Non-resident payments and India PE dispute u/s197: higher 3.5% withholding quashed, 1.5% certificate ordered.

Where a non-resident sought a s.197 certificate on the basis that it had no PE in India, the Revenue increased the withholding rate to 3.5% for AY 2022-23 on the premise that a PE existed. Since the ITAT had subsequently set aside the PE finding, the HC held that the sole legal foundation for the higher rate no longer survived; prior certificates and earlier HC directions supported continuation at 1.5%. The HC quashed the 3.5% certificate and directed issuance of a fresh s.197 certificate at 1.5% within 15 days, with future certificates to be issued similarly unless the ITAT order is reversed/modified or fresh evidence of a PE emerges after notice and response.

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1. ISSUES PRESENTED AND CONSIDERED

(i) Whether a certificate issued under Section 197 of the Income Tax Act, 1961 requiring deduction of tax at a higher rate (3.5%) could be sustained when its stated basis was a finding of existence of permanent establishment (PE) which was subsequently set aside by the Tribunal.

(ii) What directions should govern issuance of future Section 197 certificates to the petitioner, including the conditions and procedural safeguards for prescribing a rate higher than 1.5%.

2. ISSUE-WISE DETAILED ANALYSIS

Issue (i): Sustainability of the higher-rate Section 197 certificate (3.5%)

Legal framework: The Court considered issuance of certificates under Section 197 of the Income Tax Act, 1961 for deduction of tax at source at an appropriate rate.

Interpretation and reasoning: The Court noted that, prior to the relevant period, certificates under Section 197 had been issued at 1.5%, and when higher rates had been stipulated earlier, such higher-rate directions were set aside and issuance at 1.5% was directed. For the year in question, the higher rate of 3.5% was justified by the revenue on the basis that, during proceedings for AY 2022-23, the Assessing Officer had recorded a finding that the petitioner had a PE in India. The Court accepted that, at the time of issuance of the impugned certificate, this finding provided a rationale for prescribing a higher rate. However, the Court also accepted the petitioner's submission that the Tribunal, by order dated 17.10.2025, set aside the PE finding for AY 2022-23. Consequently, the Court held that the "very ground" relied upon to justify the higher rate "has lost its foundation."

Conclusions: The Court quashed and set aside the certificate dated 16.05.2025 requiring TDS at 3.5% and directed issuance of a fresh Section 197 certificate prescribing deduction at 1.5%, to be issued within 15 days.

Issue (ii): Directions for future Section 197 certificates and permissible circumstances for higher rates

Legal framework: The Court addressed the manner in which the respondents should exercise powers while issuing Section 197 certificates in future, and the relevance of subsequent appellate remedies (including the possibility of an appeal against the Tribunal order under Section 260A).

Interpretation and reasoning: The Court recorded that the Tribunal's order could be challenged in appeal, and that no appeal had been filed so far. To balance this position and regulate future administration of Section 197 certificates, the Court directed the respondents to continue issuing certificates under Section 197 in future years whenever an application is made. At the same time, it preserved the respondents' liberty to issue a certificate at a rate higher than 1.5% only in specified contingencies: (a) if the Tribunal's order dated 17.10.2025 for AY 2022-23 is set aside or modified; or (b) if the department receives information or evidence showing existence of the petitioner's PE in India. The Court further required procedural fairness: if the department proposes a higher rate on the view that a PE exists, it must first issue notice to the petitioner, elicit a response, and only if the petitioner is unable to satisfy the respondents that no PE exists, may a higher-rate certificate be issued. The Court also preserved the petitioner's right to challenge any such higher-rate certificate.

Conclusions: The Court mandated continued consideration and issuance of Section 197 certificates on application for future years, limited the circumstances in which a higher rate than 1.5% may be prescribed, required prior notice and opportunity to respond before invoking PE-based higher rates, and reserved the petitioner's right to challenge any future higher-rate certificate.

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