Tax Deduction at Source (TDS)

- Payment to non-residents

Akhil Sambhar Abhishek Chawla

May 16, 2007

Need for TDS

May 16, 2007

Withholding Tax
Ensure regular flow of income for the Revenue Collect tax in advance Minimizes cases of tax evasion or avoidance

Why TDS?

Minimizes incidence of interest costs for the recipient Place responsibility on the persons other than payees

Pay as you earn scheme Deduction at the time of payment or credit whichever earlier Deposit within one week from end of month of deduction Income credited/ paid on last day of financial year, tax withheld deposited within period of two months from last

Overview

day Default attracts

Disallowance of expenses Penal Interest Penalty Prosecution

May 16, 2007

Payment to Non Residents

May 16, 2007

Section 195 Payment made to Non Residents

Section 195 deals specifically with payments to foreign companies and other non-residents.

Foreign Cos
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Non-Residents

Section 195 Payment made to Non Residents

Nature of payment
All payments (except salary) chargeable under the Act

Responsibility to deduct tax

Any person

Rate of TDS
Rates in force
It means rate under the Act or DTA, whichever is more beneficial to the assessee to be applied

Time of deduction of tax

Date of payment or credit, whichever is earlier

May 16, 2007

Section 195 Payment made to Non Residents

Points for consideration
Form for making application to AO seeking authorizing for payments to a non-resident Refer circular No 695 Lower withholding orders Only for payer; if the payer considers that the whole of such sum would not be chargeable to tax , an application can be made to the AO to determine the proportionate amount so chargeable (sub-section 2) Person to whom interest or other sum is payable, may make an application in Form 13 and obtain certificate for receiving payment of income without deduction of tax (sub-section 3) Validity of certificate the certificate shall remain in force till the expiry of the period specified therein or on cancellation, whichever earlier (sub-section 4) The payment to non resident also permitted by obtaining CA certificate Refer circular No 759, read with circular No 10/2002 dated 9-10-2002 Conditions for Non-resident (Recipient) making an application u/s 195 Person has been regularly assessed to income tax in India and furnished all returns which became due He is not in default in respect of any tax, interest, penalty, fine or other sum payable under the Act He has not been subject to penalty under section 271 Person other than a banking company has carried on business in India for a period for not less than 5 years and the value of assets as on the previous year for which accounts were last drawn exceeds 50 lakhs

May 16, 2007

Section 195A - Income Payable Net of Tax

Section 195A - Agreements for payment of income Net of Tax
Tax to be deducted after grossing up of the net payment to be made

Points for consideration

Payer is under legal obligation to furnish certificate for the tax deducted at source within time prescribed to the payee Tax withheld and deposited shall be income in the hands of recipient as per section 198

May 16, 2007

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

vs

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 non- resident payee Application to be made before the payment/ credit, whichever is earlier

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

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

May 16, 2007

Section 198 and 199

Tax deducted is income received Section 198 Credit for Tax deducted Section 199

TDS deemed to be the income received Tax paid on non monetary perquisites not deemed income

Tax deducted treated as payment on behalf of person Credit available for TDS deducted No requirement to furnish TDS certificate on or after 01/04/2008

Is excess payment can be refunded

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May 16, 2007

Controversies

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May 16, 2007

Section 195 Payment made to Non Residents

ISSUES
Whether agreement which is void in law give rise to an enforceable debt and consequently there is an obligation on the part of the payer to deduct taxes on crediting such income Does Section 195 cover payments made by non-resident to another non- resident outside India

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May 16, 2007

Section 195 Payment made to Non Residents

ISSUES
Is refund possible? If after withholding and depositing TDS u/s 195 The contract with non-resident is cancelled and no remittance is to be made to the non-resident, or Remittance is made to the non-resident and thereafter the contract is cancelled and remitted amount is returned;

Additional conditions to be fulfilled: Prior approval of jurisdictional CCIT is required;

Undertaking is furnished to AO that no TDS certificate is issued or the certificate so issued has been taken back from the non-resident payee

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May 16, 2007

Whether trading receipts subject to TDS?

Trading receipts are subject to TDS [Transmission Corporation Ltd & other v CIT] (239 ITR 587) (SC)
Assessee entered into 2 contract with various non-residents for: supply of machinery and equipment assembling, erection, testing and commissioning of machinery and equipment Assessee did not deduct TDS on payments made to non residents Assessee contended that any other sum chargeable do not contemplate the inclusion of trade receipts in their ambit and section 195 applies only to cases where the sums paid are pure income profits

Facts

Issue
Whether section 195 is applicable only where the sums paid are pure income profits and not where the gross sum includes other costs

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May 16, 2007

Whether trading receipts subject to TDS?

Decision
The scheme of tax deduction at source applies not only to the amount paid which wholly bears "income" character such as salaries, dividends, interest on securities, etc., but also to gross sums the whole of which may not be income or profits of the recipient, such as payments to contractors and subcontractors and the payment of insurance commission. The consideration would be whether payment of the sum to the non-resident is chargeable to tax under the provisions of the Act or not ? That sum may be income or income hidden or otherwise embedded therein. If so, tax is required to be deducted on the said sum, what would be the income is to be computed on the basis of various provisions of the Act including provisions for computation of the business income, if the payment is a trade receipt. However, what is to be deducted is income-tax payable thereon at the rates in force

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May 16, 2007

Sale of software: Whether subject to TDS

Issue: Whether to deduct taxes in case of outright sale of software
In view of judgments discussed earlier, whether it can be said that there is no liability to deduct taxes in transactions involving sale of software Alternative courses of action available:
Application to AO to obtain a Nil withholding tax rate order/ order for lower withholding tax rate Application to AAR for determining liability to withhold tax in such transaction

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May 16, 2007

Appropriate alternative: Withholding Tax order?

No need to approach AO every time [Indopel Garments (P) Ltd V CIT (86 ITD 102) (Madras ITAT)]
Assessee engaged in the business of exports makes certain payments as sales commission abroad. The amount was disallowed by AO u/s 40(a)(i) on account of non-deduction of tax

Facts

Decision
Commission paid to non-resident for services rendered abroad does not accrue or arise in India and is not liable to deduction of tax u/s 195. No disallowance was to be made u/s. 40(a)(i), since no income chargeable to tax in India arose to the NonResident. It was not necessary to make an application u/s. 195(2) to the AO. An application u/s. 195(2) will be necessary where the payer considers that portion of the payment will be chargeable to tax in India.

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May 16, 2007

Appropriate alternative: Withholding Tax order?

Withholding tax order is a must [Cheminor Drugs Ltd. Vs ITO (76 ITD 37) (Hyderabad ITAT)]
Appellant engaged in the business of exports makes certain payments as legal expenses as well as sales commission abroad. AO treated the appellant as assessee in default u/s 201 on account of non-deduction of tax

Facts

Decision
AO justified in treating the appellant as assessee in default. If the appellant had genuine belief that the payments are not chargeable to tax in India, the appropriate course of action for him would have been to make an application before the AO to obtain a Nil withholding tax order.

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May 16, 2007

Appropriate alternative: Withholding Tax order?

The assessee must apply to the AO to obtain a withholding tax order

Satellite Television Asian Region ltd. Vs CIT (99 ITD 91) (Mumbai ITAT)
Appellant engaged in the business of sale of air time meant for advertisement acquired from television channel companies like Star Plus, Star Movies, Star World, Star News, Channel V, etc through its advertising agent in India. AO disallowed the sum paid by the assessee company to various channel companies towards the cost of Ad Airtime purchased from them u/s 40(a)(i) for non- deduction of TDS u/s 195

Held: Channel companies are liable for taxation in India for that part of income earned by them. Assessee company was obliged to deduct tax u/s 195 while making payments to the channel companies against the purchase of "Ad Airtime". In the circumstances, the assessing officer is justified in disallowing those payments u/s 40(a)(i) of the Income-tax Act, 1961. Alternative of making application to AO seeking withholding tax rate is always available to the appellant.

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May 16, 2007

Appropriate alternative: Withholding Tax order?

The assessee must apply to the AO to obtain a withholding tax order

ITO, Chennai vs. Poompuhar Shipping Corpn Ltd (Madras ITAT)

Appellant engaged in business of transport of coal from various ports in India. For the transportation of coal the assessee charters vessels from India as well as from Foreign Shipping Companies. While remitting the charter payments to the foreign shipping companies, the appellant did not make deduction in respect of withholding tax, which was later on disallowed by AO u/s 40(a)(i) for nondeduction of tax u/s 195.

Held: Assessee cannot suo moto presume that a payment is not taxable as there is a provision in the law to seek direction from the Revenue. Revenue's decision to treat the assessee in default u/s 201 upheld. Alternative of making application to AO seeking withholding tax rate is always available to the appellant.

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May 16, 2007

Reimbursement of cost allocation

TDS to be deducted from gross payments for rendering services Element of profit not relevant - (Danfoss Industries Pvt Ltd.) (268 ITR1)(AAR)
The applicant, an Indian company has proposed to enter into an agreement with Danfoss Singapore (DS), a foreign company which provided services to a group of companies including the Indian company. The consideration for availing of those services was a service fee based on the portion of the services it received in relation to the total costs of DS in providing such services.

Facts

Issue
Whether the payment to be made to the foreign company as fee for services would be subject to withholding tax under section 195 of the Act.

Decision
that in the absence of break-up of the cost incurred by DS in providing services and the fees payable by each individual company, the only possible conclusion was that there was no direct nexus between the actual cost incurred by the foreign company in providing the services to a company of the group of companies and the fees payable by each individual company which availed of the services; therefore,, the payments towards the service charges would be subject to the withholding taxes.

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May 16, 2007

Reimbursement of cost allocation

TDS to be deducted from gross payments fro rendering services Element of profit not relevant [Timken India Limited in re (273 ITR 67 (AAR)]

Facts
The applicant, an Indian company, was engaged in the business of manufacture and sale of bearings and other ancillary products and is a subsidiary of Timken-USA, a foreign company Under the agreement, the foreign company was to render services in USA which included management services, system development and computer usage, communication services, engineering services process in tool design services, and manufacturing services, etc. The agreement provided that the compensation payable by the applicant to the foreign company for services would cover only the cost actually incurred by it and that no profit element or mark-up on the cost would be added to it

Decision
It was ruled by the Authority that irrespective of there being a profit or income in the hands of the foreign company, the amounts payable by the Indian company would be subjected to tax in India and it was obliged to withhold tax at the appropriate rate under the Act or the Treaty, whichever was lower, under sec. 195 of the Act. Here also, the plea that the payment was nothing but reimbursement of expenditure was not accepted. There relying upon Danfoss case, the plea of the applicant that there was absence of profit element and that payments represented the reimbursement of actual expenditure, was rejected. Thus, this ruling also does not advance the case of the Revenue.

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May 16, 2007

Reimbursement of salary costs

'Reimbursement' of salary cost to non-resident company for assigning employees to Indian operations is taxable as fees for technical services - AT&S India Private Limited (287 ITR 421)(AAR)

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May 16, 2007

Supply of equipments: Whether subject to TDS

Taxability of Offshore supply of equipments
Offshore supply of equipment is a contract of sale and not taxable in India [Ishikawajima-Harima Heavy Industries Ltd. vs DIT (2007) (SC)
Appellant entered into a turnkey contract with an Indian company for setting up a LNG receiving and storage facility, which involved various activities including Offshore supply of equipments, wherein the sale was executed outside India and payment for such equipments was made outside India. The apex court ruled that since all parts of the transaction [transfer of property in goods as well as the payment] were carried on outside India, the transaction cannot be taxed in India.

Supply of equipment including installation is a contract of sale and not a turnkey contract [A.P. Power Generation Corporation Ltd v ACIT (107 TTJ 685) (Hyd)
Assessee entered into a contract with a Japanese company for supply of equipment and supervisory charges of such machinery Assessee did not deduct TDS on remittance made to the supplier. The tribunal observed on the basis of clauses in the contract, that the power project was constructed by the assessee itself and only certain plant and machinery were purchased from Jaspanese company. It further held that more than 80 percent of the activities had been undertaken in Japan and the contract in essence was sale of equipments and therefore no income could be deemed to accrue or arise in India.

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May 16, 2007

Supply of equipments: Whether subject to TDS

Issue: Whether to deduct taxes in case of offshore supply of equipments
In view of judgments regarding non-taxability of offshore supply of equipments, whether it can be said that there is no liability to deduct taxes in transactions involving such offshore supply Alternative courses of action available:
Application to AO to obtain a Nil withholding tax rate order/ order for lower withholding tax rate Application to AAR for determining liability to withhold tax in such transaction

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May 16, 2007

Supply of software as part of hardware

Lucent Technologies (ITAT Bangalore): Facts
Assessee is a limited company engaged in the business of manufacture and sale of electronic switching systems required for telecommunication industry. During the relevant financial years, assessee imported certain hardware and software from its non-resident group companies without deduction of tax at source. Consequently, assessee was treated as assessee in default for failure to comply with the provisions of section 195 of the Act

Decision
Acquisition of software was inextricably linked to acquisition of hardware and one cannot function without the other - thus this is purchase of an integrated equipment

Assessee had purchased a copyrighted article and not copyright of the rights; therefore, it is wrong on part
of Revenue to treat purchase of software as an independent transaction, therefore payments cannot be regarded as royalty

Therefore no TDS under section 195 of the Act is required to be deducted

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May 16, 2007

Sale of shrinked wrapped software

Lotus Development (Delhi ITAT): Facts
Lotus Development Corporation (LDC) , USA
100% WOS 100% WOS

Lotus Development International Corporation (LDIC) , USA

International Business Machines Corporation (IBM)

USA

Lotus Development (Asia Pacific) Pte Ltd. (LDPL) , Singapore

Distribution of shrinked wrapped software

Rights to license and distribute IBM and Lotus programs

Singapore

Market support services

India

Independent distributors
Sale of shrink wrapped software End Users End Users End Users

Branch

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May 16, 2007

Sale of shrinked wrapped software

Stand of Revenue Authorities - Sale of shrinked wrapped software is Royalty
Computer software is licensed and not sold Computer programme is a secret process and consideration for the same is Royalty Software could also be considered as information concerning scientific experience the consideration of which would be in the nature of Royalty Software can also be treated as Invention the consideration of which would be in the nature of Royalty

Decision (Delhi ITAT)

Revenues from distribution of shrink wrapped software are business profits and cannot be considered as royalty under the Act or DTAA for reasons as under
End user of software does not get any license to duplicate software and there is no transfer of intellectual property rights in the software to the end users. The original knowledge in the software (used in developing the software) remains protected and is not transferred to the end users (Special Bench judgment of Delhi ITAT in case of Motorola relied) Sale of computer software cannot be considered as transfer of copyright in secret formula, process, information containing scientific experience as in this case the end user does not get access to knowledge to develop or manufacture the software (OECD Commentaries relied).

Therefore, in such a case, there is no need to deduct TDS.

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May 16, 2007

Other issues
Where capital gains arising on transfer of shares of Indian company on account of global reorganization are exempt under the provisions of the Tax Treaty, no taxes are required to be withheld under section 195 by transferee company

(Vanenburg Group B.V. - A.A.R. No.727 OF 2006)

Periodical payments (being Royalties and fees for included services), made to the non-resident person, having no office/establishment in India, in connection with the use of software developed by him on internet are subject to tax deduction at source, under DTAA with USA.

(IMT Labs (India) Pvt Ltd (287 ITR 450)

The payments made by the Indian subscriber to a non-resident at Singapore, for providing a password to access and use the portal hosted from Singapore, are taxable in India and subject to deduction of tax at source. (Cargo Community Network Pte Limited (A.A.R. NO. 688 OF 2006)

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May 16, 2007

Miscellaneous Provisions of TDS

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May 16, 2007

Withholding Tax Compliance Calendar

Filing of quarterly statements - TDS returns in Form 24Q (in case of salaries) and Form 27Q (in cases
of payments to non-residents) to be filed as under :

Quarter ended

Form 24Q

Form 27Q

June 30

July 15

July 14 October 14 January 14

September 30 December 31

October 15 January 15

March 31

June 15

April 14/ June 15 *

* Only with respect to provision entries made on March 31 Annual Returns of TDS not required to be filed on or after April 1, 2005

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Consequences of Failure to Deduct or Pay

Penalty under *Section 271C

Non deduction or failure to pay TDS

Interest under *Section 201(1A)

*Penalty under Section 221 and prosecution Section 276B

Disallowance of expenses u/s 40(a)(i)

* Section 201(1A) Consequences of failure to deduct or pay Section 221 Section 271C Section 276B Penalty payable when default in payment of tax demand Penalty for failure to deduct tax at source Prosecution for failure to deduct tax at source (3 months 7 years)

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May 16, 2007

Penal Provisions
Section No
271C 272A(2)(c) 272A(2)(f) 272A(2)(g) 272A(2)(i) 272A(2)(k)

Nature of defaults
Failure to deduct the whole or any part of tax at source Failure to file the return of TDS under section 206 Failure to deliver in time a copy of declaration in Form No. 15G/15H Failure to issue TDS Certificate Failure to furnish a statement as per section 192(2C) Failure to deliver copy of the quarterly statement within the time specified under section 200(3) Failure to deliver the quarterly statement within the time specified under section 206A(1) Failure to apply for allotment or false quoting TAN/ TCN Failure to pay TDS to the credit of central government

Penalty
Sum equal to the amount of tax Rs 100 for every day of failure but limited to tax deductible Rs 100 for every day of failure but limited to tax deductible Rs 100 for every day of failure but limited to tax deductible Rs 100 for every day of failure Rs 100 for every day of failure

Officer who shall impose the penalty

Joint Commissioner Joint Commissioner Chief Commissioner Joint Commissioner Joint Commissioner Joint Commissioner

272A(2)(l)

Rs 100 for every day of failure

Joint Commissioner

272BB 276B

Rs. 10,000 Punishable with imprisonment term between 3 months to 7 year

Assessing officer Previous sanction of Commissioner

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May 16, 2007

Thank You!
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