1984 (7) TMI 60 - HC - Income Tax

High Court clarifies tax deduction rules for payments to non-residents under Income Tax Act

Commissioner Of Income-Tax, AP -III Versus Superintending Engineer, Upper Sileru

The High Court held that Section 195 of the Income Tax Act, 1961 applies to any sums paid to non-residents, including those not solely representing ... Harmonious Construction, Liability To Deduct Tax Issues Involved:1. Applicability of Section 195 of the I.T. Act, 1961 to payments made to non-residents.2. Determination of tax deductible at source on gross sums paid to non-residents.3. Grossing-up of net payments for tax deduction purposes.Summary:Issue 1: Applicability of Section 195 of the I.T. Act, 1961The Andhra Pradesh State Electricity Board made payments to non-residents for machinery and equipment and for work executed in India. The Income Tax Officer (ITO) held that the Electricity Board was obligated to deduct tax at source u/s 195 of the I.T. Act, 1961. The Appellate Assistant Commissioner (AAC) and the Income-tax Appellate Tribunal (ITAT) cancelled the ITO's orders, holding that s. 195 applies only to sums representing 'pure income profits.' The High Court disagreed, stating that s. 195 applies to any sums paid to non-residents, whether or not they wholly represent income, and includes sums paid during trading operations.Issue 2: Determination of Tax Deductible at SourceThe ITO determined tax on the gross sums paid to non-residents, as the Electricity Board did not apply u/s 195(2) to ascertain the chargeable portion. The High Court held that the obligation to deduct tax u/s 195 is limited to the appropriate proportion of income chargeable under the Act. The ITO should not enforce tax deduction on the entire gross sum but only on the portion chargeable as income.Issue 3: Grossing-up of Net PaymentsThe ITO grossed up the net payments to determine the tax deductible, based on the agreement that payments were made free of income tax. The High Court noted that grossing-up should be done correctly, as per the principle set out in CIT v. American Consulting Corporation, adding only the amount of tax payable by the non-resident to the net payment.Conclusion:The High Court reframed the question to address both the applicability of s. 195 and the determination of tax on gross sums. It concluded that the Electricity Board was obligated to deduct tax u/s 195 but only on the chargeable portion of the sums paid. The ITO's orders in R.C. Nos. 203 and 205 were to be modified, while the order in R.C. No. 204 was upheld. The ITAT's cancellation of the ITO's orders was found to be in error. The Tribunal was directed to modify the orders conformably to the High Court's judgment.