THE much-awaited order of the Karnataka High Court on the question of liability to deduct tax at source on payments made to non-residents for the purchase of software to be used in business is finally out. The order passed on 24th September, 2009 was made available only on 17th November, 2009. Not knowing the contents of the order, there was intense speculation among the taxpaying population as to what would be the verdict of the court on the much debated issue of characterization of payment for the purchase of shrink wrapped software – whether the same would be characterized as royalty thereby subject to TDS or whether the same would be treated as business which can only be taxed if there is a PE of the non-resident vendor of the software. The 140 page order of the High Court disappoints in as much as it does not talk of such issues at all. It is rather an expose of section 195 and the liability of deduction of tax at source when payment is made to a non-resident. As an aside, throughout the order the Court mentions of the liability of a resident to deduct tax in respect of payment made to a non-resident whereas the section applies even if a non-resident ( as in the case of a branch) makes payment to another non-resident.
On behalf of the taxpayers, there was the familiar argument that payment for purchase of software was like for payment of goods, that software has been considered as goods by the Supreme Court in the case of Tata Consultancy, that there is a difference between payment for a copyright and payment for purchase of a copyrighted article, that even if the payment is treated as royalty within the meaning of the term as per section 9, the Treaty definition being restricted, no income could arise to the non-resident in India and if there is no income which accrues in India, question of deduction of tax at source does not arise.
The revenue, relying on the decision of the Supreme Court in the oft repeated case of Transmission Corporation, argued that tax was to be deducted from any payment made to the non-resident unless there was an application under section 195(2). It was also argued that since there was no transfer of the software and the same was only licensed, it represented royalties and hence subject to deduction of tax.
On hearing the arguments based on some 30 odd case laws cited,the High Court found itself bound by the ratio of the decision of the Supreme Court in the case of Transmission Corporation and held that tax was to be deducted at source by the remitters and in default thereof consequential action under section 201 treating the remitters as assessee in default was justified. Section 195 is for prima-facie determination of liability. It is not an exercise in the determination of the actual income of the non-resident to be taxed in India . If there is any income, tax has to be deducted. There is no scope for even the A.O to consider the character of income or the treatment given to the same in different treaties. That will come later. The only way out for the assessee is to approach the A.O under section 195(2) or (3) to determine the appropriate portion that can be remitted. The Court uses colourful language to make its point. To wit:-
“66. If one is allowed the liberty of giving a rough and crude comparison to the manner in which the provisions of section 195 of the Act operates on a resident payer who makes payment to a non-resident recipient and if the payment bears the character of a semblance of an income receipt in the hands of the non-resident recipient, then the obligation on the part of the resident payer who makes such a payment to the non-resident recipient is like a guided missile which gets itself attached to the target, the moment, the resident assessee makes payment to the non-resident recipient and there is no way of the resident payer avoiding the guided missile zeroing on the resident payer whether by way of contending that the amount does not necessarily result in the receipt of an amount taxable as income in the hands of the non-resident recipient under the Act or even by contending that the non-resident recipient could have possibly avoided any liability for payment of tax under the Act by the over all operation of different provisions of the Act or even by the combined operation of the provisions of a double taxation avoidance agreement and the Act as is sought to be contended by the respondents in the present appeals.
67. The only limited way of either avoiding or warding off the guided missile is by the resident payer invoking the provisions of section 195 (2) of the Act and even here to the very limited extent of correcting an incorrect identification, an incorrect computation or to call in aid the actual determination of the tax liability of the non-resident which in fact had been determined as part of the process of assessing the income of the non-resident and by using that as the basis for claiming a proportionate reduction in the rate at which the deduction is required to be made on the payment to the non-resident. Except for this method, there is no other way of the resident payer avoiding the obligations cast on it by the provisions of section 195 (1) of the Act and as a consequence of such default when is served with a demand notice in terms of section 201 of the Act.”
The Court points out that in an exercise of determining the proportion of the actual amount being remitted to the non-resident while examining an application under section 195 (2) of the Act, the assessing officer cannot embark on an exercise as though it is meant to determine the actual tax liability of the non-resident assessee for the reason that if such a situation is permitted to take place and if the income of the non-resident is sought to be assessed in advance, even in the hands of a resident payer, there can arise conflicting decisions and versions, in so far as the tax liability of the non-resident is concerned as even after a determination under section 195(2) of the Act, where under the tax liability of the non-resident is determined in the hands of the resident payer and that too prematurely, then the exercise may not be productive as it will be always open to the non-resident to contend that no part of the receipt was taxable in India and is able to make good this position, on the basis of a return of income filed later by the non-resident assessee, it will result in there being two versions of the actual tax liability of the non-resident recipient of a payment from this country, one version when the liability is determined even in advance in the hands of the resident payer and the second version of the liability when the precise tax liability of the non-resident recipient of a payment from this country is actually determined resulting in a different determination of the tax liability of the non-resident recipient. A situation of this nature should be avoided.
Elaborating on the scope of the examination at the stage of consideration of a claim under section 195(2), the Court points out that the exercise under section 195 (2) of the Act is only for extending a limited concession in favour of the resident payer when things are very clear or does not involve any doubt or ambiguity such as in a situation where the non-resident recipient of the amount, has filed a return of his income as one arising from such a transaction with the resident payer and the assessing officer has actually examined the nature of payment and has indicated in an assessment order passed on the return of income filed by the non-resident that no part of the receipt is taxable under the provisions of the Act [for whatever reason] and if so based on this settled/undisputed factual/legal position, the resident payer by quoting the assessment order passed by the assessing officer on the return of income filed by the non-resident for any earlier year seek for granting the commensurate relief from the obligation for deduction of the percentage of payment to the non-resident.
As to the scope of the appellate function under section 246-A,[246(1) (ha)which provides for appeal against an order under section 201] the same is also limited .An example would be when an erroneous order and demand is being raised by the assessing officer under section 201 of the Act, such as an incorrect description of the resident payer or incorrect computation of the amount to be deducted from out of the payment made by the resident payer either by employing a wrong percentage for deduction, at variance with the rate as indicated in the Finance Act or such arithmetical or factual errors committed by the assessing officer, without involving the question of actual determination of the tax liability of the non-resident etc.
In another bunch of appeals, the first appellate authority had dismissed the appeal filed under section 248 of the Act at the threshold, only for the reason that the assessee/resident remitter had not availed the procedure of making an application under section 195(2) of the Act, seeking for determination of the proportionate amount in the payment to the non-resident constituting the taxable part of the payment or to put in other words income part of the payment. Here, the Court held that where a resident payer/assessee who had in fact deducted the amount in terms of sub-section (1) of Section 195 and remitted the amount to the account of the Revenue, but is nevertheless disputing such liability, the appeal under section 248 is certainly maintainable. However, here also, it was pointed out that insofar as the scope of examination of an appeal under Section 248 is concerned, the view expressed by the Court has to be kept in mind while deciding the issue.
Earlier, the High Court also negatived the argument taken that section 201 can treat only those who failed in remitting taxes withheld as assessee in default and not those who had not deducted taxes at all. It was pointed out that section 200 also covered cases of total failure.In fact, the heading of section 201 clearly indicates that it is a provision which springs into action as a consequential measure in situations of the assessee failing either to deduct or to pay.
The judgement of the High court upsets the common understanding that once it is demonstrated that there is no income arising in India even if income accrued to a non-resident, there is no liability to deduct tax at source on the part of the payer. Moreover, the limitations posed on the enquiry under section 195(2), 246,248 will also be cause of concern.This judgement is certainly going to have far reaching repercussions in the matter of deduction of tax at source although it says nothing about the taxability of payments for purchase of software in the hands of the non-resident.