All overseas payments are subject to withholding tax, whether or not the income is taxable : Karnataka High Court

Due to  recent ruling  of Karnataka High Court order, all overseas payments will now be subject to withholding tax, whether or not the income is taxable. Not only is this in dramatic contrast to previous High Court decisions, it’s also a judgment that will lead to higher cost of business, increased uncertainty and maybe even more litigation—at least for a while.
Bombay High Court, 2002  A 2-member bench overturned the Income Tax department’s claim that automaker Mahindra and Mahindra (M&M) should withhold tax on overseas payments to an overseas supplier.

Rajasthan High Court, 2008  Another important tax judgment held that the State Bank of India (SBI) need not deduct tax on interest payment to non-residents, as the interest payments were not part of taxable income.  In fact, across the country, income tax tribunals too have held that tax must be deducted at source only on those overseas payments which constitute income in the hands of the non-resident.

Pranav Sayta, Partner, E&Y:  The law itself as it reads, which is Section 195, specifically says it is a sum which is chargeable to tax under the Income Tax Act on which tax has to be deducted at source, if that payment of course is being made to a non-resident. Based on that, for example, the Rajasthan HC in the SBI case has taken a view that if income is exempt under provisions of the Indian Income Tax Act, one does not need to withhold tax at source at all when the payment is being made to non-resident of such an exempt income.
But now, a judgment by the Karnataka High Court has turned this established principle on its head.

The case before the court involved multiple software companies, including Samsung, HP and GE India that were importing shrink-wrapped software from overseas suppliers.

The software companies did not deduct tax at source while remitting payments overseas, as they did not deem the income to be taxable in India.

But Revenue disagreed!  It held that the payments made were royalty, and hence taxable in India.

It also held that it was not up to the taxpayer to decide whether or not the payments made could be classified as income or not. In fact, the department claimed that under Section 195 of the Income Tax Act, tax must be deducted at source for all overseas payments.

Last week, the Karnataka High Court upheld this view. It ruled that tax must be withheld on all overseas payments, even if the payment is likely to be eligible for lower or nil withholding tax. In short: pay now, apply for refund later.

Abhishek Goenka, Partner, BMR Advisors:  The concept of withholding has been that what taxes are due must be collected upfront because the revenue does not have the wherewithal to go after non-resident receivers of income and therefore the tax must be collected at the stage of the payment itself. I don’t think any dispute anyone has with that principle. But if we extend that principle to say that everyone must pay tax, pay tax at the highest rate and then it is the obligation of the receiver to file returns, claim refunds and fight out the battle, it makes doing business in India extremely complicated.

It is extremely complicated for all kinds of companies in almost every overseas transaction.

For instance, currently, an Indian company making payments to a Cyprus or Mauritius based entity would be eligible for nil withholding tax under the Double Tax Avoidance Agreements.

But this High Court ruling says ignore the treaty benefits, tax has to be withheld.

In fact, tax benefits accruing under domestic law will also be ignored.

For example, income received by foreign institutional investors (FIIs) upon sale of shares in India is, by law, exempt from long terms capital gains tax. But, this judgment makes such remittances liable to withholding tax.

And finally, tax would also have to be deducted at source for simple transactions like the import of goods, which are today tax exempt if the exporter does not have a permanent establishment in India.

For companies like Mindtree, that’s bad news.

Rostow Ravanan, CFO, Mindtree:  Let’s assume Mindtree buys a computer for USD 100 from a supplier based in Malaysia or Singapore or US, that supplier will expect to get USD 100. He will not want to suffer that 5-10% TDS in India. So it will push up cost of business for everyone. There is also confusion because in the past, under certain circumstances, you could make remittances supported by a chartered accountant’s certificate that the tax has been deducted at the correct rate or at zero or whatever. Now it looks like that entire process which everyone was following no longer holds good.

And that’s ironic—earlier taxpayers had to obtain a no objection certificate (NOC) from the tax department for every overseas payment. In 1997, to ease the process, the department allowed overseas remittances supported by a CA’s certificate.

Now, the Karnataka High Court has reversed that position by maintaining that an assessing officer’s consent must be obtained for every lower or nil withholding tax position! That’s bound to bring back the delays.

Abhishek Goenka, Partner, BMR Advisors:  Timing is constraint and it’s not a small constraint. Because if for every payment you have to go to revenue, and we are really looking at revenue officers who are dealing with lakhs of applications and there is no way they can deal with it within the timelines that companies need to have in place to have their business go on.

Pranav Sayta, Partner, E&Y:  Irrespective of how it is finally resolved and we believe it would be resolved in the manner that Rajasthan High Court has held in SBI. But irrespective of how it is finally resolved, in the meantime there is likely to be significant litigation on this point.

Significant litigation-but hopefully that won’t last too long. Sources say the concerned parties in this Karnataka High Court case are now taking their case to the Supreme Court. Hopefully the apex court will put to rest this withholding tax controversy.