Under the Indian tax laws, where a payment is being made to a non-resident and the same is taxable in India, the payer is required to withhold appropriate taxes. In case of non-compliance with this obligation, the payer is treated as ?assessee-in-default? and is exposed to interest, penalty and prosecution (in specific circumstances).
Withholding tax is an effective and major revenue collection measure for tax authorities. The focus of tax authorities on withholding tax compliance and enforcement is ever increasing and there are many controversies on this subject.
In a situation where the payer is of the view that only a part of the entire amount (payable to non-resident) is chargeable to tax, such a payer may make an application to the tax authority to determine such sum (which is chargeable to tax).
There have been controversies in the past on: (1) whether withholding obligation and the need to approach the tax authority is still triggered if the payments is not chargeable to tax at all, and (2) whether with regard to the transactions (such as those resulting in capital gains or trading receipts) where only a part of total payment represents taxable gain, withholding is required with respect to the gross amount or only the taxable gain portion.
Views of judiciary
In the case of Samsung Electronics and others, the Karnataka High Court took a view that any remittance made to a non-resident would be subject to withholding tax, regardless of its chargeability to tax in India. A relaxation from this requirement is possible only where specific application is made to the tax authority for determination of tax to be withheld and such tax authority confirms no tax withholding. This judgment had created a large controversy, as it meant that practically for all foreign remittances from India, application for tax withholding needs to be made.
Subsequently, the Supreme Court, in a landmark ruling in the case of GE India Technology, held that withholding tax obligation would apply only if the payments are chargeable to tax in India. Whereas, in respect of composite payments, tax is be deducted only in respect of the appropriate portion which represents the chargeable amount. The Supreme Court also held that if the payer is fairly certain, then the payer can make its own determination of the chargeable amount and restrict its tax withholding obligation to such an amount. Thus, the Samsung ruling was set aside by the Court.
Incidentally, without noticing the Supreme Court ruling in the case of GE, in a subsequent decision in the case of Chennai Metropolitan Water Supply and Sewerage Board (CMWSSB), the Madras High Court ruled that, in the absence of a specific withholding certificate from the tax authority, the payer is obliged to withhold taxes on the entire amount of payment made to a non-resident recipient which was a loss-making company.
In view of the above judicial developments, clarifications were being sought from the Central Board of Direct Taxes (CBDT), the apex administrative authority for direct taxes in India. It is pursuant to this that the CBDT has issued Instruction No 2/2014 dated February 26, 2014, directing subordinate Indian tax authority that:
l A payer can be treated as an assessee-in-default only in respect of such appropriate portion of the sum determined to be chargeable to tax. This, effectively, confirms that in respect of composite payments, tax is to be deducted only in respect of the appropriate portion which represents the chargeable amount (and not gross amount).
l The appropriate portion needs to be determined by the tax authority after taking into account the nature of remittances, income component therein or any other fact relevant to such determination.
An Instruction issued by CBDT is a binding order to be followed by tax authorities.
The impact
The Instruction to the Indian tax authority is as a welcome development for payers/tax deductors. However, considering the consequences of tax withholding default, the payer may prefer to be cautious and may continue to approach the tax authority where determination of chargeability or portion of the chargeable sum is not fairly certain.
Taxpayers continue to face other challenges with tax withholding process such as long time taken to process the applications and no effective appellate remedy (due to time taken in the appellate process); these often hold back commercial transactions or increase costs significantly. Further reforms by CBDT to bring an effective and time-bound withholding tax determination process would significantly help the taxpayer community.
Hitesh Sharma
This article has been coauthored by Rahul Patni, director,
tax & regulatory services, EY. The author is tax partner, EY. Views are personal
