Majmudar & Co discusses the latest withholding tax implications for foreign entities after the landmark ruling of the Supreme Court in the case of GE India Technology that in effect overrules the Karnataka High Court’s Samsung decision and provides a reprieve from the obligatory TDS payment and deduction on foreign remittances with no India nexus.

The Supreme Court of India has held that any payments made to non-residents will be subject to withholding tax only when such payments are chargeable to tax in India in its 9 September 2010 judgment pronounced in the case of GE India Technology Centre Private Ltd Vs CIT.

Meanwhile, it may be recalled that the Karnataka High Court in the Samsung case had earlier stated that any person making a payment for the import of shrink wrap software was under a statutory obligation to deduct tax at source.

Hence, by implication all payments for the import of any goods, irrespective of their chargeability to tax in India, became subject to withholding tax to the detriment of the foreign party.

The only way to avoid the tax withholding was to make an application to the Indian tax authorities and obtain a written permission that the payer need not deduct taxes at source.

Background

In the Samsung case, the appellants imported pre-packaged shrink wrapped standardised software from Microsoft and other suppliers outside India by making payments for such imports.

The Indian tax authorities contended that the payments for supply of software being akin to license fees were in the nature of royalty and the appellants were liable to withholding tax as such royalty payments deemed to accrue or arise in India.

On this contention, the appellant preferred an appeal to the Income Tax Appellate Tribunal which held that the amount paid to the foreign software suppliers was not in the nature of royalty payments that would give rise to taxable income in India. Accordingly, the appellants were not liable to withhold tax at source on payments made to the offshore suppliers.

The tax authorities appealed against the tribunal’s order to the Karnataka High Court with an additional ground of appeal to make the payer statutorily liable for filing a nil withholding tax certificate. Further, the tax authorities contended that unless permission for non-deduction of tax was granted by them, the payer was required to deduct tax at source. However, the high court did not address the question of taxability of the payments, but accepted the additional contention of the tax authorities and ruled in their favour. The Karnataka High Court’s ruling necessitated the appellants to prefer an appeal to the Supreme Court.

Questions before the Supreme Court in the GE India Technology Centre Private Ltd Vs Commissioner of Income Tax Case

The following two questions were placed before the Apex Court:

1. Whether the Karnataka High Court was right in holding that the obligation to withhold tax arose the moment there was a remittance?

2. Whether merely on account of such remittance to a non-resident, could it be said that such a remittance was income chargeable to tax under the Act?

Decision of the Supreme Court

1. The Supreme Court held that the expression “sums chargeable under the provisions of the Act” in Section 195(1) of the Income Tax Act 1961 (Act) is the crucial determining factor.

2. The phrase “sums chargeable” under the provisions of the Act refers to the amounts that have an element of income in them as required under the provisions of the Act and the treaty provisions.

3. The Supreme Court rejected the contention of the tax authorities that the assessees have to make an application in every case of remittance even when the income has no territorial nexus with India or is not chargeable in India.

4. The Supreme Court also observed that accepting the contention of the tax authorities would lead to the obliteration of the expression “sum chargeable under the provisions of the Act” as given under Section 195(1) of the Act.

5. The Supreme Court held that any person paying any sum to a non-resident is not liable to deduct tax if such sum is not chargeable to tax under the Act.

Majmudar & Co views that the Supreme Court judgment will put an end to the controversy created by the Karnataka High Court on the need to withhold taxes even when the underlying payment was not chargeable to tax in India.

This decision will also result in avoiding unnecessary litigation on the applicability of withholding tax obligations in India.

Samsung’s and the GE case’s relevance

The Samsung case touches upon the topic of extra-territorial operation of the Income Tax Act (highlighted in the Vodafone judgment of the Bombay High Court). It relates to the obligation of the payer to deduct and deposit TDS in relation to remittances made to foreign parties who do not have any permanent establishment in India and, therefore, are not taxable under the Income Tax Act.

Why this judgment is important is because a large number of remittances are made to foreign parties from India, on which the tax department has imposed interest and penalty for the payer not having deducted TDS.

In this case, the companies argued that no part of the payees’ incomes arose in India nor did they have a permanent establishment in the country. Furthermore, the income was exempt under double taxation avoidance agreements. In view of the foregoing, the Supreme Court reversed the judgment of the Karnataka High Court holding that it was not correct to say the moment a remittance was made to a foreign party, tax became deductible under the provisions of Section 195 of the Income Tax Act.

The authors are Majmudar & Co principal in tax Ravishankar Raghavan and corporate, M&A and tax associate Shikha Parakh, as well as corporate associate Anthony Toppo.