Non-compete payments to non-resident employees treated as salary under treaty rules and held not taxable in India.

Non-compete payments made to two employees were treated as employment-linked receipts and characterised as salary or profit in lieu of salary. The receipts were held not to be business income or taxable under the residuary head. Under the India-USA DTAA, the payments were treated as dependent personal services remuneration accruing in the USA, so they were not taxable in India. Because the amounts were not chargeable to tax in India, the payer was not required to seek determination under section 195(2), and could not be treated as an assessee in default under section 201(1) or made liable to interest under section 201(1A).

---

---

Issues: (i) Whether the non-compete payments made to the two employees were taxable in India and, if so, under which head of income; (ii) whether the payments were chargeable under the DTAA between India and USA; (iii) whether the assessee was required to seek recourse under section 195(2) before remitting the amounts without deduction of tax; (iv) whether the assessee could be treated as an assessee in default under section 201(1) and consequently liable to interest under section 201(1A).

Issue (i): Whether the non-compete payments made to the two employees were taxable in India and, if so, under which head of income.

Analysis: The payments were held to be connected with the employment relationship and made to retain key personnel after the merger. The non-compete arrangement was found to be genuine and distinct from the non-disclosure agreement. The receipts were not business income, since the recipients were not carrying on any business, and could not be assessed under the residuary head merely because another characterisation was urged. The heads of income were treated as mutually exclusive.

Conclusion: The receipts were held to be salary or profit in lieu of salary in the hands of the recipients.

Issue (ii): Whether the payments were chargeable under the DTAA between India and USA.

Analysis: The recipients were residents of USA and rendered services in USA. On that basis, the remuneration was held to fall within the treaty provision governing dependent personal services and to accrue or arise in USA. The residuary treaty article was held inapplicable once the receipt was characterised as employment-linked remuneration.

Conclusion: The payments were held not taxable in India under the DTAA.

Issue (iii): Whether the assessee was required to seek recourse under section 195(2) before remitting the amounts without deduction of tax.

Analysis: Section 195(2) was held to apply where the remittance is not salary and the payer seeks determination of the appropriate chargeable portion. Since the receipts were held to be salary in nature and not taxable in India, the statutory precondition for invoking section 195(2) was absent.

Conclusion: The assessee was held not bound to apply under section 195(2).

Issue (iv): Whether the assessee could be treated as an assessee in default under section 201(1) and consequently liable to interest under section 201(1A).

Analysis: Once the payments were held not chargeable to tax in India and no obligation to deduct tax at source was found, the foundation for treating the assessee as an assessee in default disappeared. The liability to interest was held to be consequential to the default finding.

Conclusion: The assessee was not an assessee in default and no interest under section 201(1A) was leviable.

Final Conclusion: The appeals succeeded, the non-compete payments were held to be employment-linked receipts not taxable in India, and the demand under sections 201(1) and 201(1A) could not survive.

Ratio Decidendi: Where a payment to a non-resident employee is found to be salary or profit in lieu of salary accruing in the foreign state under the applicable DTAA, no tax is deductible at source in India and the payer cannot be treated as an assessee in default.

---