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

page 02

1.5 Timing for deduction of Tax at source

1.5.1 Time of TDS when the payer follows cash basis of accounting
79 ITD 506 C J International Hotels Ltd. v. ITO (TDS) (Delhi) Financial years 1991-92 and 1992-93

It was held in above case that, it is not open to the Revenue, for the purpose of determining liability of an assessee tax deductor, to tinker with or in any way reject, the method of accounting employed by such assessee. It was not disputed that the account of the payee was not credited at the time of accrual of income and the accounting was done on cash basis. On these facts, TDS liability of the assessee could not be said to crystallise at the time of income actually accruing to the foreign company.

Since sec 195 specifically provides that the TDS liability arises only when income is credited to the account of the payee or on actual payment of the same whichever is earlier, mere accrual of income in the hands of the foreign company could not be sufficient proximate reason for tax deductor's liability u/s 195.

1.5.2 Applicability of section 195(1) on amounts credited in books but permission not received from Government

Assessee company, a 100% subsidiary of a foreign company LME, credited the account of LME for royalty but did not deduct tax at source. Payment of royalty to a parent non-resident foreign company was prohibited under the policy of the Government of India and therefore the agreement was void. As a result thereof, no income in respect of royalty accrued and assessee was under no obligation to deduct tax at source. (Erricson Communication Ltd. Vs. DCIT (2002) 81 ITD 77 (Del)).

A similar view was expressed by Karnataka HC in ACIT v Motor Industries Co. (2001) 115 Taxman 222. An interesting situation arose in as much as payment was due to a non-resident collaborator but the same was not made as the renewal of the agreement was pending with the Government, though the collaborator continued rendering services. The assessee credited the amount to Suspense Account. The approval was accorded later by the Government with retrospective effect. It was held that till the Government accorded approval to the agreement, foreign collaborator had no right to enforce the payment. The right to enforce payment arose after the approval was accorded and as such assessee cannot be held to be in default us 201 (1) in these circumstances.

1.6 Any other mode
Payments in kind are also covered in the ambit of section 195(1).

1.7 Rates at which tax is to be deducted at source (Rates in Force)
As per section 2(37A)(iii) of the Income Tax Act, 1962 after amendment with effect from 30.6.92 "rate or rates in force" or "rates in force" means for the purposes of deduction of tax under section 195, rates of income-tax specified in this behalf in the Finance Act of the relevant year or the rates of income-tax specified in an agreement entered into by the Central Government under section 90(DTAA), whichever is applicable by virtue of provisions of section 90.CBDT has also clarified vide its circular No. 728 dated 30.10.95 that in view of the provisions of sub-section (2) of section 90 of the Act, in the case of a remittance to a country with which a Double Taxation Avoidance Agreement is in force, the tax should be deducted at the rate provided in the Finance Act of the relevant year or the rate provided in the DTAA, whichever is more beneficial to the assessee.

Also in circular No. 734 dated 24.1.96, CBDT once again reiterated the principle of deducting tax at the rate, which is more beneficial to assessee. This circular specifically refers to deduction of tax on Interest and dividends to non-residents based in UAE. CBDT copied the extract of DTAA relating to interest and dividend in form of circular and stated that the above rates which are enshrined in the DTAA between India and the UAE are to be strictly adhered to so as to avoid unnecessary harassment to the tax payers.

The front-page article in Economics Times on 26th April 2002 mentioned that the tax had to be deducted on payments made to non-residents at the rates mentioned in the Finance Act, irrespective of the DTAA even if the rates of DTAA are lower than that of the Finance Act. The case, which was the basis of this article, was of Poysha Industrial Co. Limited wherein the ITAT, SMC -IV Bench in its ex-parte order dated 12th December 2001 held that the assessee ought to have deducted tax from interest paid to a German company and two UK companies at the rate of 30% being the rate of the relevant finance Act and not as per rates of the DTAA.

It may be noted that this case was for assessment for 91-92 wherein the section 2(37A) was not amended to provide for the rates of the DTAA or relevant finance Act, whichever is beneficial to asseessee.

1.7.1 Whether lower rates of DTAA applicable to payments u/s 196A - D?
It may be noted that section 2(37A)(iii) as well as the Board circulars refers to section 195 only. In cases, where specific sections are provided for Tax deduction at source for example section 194I, section 196A, 196B, 196C and 196D, the tax will have to be deducted at those rates (rates provided in the section) even if the DTAA has specified the rate lower than that specified in the section.

1.7.2 Rates for deduction of tax at source depend upon the nature of the payment
From a perusal of Part II of the First Schedule to the Finance Act, 2002, it may be seen that the rates of deduction of tax from payment to foreign companies(which are covered by section 195 vary according to the nature of payment. If the particular payment is of a nature specifically mentioned therein, the deduction has to be made at the rate prescribed for such specific item of payment.

The rates applicable to certain payments to non-residents /Foreign Companies for financial year 2002-03 as per the Finance Act 2002, are as per annexure "A".

1.7.3 Presumptive Profitability Rates
Besides above rates as given in the Finance Act, one need to refer to special provisions in following sections for presumptive profitability rates.

• Section 44B: Non-Resident in shipping business -7.5% of gross receipts.
• Section 44BB: Non-Resident in business of exploration, prospecting etc., of mineral oils-10% of gross receipts.
• Section 44BBA: Non-Resident in business of operation of aircraft -5% of the gross receipts
• Section 44BBB: Non-resident engaged in civil construction business in certain turnkey power projects-10% of gross receipts.
• Section 44D read with Section 115A: Foreign companies receiving royalties and fees shall be subjected to tax at the rate of 20% on gross basis.
• Section 115AB, 115AC,115AD,115BBA and 115D: Separate rates of tax for specified non residents for various sources of income specified therein.

1.7.4 Rate of exchange for the purpose of deduction of tax at source on income payable in foreign currency - Rule 26
For the purpose of TDS, the rate of exchange for the calculation of the value in rupees of income payable to an assessee outside India, shall be the telegraphic transfer buying rate of such currency as on the date on which tax is required to be deducted at source.

2 Section 195(2):Application by the payer to determine appropriate portion of the sum chargeable to tax

A person responsible for paying i.e. payer may make an application to the Assessing officer for lower deduction of tax at source on payments made or payable U/s 195.

Is order passed U/s 195(2) is appealable ?
The assessee who feels the rate of deduction of tax worked out by the assessing officer against application U/s 195(2) can go into appeal. CIT v. Weteman Engineering Company Pvt Ltd. 188 ITR 327 upheld the power of Deputy Commissioner (Appeal) to determine the rate. It stated that DC (Appeal) is competent to pass an order in respect of the quantum of the amount on which tax has to be deducted or revise the proportion of the amount chargeable under the provisions of the Act, as determined by the Assessing officer.

Findings given u/s 195(2) are not conclusive and hence no writ can be made to high court.

In TELCO Vs CIT (2000) 245 ITR 823 (Bom) and Elbee services Private Limited (2001) 247 ITR 109 (Bom), it was decided that no appeal to the High Court would lie as no substantial question of law arises as the ITAT had clearly stated that the decision U/s 195 is not to be treated as conclusive and is subject to determination of income in regular assessment in case of the foreign company.

Whether section 195(2) applicable even if no tax is deductible
Applying to the officer under sub section 2 for zero rate of tax amounts to application for lower rate for deduction of tax and hence sub-section 2 shall be applicable even when the payer thinks that no tax is deductible from the payments to be made.

2.1 New system of remittance of amount
Circular No: 759 dated 18/11/1997

The Reserve Bank of India has provided in their Office Manual that no remittance shall be allowed unless a No Objection Certificate has been obtained from the Income-tax Department.

Now, It has been decided that on the person making the remittance furnishing an undertaking (in duplicate) addressed to the Assessing Officer accompanied by a certificate from an accountant (other than an employee) as defined in the Explanation below section 288 of the Income-tax Act, 1961, in the form annexed to this circular, remittance can be made.

3 Section 195(3)
Subject to rules (See rule 29B and Form Nos. 15C to 15E) made under sub-section (5), any person entitled to receive any interest or other sum on which income-tax has to be deducted under sub-section (1) may make an application in the prescribed form to the Assessing Officer for the grant of a certificate authorising him to receive such interest or other sum without deduction of tax under that sub-section, and where any such certificate is granted, every person responsible for paying such interest or other sum to the person to whom such certificate is granted shall, so long as the certificate is in force, make payment of such interest or other sum without deducting tax thereon under sub-section (1).

Remark
It may be noted that no lower rate for deduction is possible under this section. In that case one has to refer to section 197, which provides that in a case where the total income of any recipient justifies deduction of tax at a lower rate or no deduction of tax at all, the assessing officer has to issue a certificate for the purpose.

It may also be noted that section 195(3) applies to the interest payment to the branches of the foreign banks but not FIIs.

4 Implications if Section 195 is not observed

I. Failure to deduct or pay tax also results in disallowance of certain deductions:
Failure to deduct or pay tax in accordance with the provisions of section 195 apart from attracting interest, penalty and prosecution also results in disallowance of deductions under the following heads of income.
(i) Income from House Property:
Annual charge or interest (w.e.f A.Y. 2002-03 annual charge deleted) is not allowed as deduction under section 24 if tax is not deducted/paid:
(ii) Income from profits and gains of the business or profession [Sec. 40(a)(i)]
Interest, royalty, fees for technical services or other sum is not allowed as deduction if tax is not deducted/paid thereon:

The proviso to section 40(a)(i), however provides that if tax is deducted at source or paid in any subsequent year, such sum will be allowed as deduction in computing the income chargeable to tax of that year.

(iii) Income from other sources:
Interest and salary not to be allowed as deduction, if tax is not deducted/paid thereon [Sec. 58]

5 Circular for Refund of taxes paid u/s 195 in certain circumstances

1. Circular No. 790 dated 20.4.2000
Claim of refund of excess TDS in respect of non-resident:

The CBDT had issued Circular No. 769 dated 6.8.1998 laying down the procedure for issuing refund in cases where excess tax has been deducted at source.

The above Circular was, however, reviewed by the CBDT and a fresh Circular No. 790 dt. 20.4.2000 was issued. Earlier Circular No. 769 referred to above, stands revoked. The new circular stipulates the circumstances in which the contents of the circular are applicable.

6 Conclusion
While deciding whether any payment made by resident to non-resident is subject to withholding tax (TDS), apart from Sec. 195 one shall also consider applicability of section 5, 9 of the Income Tax Act, 1961. Also one shall consider implication arising from double tax avoidance agreement which India has signed with the country where non-resident person resides.

Annexure - A
(All rates in percentage)

Nature of payment	Payment is made to Non-Corporate Non Resident	Payment is made to Foreign Company
Long-term capital gain on specified assets (sec 115E)	10 (NRIs only)	NA
Any other long term capital gain (Sec 115E)	20	20
Investment Income (sec 115E)	20 (NRIs Only)	NA
Certain royalties / technical fees.(115A)	N/A	20
Interest (Sec 115A)	20	20
Dividend (Sec 115A)	20	20
Any other income	30	40

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C.V.O. CA's News & Views

Vol.5 No. 6 July - Aug 2002