Withholding Obligations on Non-residents: Whether an Unintended Consequence?
This article seeks to examine the legal aspects on the applicability of withholding tax provisions on non-residents under the Income Tax Act, 1961 while making payment to residents of India. The article analyses many aspects including extra territorial operations of law on non-residents, relevance of circular No 726 issued by CBDT, recommendations of working group, various provisions of the Act. It also scrutinizes whether the tax authorities have the jurisdiction over the non-residents to recover any tax from them. As a result, it provides possible option that the non-residents may consider to get away with the penal and the prosecution consequences. Read on…
1. Introduction: The Unresolved Cross-Border Dilemma
The Indian Income Tax Act, 1961 (‘the Act’) has evolved over the years, with various amendments pertaining to non-residents. However, still there lies a deep-rooted ambiguity on the applicability of withholding provisions on non-residents. It is a settled law that the payments made to non-residents are subject to withholding tax u/s 195 of the Act. However, the question that needs to be addressed is on the vice versa scenario: whether in legality the non-residents are required to comply with the withholding provisions under the Act, while making payment to Indian residents?
2. Withholding Provisions on Payment to Indian Residents
At the outset, the withholding provisions are covered by Chapter XVII B of the Act. This chapter inter alia covers various provisions like Section 193, 194A, 194C, 194D, 194H, 194I, 194IA, 194IB, 194IC, 194J and so on, which deals with payments made to residents. The opening words of majority of these sections generally starts with the phrase “Any person responsible for paying a sum to any resident……”. Therefore, the important question is whether “any person responsible for paying” is defined under the act?
Meaning of Person Responsible for Paying
Section 204 of the Act defines the meaning of “person responsible for paying”. As per clause (iii) of the said section, in case any credit or payment of any other sum chargeable under the provisions of this Act, person responsible for paying is the payer himself or if the payer is a company, then the company including the principal officer thereof. Therefore, on literal interpretation, one may take a view that the non-resident or the foreign company would be the person responsible for paying and hence the provisions of Chapter XVII would be squarely applicable on them.
3. Extra-Territorial Operation of Law: Constitutional & Judicial Boundaries
However, the issue that warrants serious examination is whether, the Indian legislation is empowered to regulate a person, who is residing outside the territory of India with no presence in India? Legally this is understood as the “extra territorial operation of law”. In this context, the privy council in the case of British Columbia Electric Railway Co Ltd Vs King [MANU/PR/0103/1946], while interpreting the Government of India Act, 1935 held that:
“A legislature which passes a law having extraterritorial operation may find that what it has enacted cannot be directly enforced, but the Act is not invalid on that account, and the courts of its country must enforce the law with the machinery available to them.”
Therefore, the privy council dictum goes on to show that, it is within the powers of the legislature to enforce a law having extraterritorial operations. At the time when the draft Indian constitution was prepared, it contained several clauses for distribution of power to enact a legislature. Clause 179 contained provisions related to extra territorial operations, which stated that “Subject to the provisions of this Constitution, the Federal Parliament may make laws, including laws having extra-territorial operation, for the whole or any part of the territories of the Federation....” which later on was embedded in the constitution as Article 245(1) & 245(2).
Article 245(1) of the Indian Constitution, empowers the Parliament to make laws for the whole or any part of the territory of India and the legislature of the state to make any law for the whole or any part of the state. Further, Article 245(2) states that “No law made by Parliament shall be deemed to be invalid on the ground that it would have extra territorial operation”.
Therefore, it may appear that Article 245(2) may validate the extra territorial operations of the Income Tax Act. However, the question that remains is, whether the parliament is empowered to enact laws in respect extra territorial aspects or causes that have no nexus with India? This question has been lied to rest by the Apex Court Judgement in the case of GVK Industries Ltd Vs Income Tax Officer [2011 197 Taxman 337 (SC)]. The key observations of the Apex court are as under:
“The Court derived the responsibility of the Parliament with the help of word ‘for’ used in article 245(1) and stated that Parliament of India is to act as the Parliament of India and of no other territory, nation or people. The Court also derived two related limitations in this regard, the first being that the Parliament may only exercise its powers for the benefit of India in regard to the necessity. The laws enacted by Parliament may enhance the welfare of people in other territories too but the benefit to or of India remain the central and primary purpose. The second limitation that the law made by Parliament with regard to extra-territorial aspects or causes that do not have any, or may be expected to not have nexus with India, transgress the first condition. The Sudarshan Reddy J. for Constitutional bench negated the answer of question logically and held that the Parliament’s powers to enact legislation, pursuant to clause (1) of article 245 may not extend to those extra-territorial aspects or causes that have no impact on or nexus with India.”
Therefore, the key ratio decidendi drawn from Apex court precedence is that the Article 245 cannot be extended to territory beyond India that have no impact or nexus with India. Practically, a non-resident may or may not have a:
- A presence in India; or
- Income sourced in India; or
- A business connection in India.
If the non-resident does not have any of the above proximity with India, then it may be reasonably fair to contend that the non-resident does not have any nexus with India and consequently the extra territorial operation of law may not be applicable on them. However, if the non-resident has any proximity with India, then it may be difficult to take the above argument and therefore this leg of argument may not stand in the court of law.
Further, in the case of A.H. Wadia vs Income Tax Commissioner [MANU/FE/0004/1948], the federal court opined that the enactment process relating to extra territorial operation of law cannot be challenged in municipal court. Therefore, raising constitutional validity on the extra territorial operation of law may not travel higher in the Judiciary.
4. Administrative & Legislative Perspectives
Circular No 726 dated 18-10-1995
In the context of the moot issue under discussion, it will be relevant to peruse the Circular No. 726 which clarifies regarding the payments to Indian residents by foreign companies or foreign law firms that have no presence in India. Representations were made to CBDT from various law and accountancy firms’ resident in India that were receiving fees for professional fees from foreign companies and foreign law firms which had no presence in India regarding the practical difficulty in withholding tax and complying with the filing procedure. The CBDT vide circular no 726 clarified that TDS provisions u/s 194J may not be applicable on the non-resident if the fees are paid through proper banking channels and such non-resident does not have any agent, business connection or permanent establishment in India. The circular further requires the non-resident to send a quarterly statement indicating certain details of the payment to the Income Tax Department.
While it may prima facie appear that this circular has provided clarity in this aspect, it has also led to confusion on this issue:
- Firstly, all the non-residents cannot take a cue from the circular, as this is only applicable for payments made to lawyers and chartered accountants by foreign companies and foreign law firms.
- Secondly, it appears from the circular that non-residents, who do not have any nexus with India (as held contrary in GVK case supra) are required to comply with withholding provisions under the Act.
- Thirdly, the circular directly does not absolve the non-residents from any compliance requirements since they are required to submit a quarterly statement to CBDT in these regards.
Report of Working Group on Non-Resident Taxation (Dr. Vijay Kelkar Task Force)
While analysing this issue it may be relevant to take note of the recommendation made by the working group. The Government appointed a Task Force on Direct Taxes under the Chairmanship of Dr. Vijay Kelkar, which presented a “Consultation Paper” relating to tax treatment of non-residents. The Task Force recommended the creation of a Working Group headed by the Director General of Income Tax (International Taxation) and comprising representatives from trade and industry to examine various issues pertaining to non-resident’s taxation.
The working group in para 4.13.4 of the report after taking into consideration the practical difficulty on non-residents to comply with the withholding provisions recommended that:
“A provision be introduced to the effect that if the recipient undertakes to pay the withholding tax and completes all formalities including filing of TDS return on behalf of the non-resident payer then the non-resident payer shall be relieved of his obligation of deduction of tax at source. The undertaking and the deposit of the tax in such cases shall be made in non-resident tax circles. This will also safeguard revenue’s interest.”
However, the government has not considered this recommendation even after taking cognizance of this issue. This gives out a signal that the intention of the Government is to hold non-residents “the person responsible” for withholding tax.
Explanation 2 to Section 195(1) – Whether it Can Protect Non-Residents from Withholding Obligations?
As a surgical mission to overrule the landmark decision of Apex court in the case of Vodafone International Holdings B.V vs Union of India [2012 341 ITR 1 (SC)], the government inserted Explanation 2 to Section 195(1) to clarify that the deduction u/s 195(1), was always applicable to both residents and non-residents, whether or not it had any residence, business connection or presence in India in whatsoever manner.
Now, one school of interpretation could be that, since the other provisions of chapter XVII B of the Act does not emphatically hold non-residents responsible, it may be possible to take a view that non-residents are not liable under the Act.
Another school of thought could be that, Explanation 2 is more of clarificatory in nature and it holds a non-resident responsible for making payment to another non-resident, therefore if it is widely interpreted then even without having a specific explanation in other provisions, it may be said that non-residents would be covered under the provisions of the Act.
In the light of the above background let’s analyse the provisions under the Act.
5. Statutory Status: Whether Non-Resident is an Assessee under the Act?
As per Section 2(7) of the Act, assessee means any person by whom any tax or any other sum is payable under the Act and it inter alia includes every person who is deemed to be an assessee in default under any provisions of the Act.
As per explanation to Section 191 of the Act, if any person who is required to deduct any sum and does not deduct or after deducting fails to pay & where the assessee has also failed to pay such tax directly, then the payer would be deemed to be assessee in default within the meaning of section 201(1) of the Act.
Therefore, the non-resident would be an assessee under the Act if he becomes an assessee in default for not withholding tax while making payment to a resident.
However, as per first proviso to Section 201(1) of the Act, the non-resident would not be deemed to be assessee in default if the resident payee has:
- Furnished the return of income;
- Taken such sum while computing the income;
- Paid tax on such income; and
- The payee furnishes Form 26A read with Rule 31ACB to this effect from an accountant.
It may be worthwhile to note that this will not absolve the non-resident from the interest implications u/s 201. Therefore, in that case he may be an assessee under the Act for the amount of interest which may be payable by him. Having analysed the definition of assessee under the Act, it may be relevant to analyse the consequence of not withholding tax.
6. Consequences of Not Withholding Tax
If the tax is not deducted or after deducting, if it is not paid to the credit of the government, then the deductor will be deemed to be assessee in default and following are the consequences:
- Interest under Section 201: Interest @ 1% per month or part thereof for non-deduction, and interest @ 1.5% per month or part thereof for non-payment of tax u/s 201.
- Disallowance of Expenditure: Disallowance of expenditure to the extent of 30% while computing Income u/s 40(a)(ia) of the Act (not relevant for non-residents not having an income sourced in India).
- Penalty under Section 271C: Penalty u/s 271C of the Act to the extent of tax in arrears in addition to interest.
- Prosecution under Section 276B: Prosecution u/s 276B of the Act which may not be less than 3 months but may extend up to 7 years.
- Recovery Proceedings: Recovery proceedings under the Act.
7. The Structural Disconnect in Recovery Provisions (Chapter XVII-D)
The recovery provisions under the Act are contained in Chapter XVII D of the Act. Further, as per Section 228A(2) of the Act, if the assessee is in default or deemed to be in default in making a payment of tax, and he has any property outside India, in a country with which central government has entered into agreement for the recovery of income tax, then the tax recovery officer (‘TRO’) may, forward to the board, a certificate drawn up by him u/s 222 of the Act and the board make take such action as it may deem appropriate with such country.
Section 223 of the Act defines the TRO competent to take action u/s 222 of the Act and it states that the competent TRO shall be the person within whose jurisdiction the assessee carries on business / profession or his principal place of business / profession is situated or within whose jurisdiction the assessee resides or the property of the assessee is situated.
Therefore, technically in case of non-residents not carrying any business in India and neither possessing a property situated in India, there will not be any competent TRO to issue certificate u/s 222 of the Act and consequently, recovery proceeding u/s 228A of the Act cannot be initiated. This does not protect the revenue’s interest in safeguarding the amount of tax that may be withheld. Therefore, there lies a disconnect between the provision of recovery in case of non-residents.
8. Conclusion & Suggested Roadmap
The non-residents may opt to take different view on this subject matter depending upon the facts and circumstances. However, the position as on date is that the law does not in black and white obviate the compliance obligations on non-residents. On a conservative stand, the non-residents may contemplate filing Form 26A and ensure that the resident payee has paid the tax in these regards in order to get away with the penal and the prosecution consequence under the Act. However, this may be at a cost of interest u/s 201 of the Act.
Practically, it would be very difficult for a non-resident to comply with the provision of Indian Income Tax Act merely for making a payment to a resident in India, especially in case where it does not have any presence or nexus with India. This may create undue hardship and unwarranted obligation on them, moreover this would go against the motto of “ease of doing business”.
Also, as analysed in the article the revenue will also not have complete control on the recovery of tax. Therefore, it would be good on the part of the department to come out with a clarification or an alternative approach in these regards to lie the issue to rest. ∎∎∎