Tax Deduction at Source

The last few years have been eventful ones for Indian income tax law – many fundamental questions have been raised, some have been answered, and others are still before the courts. While these are too numerous to list individually, it is worth noting that the issues involved have touched on the extra-territorial applicability of the Indian Income Tax Act, 1961, the scope of fees for technical services, the threshold for levying penalties under s. 271(1)(c) etc. Last month, in GE Technology India Centre v. CIT, the Supreme Court definitively settled one of the more important of these questions – the circumstances under which the obligation to deduct tax arises in the case of payments made to non-residents.

In very simple terms, tax deducted at source [“TDS”] represents an alternative and more efficient collection mechanism for the Government. Conceptually, TDS is not a separate charge, nor is it a levy additional to the income tax charged under the Act. In other words (conceptually), TDS pertains not to whether tax is payable, but to who pays it, and when it must be paid. This conceptual understanding of TDS was thrown into some doubt last year by the well-known decision of the Karnataka High Court in CIT v. Samsung Electronics. The High Court held in that case that the obligation to deduct tax under the Income Tax Act arises regardless of the chargeability under the Act of the principal sum. Theoretically, this led to results that it is difficult to believe the legislature intended – for example, if chargeability is irrelevant, a payment made by an American company to a Belgian company for a transaction entirely outside India could attract the requirement. As a result, there was doubt as whether the Karnataka High Court reached the correct conclusion, and in GE Electronics, the Supreme Court has confirmed that it did not.

Before discussing the decision of the Supreme Court, it is worth noting that this question is governed by the provisions of s. 195 of the Income Tax Act. S. 195(1) provides that

Any person responsible for paying to a non-resident, not being a company, or to a foreign company, any interest or any other sum chargeable under the provisions of this Act (not being income chargeable under the head “Salaries” shall, at the time of credit of such income to the account of the payee or at the time of payment thereof in cash or by the issue of a cheque or draft or by any other mode, whichever is earlier, deduct income tax thereon at the rates in force …  [emphasis supplied]

S. 195 is placed in Chapter 27 of the Act, which is titled “Collection and Recovery of Tax”. S. 190, defining the scope of the chapter, provides that “notwithstanding” regular assessment in respect of “any income…” the tax on “such income shall be payable by deduction or collection at source or advance payment…” All of this seems to reiterate the conceptual understanding that the question of TDS does not arise unless it is clear that the principal sum is liable to tax. What led the Karnataka High Court to hold as it did was a decision of the Supreme Court in Transmission Corporation.

Thus, two issues arose before the Supreme Court in GE Electronics – first, whether the issue was concluded by the decision Transmission, and, if not, whether there is warrant to read s. 195 in the manner suggested by the Karnataka High Court. On the first issue, the Supreme Court held that Transmission Corporation does not conclude the matter, because it was decided on a different point of the scope of s. 195(2) in the case of a “composite” payment made by a resident to a non-resident. The Court carefully examined its opinion in Transmission, and cited certain passages from it to demonstrate that the case did not lay down any general proposition on the applicability of s. 195(1).

Having so found, it was free to consider whether the language of s. 195 points to this result. It began by noting that the expression “chargeable to tax” clearly indicates the intention of the legislature to activate TDS only when the principal sum is itself chargeable, and further contrasted this with other provisions in Chapter 27 that significantly omit the expression “chargeable under” and simply provide that TDS is applicable to any “sum paid” to a non-resident. Finally, the Court also pointed to an absurd consequence that would follow from accepting the Revenue’s position – the payer would have no avenue to appeal against the payment of TDS on a sum even patently outside the ambit of the Indian Act (since, in law, TDS is not paid to discharge the tax liability of the payer), in addition to the fact that only the payee can seek a refund. One of the Department’s main contentions was that a blanket rule requiring deduction promotes tax compliance and prevents “seepage of revenue”. The Supreme Court rejected this contention, correctly noting that it is open to the Department in such cases to disallow the expenditure claimed by the payer on the principal sum paid to the non-resident.

Two points are clear. First, as several High Courts and Tribunals across the country pointed out, the approach of the Karnataka High Court in Samsung is, with respect, incorrect. Secondly, the Supreme Court was right to affirm the primacy of the “text” of s. 195 of the Income Tax Act, 1961 in answering this question – in an era where the text of a provision is often subordinated to various other considerations, it is perhaps welcome that the Supreme Court stifled the Department’s attempt to effectively rewrite s. 195 of the Act in a bid to promote revenue-collection.