C.V.O. Chartered & Cost Accountants' Association

Section 195 of the Income Tax Act 1961 –
TDS on payments to non-residents and foreign companies

Contributed : Shri Kirit Dedhia
& Shri Manish Unadkat

1. Section 195(1)
Any person responsible for paying to a non-resident, not being a company, or to a foreign company, any interest (not being interest on securities) 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:

Provided that in the case of interest payable by the Government or a public sector bank within the meaning of clause (23D) of section 10 or a public financial institution within the meaning of that clause, deduction of tax shall be made only at the time of payment thereof in cash or by the issue of a cheque or draft or by any other mode.

Explanation: For the purposes of this section, where any interest or other sum as aforesaid is credited to any account, whether called "Interest payable account" or "Suspense account" or by any other name, in the books of account of the person liable to pay such income, such crediting shall be deemed to be credit of such income to the account of the payee and the provisions of this section shall apply accordingly.

1.1 Any person
Person has been defined u/s 2(31) of the ITA as under:
"Person" includes-
(i) an individual,
(ii) a Hindu undivided family,
(iii) a company,
(iv) a firm,
(v) an association of persons or a body of individuals, whether incorporated or not, (vi) a local authority, and
(vii) every artificial juridical person, not falling within any of the preceding sub-clauses.

Remarks
It may be noted that even an individual and HUF are required to deduct tax under this section. Also, payment by one non resident to another non resident is also covered,

1.2 Person responsible for paying
The meaning of "person responsible for paying" has been defined under section 204 of the IT Act, 1961 in the context of the section 195, which is as per clauses (iia) and (iii) of section 204.

Remark
Only payments to non residents Indians, for the sum representing consideration for the transfer by him, of any foreign exchange asset, which is long term capital asset, the authorised dealer is responsible for deducting the tax, whereas in all other cases the person making the payment to non-resident is the person responsible for deducting tax.

1.3 Payee:
Section 195 (1) is applicable to following payees:
1) Any non resident but not a company
2) A foreign company.

Other sections which are applicable to non residents (as payees) for deduction of Tax at source are section 192 (Salaries), 193 (Interest on securities), 194E (Payment to non resident sportsman or sports association), 194I (Rent), 196A (Income from Units of Mutual Fund), 196B (Income from units payable to Offshore funds), 196C (Income on bonds or shares purchased in foreign currency and 196D (Income from securities receivable by FIIs).

1.3.1Overlapping of section specifically mentioning the nature of payment V/s. Section 195
If a particular payment is of a nature specifically mentioned in that particular section for deduction of tax at source, the question often arises which section to be applied. For instance, when a company pays rent of Rs.1,20,000/- a year to a non resident , whether the deduction has to be made at the rate prescribed in section 194I at the rate of 15% / 20% or at the rate prescribed in the Finance Act for residuary category at the rate of 40%. Our opinion is, in this case section 194I shall be applied on following grounds:
(i) Various sections such as 192,193, 194E, 194I, 196A etc are enacted for specific nature of payment and so payments covered by such sections are governed by the said sections.
(ii) Secondly, Section 195 refers to "any other sum chargeable under the provisions of this Act" indicating any other sum not covered elsewhere in the Act specifically.

1.3.2 Agent is also liable to deduct tax at source from 1.6.1987 onwards:
Prior to the amendments of section 195(1) by Finance Act, 1987, w.e.f. 1.6.1987, an agent was not under an obligation to deduct tax at source from the remittances made by him to his non-resident principal.

1.3.3 Payment to an Indian agent does not absolve the payer from liability under section 195.
If in law, responsibility for payment is to a non resident, the fact that the amount was paid , at the instruction of the non resident , to his agent or nominee in India, does not absolve the payer of his liability under section 195 to deduct tax at source. [ Narsee Nagsee & Co. v. CIT (1959) 35 ITR 134 (Bom)].

1.3.4 Foreign Company can be resident
In case of payee being non-corporate, payee must be non-resident under Indian Income Tax Act, whereas in case of payee being foreign companies it can be either non resident or resident in India. In a case where, the management and control of the affairs the foreign company is situated wholly in India, it becomes resident in India u/s 6 and, at the same time section 195 shall be applicable.

1.3.5 Payment to foreign firm having a branch in India.
Any payment to foreign firm, having branch in India, managed by a partner who is resident in India, is not subject to deduction of tax at source under section 195 as control and management of the affairs of the foreign firm were not wholly situated outside India and hence the firm became resident in India by virtue of section 6 (Raza Textiles Limited 106 ITR 408 - Allahabad High Court).

1.3.6 Payment of Interest by branch of a foreign company to its Head office.
Circular 740 dated 17.4.96 clarified that branch of a foreign company/concern in India is a separate entity for the purposes of taxation. Interest paid/payable by such branch to its head office or any branch located abroad, would be liable to tax in India and would be governed by the provisions of section 115A of the Act. If the double taxation avoidance agreement with the country where the parent company is assessed to tax provides for a lower rate of taxation, the same would be applicable. Consequently, tax would have to be deducted accordingly, on the interest remitted, as per the provisions of section 195 of the Income-tax, 1961. Though the circular speaks only about interest payable by branch to head office , the same analogy can be applied for any other payment of revenue nature to head office.

1.3.7 Payment by resident to the branches of the foreign bank
Persons paying interest to the branches of the foreign banks on the loans borrowed are liable to deduct tax u/s 195. However, it may be noted that the branches of the foreign banks generally obtain a certificate for non-deduction of tax
u/s 195(3).

1.4 The section 195 does not apply if sums paid are not chargeable to tax
If non resident can rightly keep himself away from income tax liability in India, the payer in India is neither under an obligation to deduct tax at source U/s 195 nor the amount so paid or payable to non resident be disallowed under section 40(a)(i) in the hands of resident for computing the profits and gains of the business or profession.

1.4.1 Payment for import of goods (Trading operations)
Circular 23 dated 23.7.69 has in a very classic manner described the transactions, which would result into "income to accrue or deemed to accrue" in India. It has elaborated the meaning of the term "business connection" in depth. It has stated that in the case of payment made to any non-resident exporter selling goods to Indian importer, no liability will arise on accrual basis to the non-resident on the profits made by him where the transactions of sale between the two parties are on a principal-to-principal basis.

1.4.2 Payment of commission to foreign agents of Indian exporters
In the above-mentioned circular no. 23, it is stated that a foreign agent of an Indian exporter operates in its own country and no part of Income arises in India. His commission is usually remitted directly to him and is, therefore, not received by him or on his behalf in India. Such an agent is not liable to pay income tax in India on the commission income. The said findings are again reiterated in Circular 786 dated 7.2.2000

1.4.3 Gross sum Vs. Pure profit
Once it is determined that the amount payable to the non-resident is the income chargeable to tax, the tax has to be deducted on the gross sum payable to the non-resident irrespective of whether whole of such sum would be taxable in the hands of the non-resident or not.

The Supreme Court in case of Transmission Corporation of A.P. Limited Vs. CIT (239 ITR 587) held that Tax is required to be deducted u/s 195 only if the sums are chargeable to tax. Even if part of the payment constitutes income, the payer is under obligation to deduct tax at source at the rates in force on the whole of amount. The recourse to section 195(2) is open to the payer if he is of the opinion that the sum payable does not fully constitute income. In such a case the application has to be filed with the Assessing officer and the tax has to be deducted according to the order of the Assessing officer.

1.4.4 Income exempt under the Act not liable for deduction u/s 195
An income or a benefit, which is not includible in the total income of a person by virtue of the clauses of section 10 or otherwise, cannot be considered as 'income' for the purposes of deduction of tax at source at all. This is so because the purpose of deduction of tax at source is not to collect a sum which is not a tax leviable under the Act, it is to facilitate the collection of tax lawfully leviable under the Act. An interpretation which would lead to collection of certain amounts by the state which is not the tax qualitatively, is impermissible in case of a taxing statute [Hyderabad Industries Limted Vs. ITO, (1991) 188 ITR 749, 752 (Karn)]

1.4.5 Grossing up of the amount.
In case the payer agrees to bear the tax incidence and is supposed to remit the net-of-tax amount to the non-resident, the amount to tax has to be determined after grossing up the net of tax amount and the tax amount. The tax rate had to be applied on this total amount.

Cognizance needs to be taken of amendments by Finance Act, 2002, regarding omission of sections 10(6A), 10(6B) and 10(33). From assessment year 2003-4 the income as per those section would not be exempt and hence section 195 would be applicable to remittance of such sums.

1.4.6 Payments to foreign shipping companies are not subject to TDS under section 195
Circular No.723 dated 19.09.1995

Section 172 deals with shipping business of non-residents. Section 171(1) provides the mode of recovery of tax in case of any ship, belonging to or chartered by a non-resident, which carries passengers, live stock, mail or goods shipped at the port in India. Section 172 is a self-contained code for the levy and recovery of the tax, ship-wise and journey-wise, and requires the filing of the return within the maximum period of 30 days from the date of departure of the ship. Hence, in such cases only section 172 need to apply and not section 195 or 194C.

1.4.7 Payment for purchase of software
Circular No. 588 dated 2.1.91
CBDT has decided that lump-sum payment for systems software supplied by the manufacturer along with the hardware itself would be subjected only to customs duty and not to income-tax. Application software forming part of an approved software export scheme would be subjected only to income-tax on the licenser or seller. However, while determining applicability of TDS on payment for software, one has to determine the character of Income i.e whether a product is being purchased or a license is being obtained. One can refer to the TAG report of OECD for determining the character of Income.

1.4.8 Reimbursement of expenses
The term "reimburse" means to restore, to pay the exact amount expended. It envisages expenditure by person (non-resident) first and indemnifying the non-resident with the same amount as incurred by him. Hence this reimbursement cannot be characterised as income. However, the essence of reimbursement is that there is no element of profit built in to the same. If there is any element of profit, then whole amount is to be construed as the income of the receiver and accordingly the tax has to be deducted on the whole amount.

More relevance is to be attached to the terms of agreement between the parties. So if there is a composite agreement which provides for payment of daily allowances and travelling cost and such amount is included in the lump-sum consideration, then the reimbursement shall be treated as the part of the income - Steffen, Robertson & Kirsten consulting engineers and Scientist Vs. CIT (AAR) 230 ITR 206.

In case of CIT Vs. Industrial Eng. Products [202 ITR 1014 (Del)], it was held that reimbursement of expenses does not constitute income and hence not taxable.

However, Honourable Kerala High Court in Cochin Refineries Ltd (222 ITR 354) has taken a contrary view. The court held that reimbursement of expenses by the Indian company to the foreign company would be regarded as income and is liable to tax in India.

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Vol.5 No. 6 July - Aug 2002