RCA

The Karnataka High Court has held that T.D.S. [withholding tax] provisions are triggered whenever there is payment is made to a non-resident, in the absence of an order from the revenue authorities for NIL / lower withholding of tax.

Background

The issue of deducting TDS [withholding tax] on purchase of “shrink-wrap”/ “off the shelf” software has been in controversy for quite some time. The issue was decided in the favour of the taxpayer by the Bangalore Income Tax Appellate Tribunal (“Tribunal”) on the basis that the payment for purchase of such software is not royalty and consequently, there would be no liability on the payer to withhold tax from such payments.

Against the order of the Bangalore Tribunal, the Karnataka High Court has held that any payment to a non resident would attract withholding tax. This Ruling is an outcome of the appeals filed by the Revenue against the orders passed by the Tribunal in different cases. The High Court while deciding this case has considered the facts in the case of Samsung Electronics Co Ltd (“assessee”).

The assessee was engaged in the business of development, manufacture and export of software for use by its parent company. The assessee purchased certain off the shelf software from a non-resident for the use in its business. The assessee did not withhold tax on the amounts payable for the purchase of software, since the payment did not fall under the purview of „royalty‟ under the Income Tax Act, 1961 (“Act”) and under the Double Taxation Avoidance Agreement (“DTAA”).

The Assessing Officer (AO) and the Commissioner of Income Tax Appeals [CIT(“A”)] concluded that the payment was in the nature of royalty under the Act and DTAA and hence the assessee was a defaulter by not deducting tax from the remittance made by the assessee for the purchase of software.

The Tribunal held in favour of the assessee. It concluded that the payments made for the purchase of shrink wrap software was in the nature of payments for “purchase of goods” and not royalty. It was held that if the payment is not taxable in India, the withholding tax provisions would not apply. The Revenue appealed to the High Court against the Ruling of the Tribunal.

Contentions of the Revenue

• The payments made by the assessee are in the nature of license fee and not outright sale since the software remains with the transferor.
• The amount paid as license fee would come under the definition of royalty both under the Act and DTAA. Software is scientific work liable to tax as royalty both under the Act and DTAA.
• The assessee is bound to deduct tax under section 195 of the Act and he cannot contend that it is not the income of the recipient.
• It is only deemed income irrespective of whether it is „shrink wrapped‟ or „off the shelf / branded‟ software which is required to be considered.
• The Tribunal did not consider whether the assessee can question the taxability of the recipient under section 201 and 201(1A) of the Act.
• Reliance placed on the Supreme Court decision in the case of Transmission Corporation Limited vs CIT (239 ITR 587).
Contentions of the Assessee

• Withholding tax provisions are applicable only where the income is chargeable to tax in India.
• The payment for purchase of software is not in the nature of royalty. The definition of royalty in the DTAA does not mention the word software.
• The payment is made to acquire a copy of a copyrighted article and not for the copyright itself.
• Sale of software is a trading receipt taxable in India only if it arises in India. Since the payment is made outside India, it is not chargeable to tax in India and the assessee is not liable to deduct tax thereon.
• Such payments would constitute business income in the hands of the recipient. Such income can be taxable in India only if the recipient has a permanent establishment in India.
• Even if such payment is considered as royalty under the Act, it does not retain the character of royalty under the DTAA, the provisions of which, being more beneficial would apply.
• The Transmission Corporation case did not consider the consequences where the sum payable to the non-resident is not chargeable to tax at all.
• The Transmission Corporation case is not an authority to hold that even where there is no chargeability, there is an obligation to deduct tax at source, unless one has gone through the process of obtaining a NIL/lower withholding certificate from the tax authorities.

Ruling of the High Court

• The law declared by the Supreme Court in Transmission Corporation is binding on all Courts within the territory of India.
• Section 195 of the Act is neither a charging section nor a section providing for determination of the tax liability of the non-resident who is in receipt of payments from residents.
• Where the payment to the non-resident bears the character of a semblance of an income, the obligation of the payer under section 195 of the Act would arise the moment the payer makes the payment.
The payer cannot avoid the obligation by contending that the payment does not result into income under the Act or DTAA.
The only limited way of either avoiding or warding off the withholding tax obligation by the resident payer is by invoking the provisions of section 195(2) of the Act, i.e making an application to the AO for a lower or a nil withholding tax.
• While examining the application under section 195(2), the AO cannot embark on an exercise to determine the actual tax liability of the non-resident.
• In the absence of an application under section 195(2) by the payer, assuming that an appeal is filed against the consequential order passed by the AO under section 201 of the Act, the appellate authority is precluded from going into the question of determining the liability of the non-resident in respect of the payment received by the non-resident from the payer for determining the extent of obligation on part of the payer as to whether there is any scope for relieving the payer from the obligation of deduction of tax at source.
• An appeal against a demand notice / order under section 201 of the Act cannot serve the purpose of seeking correction of the demand / order on the premise that the receipt in the hands of the non-resident was out of the net of taxation under the Act due to one or the other reason.
• The Tribunal is clearly in error in enabling a tax payer to seek determination of the tax liability of a non-resident recipient.
• The High Court has held that all the orders of the Tribunal in this case are not sustainable.
• The High Court refrained from answering the questions raised in the appeals relating to actual determination of the tax liability of the non-resident assessees.

Conclusion

This Ruling will have a significant impact on the issue of applicability of withholding tax provisions in case of payments to non-residents. The principle laid down will require withholding tax on every kind of payment to a non-resident, unless an application under section 195(2) is made for a lower or a nil withholding tax. The High Court has not ruled on whether the payments for off the shelf software would constitute royalty under the Act or DTAA.

Considering the significant impact of this ruling, further litigation against this order may be expected. The tax authorities, however, may aggressively enforce the withholding tax provisions on both past and future payments to non-residents.

The impact of the above ruling on appeals preferred against order passed under section 201 of the Act, where no application has been made in terms of section 195(2) of the Act, will need to be assessed.

Source: Samsung Electronics Co Ltd and others [ ITA No.2808 of 2005] quoted by Deloitte