Delhi High Court (HC) [2010-TIOL-139-HC-DEL-IT] in the case of Idea Cellular Ltd. (Taxpayer) on the issue whether the discount retained by Prepaid Market Associates (PMAs) on sale of Subscriber Identification Module (SIM) cards or recharge coupons belonging to the Taxpayer is liable for withholding tax, under the provisions of Indian Tax Law (ITL) held that the transaction between them is a service transaction and not in the nature of sale and purchase of goods.
The HC, based on the terms of agreement between the Taxpayer and the PMAs concluded that the relationship between them is in the nature of principal and agent and, hence, the discount retained by the PMAs is in the nature of commission or brokerage under the ITL, liable for withholding by the Taxpayer.
Background and facts of the case
- Under the ITL, payment of income in the nature of commission or brokerage attracts withholding for the payer. The term ‘commission or brokerage’ is defined, inter alia, to include any payment received or receivable, directly or indirectly, by a person acting on behalf of another person for services rendered (not being professional services).
- The Taxpayer, engaged in the business of providing cellular telephone services through SIM cards, appointed PMAs as distributors, to provide prepaid and postpaid connections to the subscribers. The Taxpayer offered discount to the PMAs on the prepaid connections provided to the subscribers.
- The Tax authority, treating the agreement between the Taxpayer and the PMAs as an agency contract, held that the discount provided to the PMAs was in the nature of commission liable for withholding by the Taxpayer. This was confirmed by the first appellate authority.
- On further appeal to the Tribunal by the Taxpayer, the Tribunal held that the relationship between the Taxpayer and the PMAs was that of ‘principal-to-principal’ and not a contract of agency. The Tribunal held that the transactions between them were in the nature of contract for sale and purchase of goods and, hence, the discount cannot be regarded as commission liable for withholding. Aggrieved by this, the Tax Authority preferred an appeal before the HC.
Contentions of the Tax Authority
- The PMAs merely acted as an agent and a link between the Taxpayer and the ultimate subscribers and the relationship between the Taxpayer and the PMAs was that of principal and agent. This was borne out by the following terms of the agreement between the Taxpayer and the PMAs:
-The PMAs were required to store SIM cards and recharge coupons and were not allowed to remove, obscure or delete in marks placed on prepaid SIM card or recharge coupons.
-The PMAs were cast with the responsibility of obtaining the information concerning the subscribers and forward the same to the Taxpayer, without which the activation of SIM card was not possible.
-The title and interest in SIM cards and recharge coupons at all times vested with the Taxpayer and their ownership was never transferred to the PMAs.
-The PMAs could appoint retailers only after a written approval of the Taxpayer. The maximum retail price was fixed by the Taxpayer.
-The PMAs were also bound by obligations such as compliance of invoicing and accounts, maintenance of the Taxpayer’s brand image, provision of access to the Taxpayer to inspect SIM cards and recharge coupons, minimum performance targets etc.
– On termination or expiry of the agreement, PMAs were obliged to return the unsold stocks to the Taxpayer and obtain refund of the payment thereof.
- The Taxpayer activates SIM card in the name of the subscriber by virtue of a specific agreement between the Taxpayer and the subscriber which establishes direct privity between them.
- The transactions between the Taxpayer and the PMAs are not subjected to sales tax levy. This also supports that the transactions are service transactions and not sale and purchase transactions.
- Since the PMAs acted as agents of the Taxpayer, the discount offered to them is in the nature of commission or brokerage, liable for withholding by the Taxpayer.
Contentions of the Taxpayer
- The relationship between the Taxpayer and the PMAs are not of principal and agent. The transactions between them are in the nature of sale and purchase of goods not attracting withholding as commission or brokerage. This is borne out by the following terms of the agreement between them:
-The PMAs were required to make payment for SIM cards and recharge coupons to the Taxpayer upfront, prior to realizations from the subscribers.
-The PMAs are allowed discretion to sell the same to the subscribers at a different price.
-The agreement specifically mentions that there exists no principal-agency relationship.
- The operational or geographical controls exercised by the Taxpayer over the PMAs, maintenance and submission of records and accounts to the Taxpayer are irrelevant for determining the principal-agency relationship.
- In addition to the absence of principal-agency relationship, the withholding was not attracted for the reason that the income was not paid or credited by the Taxpayer to the account of the PMAs. The arrangement involved payment of the value of SIM cards and recharge coupons by the PMAs to the Taxpayer and there was no payment by the Taxpayer to the PMAs.
Ruling of the HC :-The HC held that the relationship between the Taxpayer and the PMAs was one of principal and agent and, hence, the discount offered to the PMAs on SIM cards and recharge coupons attracted withholding by the Taxpayer for the following reasons:
- A transaction is a sale transaction in a principal to- principal relationship where the ownership of the goods passes from the manufacturer to distributors and from distributors to the consumers. In such cases, the principal manufacturer owes no responsibility to the consumer on such sale barring warranty obligation in case of defect etc.
- On the other hand, in the case of the Taxpayer, the privity of contract is established directly between the Taxpayer and the subscribers by virtue of a specific agreement and activation of SIM card by the Taxpayer in the name of the subscriber. The telecommunication service is provided by the Taxpayer directly to the subscriber including attending to any complaint for improper service or defect in SIM card. The PMAs merely assist the Taxpayer in establishing relationship with the subscriber on behalf of the Taxpayer.
- The fact that the payment for SIM cards and recharge coupons is made upfront by the PMAs is not relevant since the Taxpayer is obliged to refund the value thereof in the event of return by the PMAs. The purpose of advance payment is just to ensure that the Taxpayer receives amount on SIM cards or recharge coupons ultimately sold to the subscribers.
- Concurring with the views expressed in two Tribunal decisions (Vodafone Essar Cellular Ltd. v ACIT [2009-TIOL-630-ITAT-Cochin] and ACIT v Bharti Cellular Ltd. [294 ITR (AT) 283(Kolkata)] ) on identical issue, the HC held that discretion provided to the PMAs on pricing is not relevant in determining the principal-to-principal relationship. The pricing mechanism is a matter of agreement for mutual convenience between the parties and is a neutral factor. The crux of the matter is that the Taxpayer provides the service to the ultimate subscriber and the PMAs merely assist in establishing the legal relationship between the Taxpayer and the subscribers by acting as a link in the chain.
- The HC held that the facts in the present case are similar to the case of CIT v Singapore Airlines Ltd. [2009-TIOL-183-HC-DEL-IT] in which the Delhi HC held that the airline companies were liable to withhold tax on the commission and supplementary commission earned by the airline agents since by selling the airline tickets to the passengers, the airline agents acted as agents for the airline companies. The withholding was attracted notwithstanding the fact that the airline agents were retaining the commission while making the payment to the airline companies and, thus, the airline companies were not directly paying any commission to the agents. Hence, even in the present case, the Taxpayer is liable for withholding though it does not pay or credit the amount of discount in its books in favour of the PMAs.
Summary/ Comments:- Where a taxpayer provides services to the end user through a chain of intermediaries who act as a link between the taxpayer and the end user, the intermediaries would be regarded as agents of the taxpayer and not independent distributors. This is for the reason that the subject matter of supply from the taxpayer to the end user is a service, resulting in establishment of direct privity of contract between the taxpayer and the end user, and it is not a sale of goods. This triggers the applicability of withholding obligation on the taxpayer since the margin earned by the intermediaries in such circumstances gets characterised as commission or brokerage in terms of specific definition under the income Tax Act, 1961.