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Coping with effects of Karnataka High Court ruling in Samsung
Electronics

JANUARY 06, 2010

By Romesh S A Sankhe

LAST month, the Karnataka High Court while dealing with withholding tax on payment for
software has delivered a ruling which has the potential to impact the withholding tax
mechanics on cross border transactions executed by taxpayers in India. This article is to
share some thoughts for coping with effects of this ruling and to explore possibility of a
golden mean, respecting the High Court ruling as well as comforting the taxpayers.

How taxpayers are affected

The Karnataka High Court has held that any payments in the nature of income per se to
non-resident taxpayers would require withholding of tax under section 195(1) of the Indian
Income Tax Act (Act). For no withholding of tax or withholding at lower rate, a taxpayer will
have to obtain a prior approval of tax officer under section 195(2) of the Act.

The aggrieved parties in this case may file an appeal before the Supreme Court. However,
till the matter is decided by the Supreme Court, the revenue authorities may cast TDS
obligation on the tax payers and raise tax demands along with interest and penalties on
several cross border payments in which the tax is not withheld. This may also have
consequential impact resulting in disallowance of expenses in the hands of the tax payers if
they do not withhold tax on payments made to non-residents.

The interpretation of the Supreme Court ruling of Transmission Corpn. of A.P. Ltd. v. CIT
(2002-TIOL-471-SC-IT) made by the Karnataka High Court is a crucial factor which may have
far reaching implications on the cross border tax compliance in India. Therefore it is very
important for tax payers in India to explore the possible avenues which will mitigate the
implications arising out of this judicial precedent.

Options before the tax payers

The Karnataka High Court has passed the ruling placing reliance on the decision of
Transmission Corpn. of A.P. Ltd. in which the Apex Court had held as under;

“the scheme of tax deduction at source applies not only to the amount paid
which wholly bears ‘income' character such as salaries, dividends, interest of
securities, etc., but also to gross sums, whole of which may not be income or
profits of recipient, such as payment to contractors and sub-contractors and
payment of insurance commission . The Apex Court had further held that the
expression ‘any other sum chargeable under the provisions of this Act' would
mean ‘sum' on which income-tax is leviable and that, the expression ‘any other
sum chargeable under the provisions of this Act' would include cases where any
sum payable to the non-resident is a trading receipt which may or may not
include ‘pure income'.”

http://www.taxindiaonline.com/RC2/print_story.php?newsid=10191&forumid=1&hea... 01/06/2010


On a careful reading of the Supreme Court ruling and interpretation made by various courts
till date, the few options which tax payers may wish to exploit are discussed hereunder;

a) Contention of non applicability of Section 195 to exempt income

Pursuant to the reading of the Supreme Court ruling in Transmission Corpn. of A.P. Ltd., a
possible argument which may be taken by the taxpayer is that Section 195(1) of the Act
could not be made applicable to sums which are not chargeable to tax at all in India, such
as the sums which are explicitly exempt either under the Act or the relevant tax treaty.
Courts have had the opportunity to decide on cases involving Section 195, post the Apex
Court's judgment in the Transmission Corpn. of A.P. Ltd's case. A few of these relevant
decisions are discussed as under;

M/s Mahindra & Mahindra Limited v DCIT (2009-TIOL-255-ITAT-MUM-SB); where it was held
that

“Section 195 (1) casts duty on the person responsible for paying or crediting to
the account of a non resident any sum chargeable to tax under this Act for
deducting tax at source. On failure to deduct or pay to the Government after
deducting, the person responsible is treated as assessee in default u/s.201(1).
what is pre-requisite for the Revenue to satisfy before treating an assessee in
default is to find out whether the payee's income is liable to tax or not?”

From the perusal of above ruling, it appears that the Mumbai tribunal has acknowledged
that onus under Section 195 cannot be cast upon the taxpayers if the sum payable is not
chargeable to tax in India. This ruling given by Special Bench of Mumbai Tribunal will have
precedence over the ruling of non-jurisdictional High Court on the cases falling under its
jurisdiction and hence the ruling of Karnataka High Court being non jurisdictional high court
will have no impact on the cases covered under Mumbai tribunal jurisdiction. This view can
be supported through a recent decision in Kanel Oil vs. JCIT [2009] unreported (ITAT
Ahmedabad Third Member), where it was held that;

“The ruling delivered by the Special bench will be binding on the division
benches of that tribunal , otherwise the very purpose of constituting them will
get frustrated. The decision of special bench can be disregarded or
distinguished only if there is any contrary view expressed by the jurisdictional
High Court or the Supreme Court”

Further, the judgment of a High Court does not have binding force outside its jurisdictional
state as held in various decisions till date such as Dr. T. P. Kapadia v. CIT [1973] 87 ITR
511 (Mysore HC) and CIT v Thane Electricity Supply Ltd [1994] 206 ITR 727 (Mumbai HC).
In this regard, the taxpayers may also use the following decision of Kerala High Court
where the views were expressed with respect to Section 195(1) which is as under;

CIT v. Fertilisers & Chemicals (Travancore) Ltd. [1990] 86 CTR 40 (Ker HC); where it was
held that

Where question of failure to deduct tax at source under section 195(1) is to be decided, the
basic question to be considered is whether the foreign collaborator rendered any service in
India in terms of the agreement on the basis of which it could be said that a portion out of
the payments made to the foreign collaborator is income that accrued to such collaborator
in India.

With respect to tax payers in Karnataka state, then a High Court decision would generally
have a binding force in the state in which the High Court has jurisdiction and is binding on
all subordinate courts, appellate authorities and the Tax Authority situated within its
jurisdictional territory. Therefore the taxpayers in Karnataka state are bound by this ruling
delivered by Karnataka High Court.



b) Validity of the Chartered Accountant (CA) certificate

Another important aspect which needs to be considered in such case, is validity of
withholding tax certificate obtained from CA. Central Board of Direct Taxes (CBDT) vide its
Circular number 759 dated 18 November 1997 and 10/2002 dated 9 October 2002 has
provided that remittances were allowed to be made by the Reserve Bank of India without
insisting upon a No Objection Certificate from the Department provided the person making
the remittance furnished an undertaking in duplicate accompanied by a certificate from an
Chartered Accountant ( other than an employee as defined in the Explanation below section
288 of the Act).

Through issuance of these circular, the power bestowed under section 195 to Income tax
officer has been given to qualified Chartered Accountant. Therefore, in the cases where the
entire sum is either taxable or exempt under the Act, then said payments can be remitted
after obtaining a certificate from the qualified Chartered Accountant. This position is
affirmed by Delhi Tribunal in its ruling discussed hereunder;

Millennium Infocom Technologies Limited (2008-TIOL-166-ITAT-DEL); where it was held that

“Hon'ble Supreme Court has clearly laid down the principle that the obligation
of the assessee to deduct tax under section 195 is limited only to the
appropriate proportion of income chargeable under the Act. This leaves no
doubt in our mind that at the time of making payments of any sums to non-
residents, the nature of the remittance has to be determined for the purposes
of deduction of tax at source. CBDT in three Circulars i.e. Circular No 759 dated
18 11.1997; No 767 dated 22.05.1998; and No 10/2002 dated 9.10.2002 have
entrusted this task to the chartered accountant. Only in the cases where the
person responsible for paying any such sum, other than salary, chargeable
under the Act to a non resident considers that the whole of such sum would not
be income chargeable in the case of the recipient, he is obliged to make
application to the assessing officer u/s 195(2) to determine the appropriate
portion of such sum so chargeable and tax shall be deducted under sub section
(1) only on that proportion of the sum which is chargeable.”

These circulars and the validity of the CA certificate were not before the Courts either in
Transmission Corpn. of A.P. Ltd. or in Samsung Electronics . In Samsung Electronics ,
Karnataka High Court specifically observed in paragraph 11 and 75 that the tax payers
have not chosen to apply for any relief under Section 195(2) or 195(3) of the Act.
Therefore, a possible contention may be adopted that once the CA certificate is obtained by
the tax payers then onus under Section 195(1) is deemed to be discharged.

Conclusion - Striking a golden mean

Based on the above discussion and analysis of the judicial positions till date, the majority of
the Court seems to have agreed on the point that the provisions of section 195 are not
provisions of convenience which the assessee may or may not use, also tax payer itself
should not enter into the shoes of the tax officer while deciding the taxability of the any
payment made to non-resident. Therefore while making the payment to nonresident a two
step strategies may be adopted by the tax payer which is as under;

1. Where the entire sum is either taxable or explicitly exempt under the Act or
a relevant tax treaty, then said payments may be remitted after obtaining a
certificate from the qualified Chartered Accountant, and

2. Where the taxpayers feels that only part of the gross sum will be liable to tax
in India, then the taxpayers should approach the tax office for determination of
the taxable income.



In such manner, excessive pressure on the Income tax department in issuing the
certificates in all the cases can be avoided and the process of remittance will be expedited
for the taxpayers in cases where the taxability is amply clear. Thus, it will help to achieve
the desired results with a win-to-win situation to all the concerned persons.

It is also to be noted that it is very important on the taxpayer's part to properly comply
with the withholding tax provisions in India with respect to non-residents, especially
keeping in mind the amendment in Section 201 vide Finance Act 2009 which does not put
any bar on the Income tax officer to reopen the assessment when there is a default in tax
withholding with respect to payment made to non-resident. Therefore, the mantra to be
followed by the taxpayers in India should be that “precaution is better than cure”.

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Article on Karnataka High Court ruling in Samsung Electronics published on TIOL.com

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Article on Karnataka High Court ruling in Samsung Electronics published on TIOL.com