Taxpayer obligated to withhold tax only if payment is chargeable to tax under the provisions of Income Tax Act

This Tax Alert summarises a recent ruling of the High Court (HC) of Delhi in the case of Van Oord ACZ India (P) Ltd. (Taxpayer) [2010-TIOL-187-HC-DEL-IT] on withholding tax obligation arising under the provisions of the Indian Tax Law (ITL) in respect of reimbursement of expenses to non-resident companies. The Delhi HC held that a payer is obligated to withhold tax only if the payment is chargeable to tax under the provisions of the ITL.

Further, if the payer considers that the entire payment is not chargeable to tax under the ITL, he can seek a certificate for withholding at nil/ lower rate of tax from the Tax Authority. In reaching its conclusion, the Delhi HC has expressed its disagreement with some observations of the Karnataka HC ruling in the case of Samsung Electronics [320 ITR 209] (Karnataka HC ruling).

Background and facts of the case

• The Taxpayer, an Indian company, is a wholly-owned subsidiary of a company incorporated in the Netherlands (Parent company). The Taxpayer is engaged in the business of dredging, contracting, reclamation and marine activities in India.

• The Taxpayer reimbursed to the Parent company certain mobilisation and demobilisation expenses incurred by the Parent company on the basis of invoices raised from other non-resident service providers.

• The Taxpayer applied for a certificate for nil withholding tax in respect of the reimbursement made to the Parent company on the ground that such reimbursement was not chargeable to tax under the ITL. However, the Tax Authority determined a sum equivalent to 11% of such reimbursement as profit arising to the Parent company in India and directed the Taxpayer to withhold tax on such sum. The Taxpayer withheld the taxes in accordance with the Tax Authority’s order.

• In the tax return, the Taxpayer claimed deduction for the amount reimbursed to the Parent company. However, such expenses were disallowed by the Tax Authority on the ground of default, in compliance with the withholding tax obligation. The Tax Authority’s order was upheld by the first level appellate authority.

• The Income Tax Appellate Tribunal (ITAT) also upheld the Tax Authority’s order. Based on the findings of the Tax Authority, the ITAT observed that the Parent company was, in substance, executing the Taxpayer’s contract and, thus, held the Taxpayer to be a dependent agent permanent establishment (PE) of the Parent company. Hence, the Parent company was taxable in India with respect to reimbursements received from the Taxpayer. Further, the ITAT, placing reliance on the Supreme Court (SC) ruling in the case of Transmission Corporation of A.P. Ltd. [239 ITR 587] (SC ruling), held that the Taxpayer was obligated to withhold tax regardless of whether the payment/ reimbursement was chargeable to tax in the hands of the non-resident under the ITL. Additionally, the Taxpayer is not required to independently determine the tax liability of the non-resident recipient. The Taxpayer filed an appeal before the HC against the ITAT’s ruling.

Contentions of the Taxpayer

• Under the ITL, withholding tax provisions are attracted only when the payment made to a non-resident is chargeable to tax in India. Reliance was placed on the SC ruling which categorically held that the obligation to withhold tax was triggered only when the payment made to the non-resident was chargeable to tax in India. Therefore, if a sum is not chargeable to tax in India, withholding tax provisions will fail to attract.
• In case where a taxpayer is of the view that only some part of the payment is chargeable to tax in India, it can seek a lower/nil withholding order from the Tax Authority for determining the taxable proportion of the payment and the withholding tax rate.
• In the assessment of the tax return filed by the Parent company, the Tax Authority has held that the Parent company does not have a PE in India and, hence, is not liable to tax in India. Further, the tax withheld by the Taxpayer has been refunded to the Parent company. Consequently, the Taxpayer was not obligated to withhold tax in respect of the reimbursement made to the Parent company.

Contentions of the Tax Authority

The Tax Authority has reiterated the reasons stated by the ITAT.

Additionally, the Taxpayer has failed to furnish documents in support of its claim for tax- free remittance of the reimbursement to the Parent company.

Ruling of the Delhi HC

• The SC ruling dealt with a situation where the amount paid to a non-resident was chargeable to tax under the ITL. However, the SC did not deal with a situation where the amount paid was not taxable in the hands of the non-resident.
• In case of payments made to a non-resident, a payer is obligated to withhold tax only if such payments are chargeable to tax under the provisions of the ITL. On this aspect, the Delhi HC approved the ratio of the following rulings:

1. CIT Vs. Estel Communications (P) Ltd. [217 CTR 102] (Del)
2. Jindal Thermal Power Company Ltd. Vs. DCIT [182 Taxman 252] (Kar)
3. Mahindra & Mahindra Vs. DCIT [313 ITR (AT) 263] (Mum)

• In view of the above analysis, the HC has expressed its disagreement with some of the observations made in the Karnataka HC ruling which had held that a payer responsible for withholding tax on payments made to a nonresident cannot determine charge ability and would be treated to be in default if it fails to withhold tax on such payments.
• The Delhi HC has summarised the legal position on the withholding tax provisions as follows:

1. 1. The withholding tax provisions of the ITL deals with withholding tax at source by the payer if the payments are to be made to a non-resident.
   2. The payer is required to withhold tax on such payments made to a non-resident at the specified rates in force.
   3. The obligation to withhold tax at source arises only when the payment is chargeable under the provisions of the ITL.
   4. If the parties feel that either the withholding tax by the payer is required to be at a rate lower than the prescribed rate or no withholding is required to be made, they are required to file an application before the Tax Authority for obtaining such a certificate. The Tax Authority’s order is tentative in nature.

• In case it is determined that the sum received by the recipient was not chargeable to tax, the payer will not be treated in default and would be absolved of any consequences for not withholding the tax at source.

• In the facts of the case, as the Parent company’s claim for nil taxation has been accepted in the tax return filed by it, the Taxpayer is also not liable to withhold tax in respect of the amount reimbursed to the Parent company.

 Comments

The ITL casts an obligation on any person responsible for making payment to a non-resident, of any sum that is chargeable to tax, to withhold tax on such a sum at the applicable tax rate. The Karnataka HC ruling had held that any payment resulting in any income in the hands of a non¬resident, regardless of its charge ability to tax in India, would be subject to withholding tax under the ITL. The Karnataka HC ruling had resulted in concerns for taxpayers on the extent of their withholding tax obligations on payments made to a non-resident and the same is currently under appeal before the SC.

The present ruling acknowledges the view that withholding tax on payments to a non-resident is applicable only if the sum is chargeable to tax in India. The ruling is in line with the views expressed by various ITATs. The present ruling has also explained the ratio of the SC ruling and has expressed its disagreement with some observations of the Karnataka HC ruling. The present ruling specifically clarifies that if a payer fails to withhold tax on a sum that is ultimately determined as not being chargeable to tax in India, the payer cannot be treated as having defaulted on withholding tax.

NF