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This article is written by Shubham Mahadeo Walunj, a student of Yashwantrao Chavan Law College from Pune, Maharashtra. This article contains information about the Withholding tax provisions in Indian law & the relevant cases.

Introduction 

Before one can embark on a study of withholding tax under Income tax, it is vital to understand some of the expressions found under the Income Tax Act, 1961. The concept of tax is very vast when we look at the fast-growing corporate world. The withholding tax is the amount of deduction that takes place directly from the employees earning by the employer and is paid to the government as tax. This withholding tax has a large scope as day by day the industries are growing and this leads to employment. When there is more employment there would be a large amount of tax deduction and this may help the government. As the government gets more tax it can be used for the development of the country.

In this article, we will talk or know more about the withholding tax provisions in Indian law with the help of important cases and their judgments.

What is withholding tax

Withholding tax is an amount of which deduction takes place directly from the earning of an employee by the employer & paid to the government as a part of individual tax liability. It is also called Retention tax. Such income tax will be paid on the total income of the earlier year in the pertinent evaluation year. However, the total income is not settled forever depending on the residential status in India. These taxes are paid to the Central government of India. In India, the Central Government is empowered to levy & collect taxes. The tax is being charged based on the income of the person. 

Withholding tax is the commitment of the citizen to keep a charge when making payments under explicit categories at the rates specified in the current tax slabs. The specific categories include rent, commission, payment for professional services, salaries, contracts, etc.   

Section 195 of the Income Tax Act

Section 195 of the Income Tax Act, 1961, governs the rules & regulations regarding payments made to a non-resident. It states in Section 195 of Income Tax Act, 1961 that “Any individual answerable for paying to a non-resident, not being an organization or to a foreign organization, any interest or segment 194LD or some other total chargeable under the arrangements of this demonstration will, at the hour of credit of such income to the account of the payee or at the hour of the payment thereof in cash or by whatever other mode, whichever is prior, deduct income tax subsequently at the rates in power.”

How are tax liabilities counted in India

It is by calculating the net income earned for the previous financial year in the current assessment year. As we know, the income tax payable of any person depends on the residential status of that person. We should know how residential status is categorized in India.

Residential status is of two types

Resident Indian

It is mentioned in the Finance Act, 2020 which has introduced a new Section 6(1A) in the Income Tax Act, 1961. A resident taxpayer is a person who fulfils any one of the following conditions: 

  • Staying in India for a year is 182 days or more in the previous financial year that is between April to March 31 of the following year.
  • Staying in India for the immediately 4 preceding years is 60 days or more for a total of 365 days or more in the 4 years preceding the previous year.  

Non-resident Indian

Royalty and fees for technical services under the Indian Income Tax Act, 1961 is defined under Section 9 of the Information Technology Act, 1961. A person who doesn’t fulfil the essential conditions of residence can be considered a non-resident. Simply those NRIs are obligated to pay tax who are acquiring income in India from sources referred underneath: 

  • Salary paid for the services provided in India.
  • Income earned from the property in India or income arising out of business carried out in India.
  • Fees, royalty, interest paid by Resident Indian to NRI for giving any technical services offered by the Non-Resident Indian in India.  

Charges related to withholding tax

The withholding tax rates for payments by resident companies are

Nature of PaymentsWithholding Tax Rate
Residents interest10%
Non-Residents interest 5 – 40%
Commissions & brokerage10%
Lease of plant, machinery, or equipment2%
Lease of land, building, or furniture2%
Legally payments (except for individuals/ HUF)2%
Legally payments to individuals/ HUF1%
Purchase of immovable property1%
Royalty25%
Fees for Technical Services 25%

Consequences of non-payment of withholding tax

  • Penalties for non-deduction & failure to pay deducted tax to the government may result in a minimum penalty under Income Tax Act, 1961.
  • Under sub-section (1) of Section 201, Income Tax Act, 1995 no order shall be made considering an individual to be an assessee in default for failure to deduct the whole or any part of the tax from a person resident in India, whenever after the expiry of seven years from the end of the financial year in which payment is made or credit is given. 
  • Under Equalization Levy, in case there is a delay in payment: Interest is charged at 1% of the extraordinary duty for every month or part thereof is delayed.
  • Penalty under equalization levy of Income Tax Act, 1961 is equivalent to INR 1,000/day subject to the maximum of the amount of levy failed to be deducted. 
  • Penalty for failure of filing a statement of compliance, INR 100/day for every day the non-compliance proceeds. 
  • If a false statement has been filed, the individual might be subjected to imprisonment of a term of up to 3 years and a fine.

Legal advantages and other intricacies involved

Advantage of keeping taxes from paycheck

The biggest advantage to having enough taxes kept from your paycheck is that you don’t have to think of a truckload of cash at year-end to pay the taxes you owe. You can likewise request that your boss keep extra money to cover the tax owed on other income, like independent work profit or betting rewards. This keeps you from expecting to document tax payments quarterly during the year to remain mindful of your tax commitment. If you overpay your taxes, at year-end you can apply for a discount on the overpaid sum. Many individuals find this component helpful as a reserve fund intended to pay for huge buys.

Exchange of withholding tax 

The essential advantage is that the public authority at an early income age gets nothing. Withholding tax is claimed on an exchange, the payee deducts the amount of the tax while setting aside payments and deposits a similar amount with the government. The government gets the sum promptly or as when any such exchange is brought about.

Risk on the payer

The subsequent advantage is that every transaction made is under the radar & scrutiny. It is the responsibility of the payee to do the tax deduction & pay that deducted amount to the government. In this way, the risk is on the payer, it is a must for the payer to make sure that the tax charge is accurate and a similar deducted amount is kept with the government. Thus, for this, the transaction is scrutinized at every designated point.

Tax cannot be avoided 

The third advantage of charging withholding tax is that there is no other way by which one can avoid the withholding tax. Initially, Non-Resident Indians can’t exit from paying charges as NRI doesn’t have to make direct instalment of duties, however, the payer has the onus of deducting & paying taxes. So, the NRIs must pay tax via payer & secondly, the payer needs to take care of the deducted tax to the government. 

Relevant case studies

Prasad Production Case

In Prasad Productions Ltd., Chennai vs Department Of Income Tax (2009), the assessee company got the contract from the Tourism Department Of Government of Andhra Pradesh to establish an IMAX theatre at Hyderabad. So, the assessee entered into an agreement with IMAX Ltd. for the purchase of equipment and installation. As part of the agreement, it was decided that the assessee will pay IMAX US $ 13,65,000 for the purchase of the system and US$ 9,50,000 as a technology transfer fee. As per the agreement the assessee paid the US $ 9,02,500 to IMAX Ltd. without deducting tax at source (TDS). So the Assessing Officer asked for the detailed description but the assessee could not provide it. The Assessing Officer concluded that since the assessee has not obtained an order under Section 195(2), Section 195(3) or under Section 197, the gross sum remitted by the assessee was liable to tax under Section 195 of the Act. 

The remittance of US$ 9,02,500 was for the provision of technical services by IMAX which falls under Section 9(1)(vii) of the Income Tax Act, wherein it is stated above to Section 9(1)(vii) that fees for technical services mean any consideration for the rendering of any managerial, technical or consultancy services it would be chargeable to tax under Section 44D read with the Section 115A. Detailed submissions were made by the assessee before the Commissioner of Income Tax. It was pointed out that where the Double Taxation Avoidance Agreement (DTAA) was entered into by India, the provisions of DTAA would prevail over the provisions of the Act. Accordingly, the Court held that there is no uncertainty concerning the portion which is not taxable and the portion which isn’t taxable. However, the payment of US  $ 9,02,500 is a part of the equipment price which includes the services of installation and training. Therefore, the sum of US $ 9,02,500 is not chargeable to tax in India and hence the assessee was justified in not deducting any tax at source. So every overseas remittance had to withhold tax unless it had a nil withholding order from the Revenue Department.

Van Oord Case

In Van Oord Acz India (P) Ltd. vs Commissioner Of Income Tax (2010) case, the appellant was a company incorporated in India and was a wholly-owned subsidiary of Van Oord ACZ Marine Contractors, a company incorporated in the Netherlands. The appellant executed inter alia dredging contract at Port Mundra for Gujarat Adani Port Ltd. The appellant debited to its profit and loss account, inter alia, mobilization and demobilization cost of Rs.8,92,37,645/- reimbursed to VOAMC, out of which Rs.8,65,57,909/- pertained to the aforesaid dredging contract at Port Mundra which was completed during the previous year. The appellant had filed an application with DCIT, Circle 2(2), International Taxation, New Delhi (DCIT) for issuing NIL tax withholding certificate in respect of reimbursement of various costs required to be made by the appellant to VOAMC, on the ground that the amount represented pure reimbursement of expenses and thus, there was no income liable to tax in India in the hands of VOAMC. 

The amount repaid to VOAMC was not chargeable to tax in India in the possession of VOAMC. The appellant was thus not liable to deduct tax at source under Section 195 and the prohibition under Section 40(a)(i) of the Act. In favour of the appellant it was seen that the assessee was not responsible to deduct tax at source under Section 195(1) of the Act,  about mobilization and demobilization cost which was reimbursed by the appellant to VOAMC. The evaluation procedures in VOAMC were reopened and the last view taken was that the VOAMC is assessable to tax, the assessee, in this case, would likewise be treated as assessee in “default”, which would attract the consequences provided under Section 40(a)(i). The submission was that where sums paid to the non-resident represent pure reimbursement of expenses with no element of profit, there is no income liable to tax in India in the hands of the non-resident. Finally, in this case, the Delhi High Court ruled that withholding taxes apply only to payments that are taxable in India.

Conclusion

This article provides a detailed description of withholding tax, cases and their judgments. A person who is liable for the withholding tax should compulsorily pay the tax. A non-resident can still take shelter under the tax treaty, particularly India’s tax treaties with nations like Singapore, USA, UK & so on that have a confined/ narrow definition of fees for technical services. Although the AAR is restricted to show up before the authority, the gatherings & the transaction for which the decision was given because the decision was delivered on the set of facts & it can’t be a general application. However, it may have convincing value.

References


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