset situate in India– Too simplistic to hold that Vodafone merely acquired the shares of an unknown

Cayman Island Company– The purpose was to acquire controlling interest in the Indian Company

• The ‘Effects Doctrine” approved and relied upon

• Vodafone has not been able to demonstrate that the SCN is ‘non-est’ and there is absolute want of jurisdiction of the authorities

• Vodafone’s interests are fully safeguarded by Section 195 / 197 of the Act and has other efficacious remedies – assessment, appeal

• Vodafone has failed to produce the relevant document without which it is impossible to appreciate the true nature of the transaction

• The High Court dismissed the Writ Petition with costs to the Tax Authorities with stay for eight weeks

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Vodafone Supreme Court Ruling dated 23January 2009, [2009] 221 CTR 617 (SC)

• SC directs Vodafone to respond to the Tax Department’s Show Cause Notice, expressing displeasure on non-production of relevant document

• Assessing Officer to determine the Jurisdictional Issue

• Vodafone allowed to approach High Court directly to appeal against Order of Assessing Officer

• Decisions have created Uncertainty coming at an Inopportune time when Investment Climate has considerably worsened

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Case study for discussion

Case Study

A Ltd. is in the business of providing telecommunication services to its customers in India. It has entered into an agreement with M Pte. Ltd., a Singapore company by which customers of A Ltd. would be able to send and receive SMS from a subscriber outside India. The SMS Center of M Pte Ltd., through which message would be transmitted is situated outside India. The messages to SMS Center would be transmitted through the Internet. Whether payment made by A Ltd. to M Pte. Ltd. outside India would be liable to tax in India?

Taxability under ITA.

Ref: Provisions of s 9 (1)(vi) and similar definition in treaties Decision of the Madras HC in case of Skycell Communication Ltd. (251 ITR 53)(Mad.)

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Case Study for discussion

Case Study

B Ltd. has entered into Reseller Agreement with L Inc., an American Company, whereby B Ltd. would be reselling ‘Web Conference Services’ provided by L Inc. to the Indian Customer. Indian Customer in India will not be provided with any equipment etc. but would be provided user id and a password. By using this user id and a password, the customer of B. Ltd. in India would be able to view live presentation of seminar held by their parent company outside India through their own computers. Further with this user id and password, the said presentation can be viewed on different 100 locations on the customer’s own computer through Internet.

Taxability under ITA

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Case study for discussion

The question that arise is whether payment made by B Ltd. to L Inc towards this web conference charges is liable to tax in India under ITA.

Whether payment can be categorised as “fees for included service” under Article 12 of DTAA.

Ref: Decision of Skycell Communication Ltd. (251 ITR 53)(Mad.)

Report of High Powered Committee on E-commerce (251 ITR

(St.) 118) Category 26 ( Real time web based broadcasting)

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Thank You