TDS liability on payment to non-residents which is exempt under DTAA

The Supreme Court in its recent judgment in the case of  PILCOM vs CIT in SLP (CIVIL) No.7315 of 2019  has created a controversy on the withholding tax provision on the payment to be made to Non-resident. The recent judgement of Supreme Court has created far reaching, and apparently unintended, implications in cases where the person is responsible for paying any income of the nature on which rates of deduction at source has been prescribed in the Income Tax Act itself under a specific provision as against tax rates being prescribed with reference to the ‘Rates in Force’ under the general provision of section 195 of the Act.

Decision :

Apex Court has laid down the principle that obligation to deduct TDS under section 194E, that deals with TDS obligation in respect of the income of the nature specified under section 115BBA paid to non-resident sportsman or a non-resident sports association or institution, is not affected by the DTAA, i.e., the provisions of the DTAA are not to be considered while determining the liability to deduct tax at source and TDS is to be deducted even if the amount is not chargeable to tax by virtue of the DTAA. The Apex Court has held that in case the payee disputes exigibility to tax by virtue of DTAA, then the same may be pleaded and consequently, the amount along with the interest will be refunded to the payee. However, it was emphasized that the said fact cannot absolve the liability to deduct TDS under section 194E of the Act.

Earlier Position :

It was the settled provision of law that income of a Non-resident is liable to tax in India as per the provision of Income-tax Act [“ITA”] or provision of DTAA whichever is more beneficial in terms of section 90 of ITA. Similarly, tax is required to be withheld on the payment made to Non-resident after considering the beneficiary provision of DTAA.


Apparently, the principle laid down by the Apex Court is primarily driven by the peculiar language of section 194E, according to which, TDS is required to be deducted at a flat rate of TDS @ 20% as against rate in force prescribed under section 195 of the Act. Further, the principle, apparently, is also guided by the fact that there is no requirement under section 194E that the sum paid should be chargeable to tax in order for the withholding obligation to arise.

As per the provisions of section 195 of the Income Tax Act, every person responsible for paying any sum to a non-resident which is chargeable to tax is required to deduct tax at source at the ‘rates in force’. The expression ‘rates in force’ means the rates prescribed by the Finance Act or the rate as per DTAA, whichever is beneficial. Thus, it has been a settled position that in respect of payment made to non-residents which are governed by section 195 of the Act, TDS is to be deducted as per the rate prescribed in the Finance Act or the DTAA, whichever is beneficial. This has also been clarified by the CBDT vide Circular No. 728 Dated 30/10/1995.

It has also been a settled law in view of the judgment of the Supreme Court in the case of G.E. India Technology Centre Pvt. Ltd. Vs. CIT (2010) 327 ITR 456 (SC) that TDS under section 195 is required to be deducted only in respect of such sum that is chargeable to tax and while determining whether a particular sum is chargeable to tax, the provision of section 4, 5, 9, 90, 91 as well as the provisions of DTAA are relevant. It may be relevant to point out that the Tax Department has accepted the principle laid down by the Apex Court in the case of GE India which is evident from the fact that no amendment was carried out in the provision of section 195 after the said judgment was rendered.

Thus, it has been the accepted position since long both by the taxpayer and tax administration that in case the sum payable to non-resident is not chargeable to tax under the DTAA, or is exigible to tax at concessional rate under the DTAA, then the TDS obligations should be determined in consonance with the position under the DTAA and thus, TDS should also not be deducted or should be deducted at concessional rates, as the case may be. Consequently, no tax was being deducted on payment made to non-residents where the sum payable was not liable to tax under the DTAA and the benefit of concessional rate prescribed under the DTAA was also being extended while deducting the TDS all along.

While there may be some difference in the language of the provision of section 195 and 194E, however, the both sections deals in Withholding of tax on payment made to Non-resident. Section 195 is a general section dealing with any sum paid to non-resident while section 194E is a specific section dealing with payment made to Non-resident Sportsman or sports association. The above recent judgement by the Supreme Court in the case of PILCOM, apparently, inadvertently, has unsettled this accepted position and as it appears, in view of this judgment, the accepted position has now become limited to section 195 of the Act only.

In this judgement, the Supreme Court has held that though such income is not liable to tax in India under DTAA, but still tax need to be deducted by the person paying such income at the rates prescribed in the Income Tax Act and the non-residents whose tax is so deducted despite not being liable to tax in India under DTAA, should claim refund of such tax. The implication is that first you deduct tax and pay the same and then the non-resident claims the refund. This seems to be never the intention of legislature nor of tax administration. Once an income is not chargeable to tax, there is no reason why tax should be deducted on such amount and then refund should be claimed.

Impact :

After this judgment of Apex Court, payment made to Non-resident will be first subject to withholding and then non-resident will claim refund of same. This exercise not only being futile, but will considerably increase the administrative work and seriously affect the fund flow.

There is no reason why a deductor should deduct TDS despite the fact that the payee has to ultimately claim refund of the same that too with interest. The same only leads to additional paperwork, compliance and fund flow impact both at the end of the taxpayer and the tax administration.

This judgment of the Apex Court will have an impact in respect of all the specific TDS provisions (i.e., 194LC, 194LD, 196A,196B, 196C, and 196D etc.,) wherein TDS is required to be deducted at specified rate prescribed in the Act itself as against as per the ‘rates in force’ For instance, TDS income in respect of specified securities payable to a Foreign Institutional Investor is deductible at a flat rate of 20%. Thus, in case of dividend being paid to a Foreign Institutional Investor, no reference can be made to the DTAA even if the DTAA prescribes for a lower rate of 5%/10%/15% in respect of dividend income. This creates an artificial distinction as in respect of dividend income payable to other non-residents which are governed by section 195 of the Act, TDS will be deducted at the rate of 20% as prescribed under the Finance Act, or the rate prescribed in the DTAA, whichever is beneficial whereas in the case of FII’s, TDS will have to be mandatorily deducted at the rate of 20%.

Issues / Challenges :

(i) Although law laid down by the Supreme Court is a land of country unless it is amended by Parliament but this judgment of Apex Court has overlooked the following legal positions / bilateral commitments while dealing with the issue of tax withholding under DTAA:

  • Section 90 of ITA specifically states that If India has entered into any agreement (DTAA) with any other country outside India, then for the purpose of relief of tax or avoidance of double taxation, the provision of Act shall apply to the extent they are more beneficial to the assessee (i.e., If the provisions of DTAA are more favourable to assessee, then assessee is free to apply provision of DTAA).
  • DTAA are the bilateral agreements with two Sovereign nations involves lots of negotiations, commitments and concessions and majors to improve bilateral trade etc. What if, in the case of particular income, taxation rights of a such income is specifically allocated to Resident Countries under DTAA through bilateral agreement or negotiations?
  • It is a settle position of law world-wide and affirm by various courts of the country that provision of DTAA can not be overridden by a unilateral legislative amendment by one Country.

(ii) Supreme Court in this case has held that in case the payee disputes exigibility to tax by virtue of DTAA, then the same may be pleaded and consequently, the amount along with the interest will be refunded to the payee.

Most of the foreign Vendor enters into net off tax contract with Indian Payer. In that case, tax liability in India on that contract is on account of Indian Payer and the payee gets the full contract amount. By virtue of this judgment, Indian Payer is required to pay the tax from his own funds on the tax liability of Non-resident which is actually non-taxable under the DTAA.

This will lead to litigation between deductor and deductee as non-resident is entitled to claim refund of such tax so deposited by deductor.  It will possible that many of such non-residents after claiming such refund may not return such refund to the deductor, causing a loss not only to Indian resident deductor but also to the nation as such money will go out of the country and that too in precious foreign currency.

Conclusion and clarification required from CBDT :

Till the time, CBDT comes with a clarification, payer is required to deduct TDS on the payments made  to non-resident at the rate specified under the specific section of TDS (other than section 195) irrespective of the fact that such payment is exempt under DTAA or not.

Since these payments are being made regularly to non-residents exempt under DTAA, there is an urgency for CBDT to issue clarification at the earliest so as to avoid possible dispute between deductor and deductee. The deductor will like to get tax deducted and deductee will resist such deduction as he is not liable to pay tax under DTAA.  By issuing such clarification expeditiously, the CBDT will help in improving Indian position of ease of doing business in India, where one of the consideration is ease in paying/ complying tax laws.

In the absence of such circular, it will create a chaos in respect of all such payments such as of interest made in respect of borrowings in the past on which tax has not been deducted in view of DTAA provision. Now, all such person will be declared defaulters as tax has not been deducted as per the rates prescribed in the Income Tax Act, and all such person will be required to deposit tax which was required to be deducted. Once such tax is deposited, the non-residents deductee will become entitled to claim refund of the entire tax so deposited as there is no liability on such non-residents to pay tax in view of DTAA. Thus, the entire exercise will be a zero sum game but with a lot of administrative hassles, paper work and of course litigation as usual.

Author Bio

Qualification: CA in Practice
Company: Vijay Deepak & Co.
Location: Delhi, New Delhi, IN
Member Since: 25 Jul 2020 | Total Posts: 1

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April 2021