2010 (9) TMI 7 - SC - Income Tax

TDS under Section 195 applies only to payments containing income chargeable to tax in India

GE India Technology Centre Private Ltd. Versus Commissioner of Income Tax & Anr.

SC held that TDS under Section 195 applies only to payments containing income chargeable to tax in India under Sections 4, 5, and 9 of the Income Tax Act. ... Withholding Tax - TDS u/s 195 - Incidence - principle of proportionality - Whether merely on account of such remittance to the non-resident abroad by an Indian company per se, could it be said that income chargeable to tax under the Income Tax Act, 1961 arises in India? Held that:- Section 195(2) is based on the 'principle of proportionality'. The said sub-Section gets attracted only in cases where the payment made is a composite payment in which a certain proportion of payment has an element of 'income' chargeable to tax in India - the observations of this Court in Transmission Corporation case [1999 (8) TMI 2 - SUPREME COURT] has been completely, with respect, misunderstood by the Karnataka High Court - This interpretation of the High Court completely loses sight of the plain words of Section 195(1) which in clear terms lays down that tax at source is deductible only from 'sums chargeable' under the provisions of the I.T. Act, i.e., chargeable under Sections 4, 5 and 9 of the I.T. Act. - Matter remitted back to HC to decided the nature of payment made to non resident. The core legal questions considered by the Court in this batch of cases are:(a) Whether the obligation to deduct tax at source (TAS) under Section 195 of the Income Tax Act, 1961 arises the moment there is remittance to a non-resident abroad by an Indian company;(b) Whether mere remittance to a non-resident abroad by an Indian payer per se results in income chargeable to tax under the Income Tax Act arising in India;(c) The scope and interpretation of Section 195, particularly the meaning of the phrase 'sum chargeable under the provisions of the Act' and its impact on the obligation to deduct TAS;(d) The applicability and scope of Section 195(2), which allows the payer to apply to the Assessing Officer for determination of the appropriate proportion of the sum chargeable to tax;(e) The effect and interpretation of the Supreme Court's earlier decision in Transmission Corporation of A.P. Ltd. vs. CIT, in light of the present facts;(f) Whether the payments made by the appellant(s) to foreign software suppliers constituted 'royalty' and thereby gave rise to taxable income in India.Issue-wise Detailed Analysis1. Obligation to Deduct Tax at Source under Section 195 and Meaning of 'Sum Chargeable under the Provisions of the Act'The relevant legal framework is Section 195 of the Income Tax Act, which imposes an obligation on any person responsible for paying to a non-resident any interest or other sum chargeable under the Act to deduct tax at source at the time of credit or payment, whichever is earlier. Section 195(2) permits the payer to apply to the Assessing Officer to determine the appropriate proportion of the sum chargeable to tax, if the payer believes the whole sum is not chargeable.The Court emphasized the critical phrase 'sum chargeable under the provisions of the Act' in Section 195(1). It reasoned that this phrase limits the obligation to deduct TAS only to those sums that are chargeable to tax in India. The mere fact of remittance to a non-resident does not automatically create a taxable event or income chargeable in India. The Court held that if the sum is not chargeable to tax in India, no obligation to deduct TAS arises.The Court distinguished Section 195 from other provisions in Chapter XVII relating to TDS, noting that the phrase 'sum chargeable under the provisions of the Act' is unique to Section 195, underscoring the necessity of a taxable income element before TAS obligation arises.The Court also rejected the Department's contention that the obligation to deduct TAS arises immediately upon remittance, viewing such an interpretation as obliterating the statutory language and leading to absurd consequences, such as the government collecting tax on payments that are not taxable and the payer having no remedy to recover such tax.The Court noted that the Income Tax Act must be read as an integrated code, where charging provisions (Sections 4, 5, 9, 90, 91) must be read in conjunction with the machinery provisions like Section 195. It held that the obligation to deduct TAS arises only when the payment includes an element of income chargeable under the Act.Further safeguards against revenue leakage exist in the Act, such as disallowance of expenditure under Section 40(a)(i) if TAS is not deducted on payments chargeable to tax, and interest and penalty provisions for non-compliance.2. Scope and Purpose of Section 195(2)Section 195(2) allows the payer to apply to the Assessing Officer for determination of the appropriate proportion of the sum chargeable to tax, where the payer believes only part of the payment is taxable. The Court interpreted this as a safeguard provision, applicable only when the payer is certain that some portion of the payment is taxable but is unsure about the exact amount or tax to be deducted.The Court clarified that Section 195(2) does not mandate an application for every payment to a non-resident, nor does it require the payer to obtain permission for non-deduction if the payment is not chargeable to tax in India. It rejected the Department's argument that Section 195(2) is a mandatory reporting requirement to prevent revenue leakage, emphasizing that the obligation to deduct TAS is tied to the existence of taxable income, not merely remittance.3. Applicability of the Transmission Corporation JudgmentThe Department and the High Court relied heavily on the Supreme Court's decision in Transmission Corporation of A.P. Ltd. vs. CIT, which held that when a composite payment includes an element of income taxable in India, TAS must be deducted on the gross amount unless the payer obtains permission under Section 195(2) to deduct on a lesser amount.The Court distinguished the present case from Transmission Corporation, noting that in that case it was undisputed that the payment included income taxable in India. The issue was whether TAS should be deducted on the gross or net amount. In contrast, the present case concerns whether any income chargeable to tax arises at all from the payment made to the non-resident.The Court observed that the High Court misinterpreted Transmission Corporation to mean that TAS must be deducted on all remittances regardless of chargeability to tax, which the Court rejected. The Court reiterated that TAS deduction is only required on sums chargeable to tax under the Act.4. Whether the Payments Constituted 'Royalty' and Gave Rise to Taxable IncomeOn the facts, the appellant(s) were distributors of imported prepackaged software and made payments to foreign suppliers, which they contended were purchase prices for software and not royalty payments. The ITO (TDS) and Commissioner (Appeals) held the payments constituted royalty and were taxable in India, attracting TAS deduction under Section 195(1). However, the ITAT held the payments were not royalty and did not give rise to taxable income in India, thus no TAS was deductible.The High Court did not examine the merits of whether the payments were royalty or not but held that TAS deduction was mandatory upon remittance. The Supreme Court overruled the High Court's approach, holding that the question of whether the payments were royalty and taxable must be decided on merits.The Court remitted the case to the High Court for de novo consideration of the factual and legal issues regarding the nature of the payments and their taxability.Significant Holdings'The obligation to deduct TAS arises only when there is a sum chargeable under the provisions of the Act forming part of the gross sum payable to the non-resident.''If the sum paid by the resident to the non-resident is not chargeable to tax in India, then no tax is deductible at source even though the assessee had not made an application under Section 195(2).''Section 195(2) is a safeguard provision which applies only when the payer is in doubt about the taxable proportion of a composite payment, not a mandatory reporting requirement for all remittances.''The Income Tax Act constitutes one single integral inseparable Code, and the charging provisions must be read in conjunction with the machinery provisions like Section 195.''The High Court erred in holding that the moment there is remittance, the obligation to deduct TAS arises, thereby obliterating the words 'sum chargeable under the provisions of the Act' in Section 195(1).''The Department's contention that Section 195(2) is a provision for administrative convenience to plug revenue leakage is without merit.''The question whether the payments made to foreign software suppliers constituted royalty and gave rise to taxable income in India must be decided on merits and the matter is remitted to the High Court for de novo consideration.'