TAX DEDUCTION ON INTEREST PAYMENT TO NON-RESIDENTS

1. Introduction:

Section 195 of the Act deals with deduction of tax on payments made to

Non-Resident and the interest payments to Non-residents falls under this

section. Sections 193,194A, 194-C, 194-D, 194-H, 194-I and 194-J deals

with payments made to residents in respect of specifi ed payments mentioned

therein. In case of payment made to Non-residents in respect of any sum of

money, including the payment which falls in the nature payments mentioned

in sections 193 to 194-J referred above, tax deduction is to be made as per

section 195 of the Act. This section has the wording as “Any interest or

any other sum chargeable under the provisions of this Act”. If Payment

is made to the Non-resident, tax is to be deducted as per the rates in force.

Non-deduction of tax at source u/s 195 will attract disallowance of the related

expenditure u/s 40(a)(i) of the Act whereas Non-deduction of tax on payments

to residents are dealt by section 40(a)(ia) from the asst-year-2005-06 onwards.

In this article certain issues regarding payment of interest and liability for tax

deduction are analyzed.

2. Nature of payments covered u/s195:

One of the prime criteria to attract tax deduction under this section is that the

payment made to Non-resident should be chargeable to tax under the Act. If

the payment is not chargeable to tax in India as per the provisions of the Act,

then the tax deduction is out of the purview of this section. Further this section

deals with payment made to Non-residents not being a company or to a

foreign company. All payments made to Non-residents are covered under this

section. Provisions of this section is applicable even if the amount payable is

credited to suspense account or payable account.

3. Rate of deduction of tax:

Rate of tax deduction for payments to Non-residents has been specifi ed in

part-II of First Schedule to Finance Act.

Rate of tax is specifi ed in (A) to (K) of this part. These rates are applicable to

NRIs only. Rate of tax deduction for three payments is considered here.

i) Any investment income ---- 20%

ii) On the whole of the other income ---- 30%

iii) Interest on money borrowed ---- 20%

In case any payment is made to Non-resident Indians, tax has to be deducted

on the specifi ed rates in respect of that particular income.

In respect of investment income (as specifi ed under the Act), tax has to be

deducted at 20%, since the amount deposited with any concern is in the

nature of investment only.

In respect of any other payment like rent, commission, etc. paid and for the

same if the rate of tax for deduction has not been specifi cally mentioned in the

schedule, general rate of tax of 30% is to be applied.

The tax deduction rates applicable to Non-residents (other than NRIs) are

also specifi ed in the above referred schedule. Non-residents are not entitled

to the rate of 20% for the investment income. Rate of tax deduction for three

payments is considered here.

i) Any investment income ---- 30%

ii) On the whole of the other income ---- 30%

iii) Interest on money borrowed ---- 20%

4. Practical issues involved in payment to Non-resident:

In this article three kinds of payments are considered and the practical issues

involved therein are analyzed.

a) Interest paid by an Individual to a Non-resident on the loan borrowed for

purchase of machinery.

b) Partnership fi rm pays interest to loan creditor on the loan borrowed.

c) A Scheduled bank pays interest on the NRO Deposit.

a) Interest paid by an Individual to a Non-resident on the loan borrowed

for purchase of machinery.

Example:- An individual doing the business had purchased a machinery from

the foreign country on credit basis. Interest is paid through the banker on the

loan availed. What are the compliances he has to make for the payment of

interest as per IT Act?

As per the section 195, if the amount, which is paid to a Non-resident, is

taxable in India then only the payment will attract TDS under this section.

Interest payable by a resident to non-resident is taxable in India as per section

9(1)(v) of the Act. So the fi rst and prime condition is satisfi ed to attract TDS

under section 195. The Hon’ble Gujarat & Madras High Court’s view on this

issue is given below.

CIT vs. Vijay Ship Breaking Corporation (261 ITR 113) (GUJ)

Held: “…. The assessees being responsible for paying to the Non-residents

usance interest, which was chargeable under the provisions of the Incometax

Act, 1961, were liable to deduct income tax thereon under section

195(1) thereof. The Tribunal was, therefore, wrong in holding that the

usance interest partook of the character of purchase price and therefore,

not liable to deduction at source under section 195(1) of the Act…”.

CIT vs. C.C.C Holdings (260 ITR 433) (MAD)

Held: “…It is also relevant to mention that under section 9(1)(v) of the

Income-tax Act, the interest income payable by a resident is deemed to

accrue or arise in India and unless the tax has been deducted at source

as provided in Chapter XVII-B of the Income-tax Act, the interest paid is

not deductible…”.

Hence, if interest payment to Non Residents is taxable in India, tax is to be

deducted as per section 195 of the Act.

Rate of tax: Rate of tax for tax deduction is 20% as specifi ed in (A) in (ii) of

Schedule I - Part-II of the Act.

Applicability of DTAA: If Double tax avoidance agreement prevails between

the contracting State and the Country in which non-resident is residing, tax

has to be deducted at a lesser rate either the rate as per the provisions of

the act or the rate provided in DTAA by complying applicable provisions of

the Act.

Hence, in this case, the Individual has to deduct tax as per section 195 or as

per DTAA in order to claim the interest as allowable as per section 40(a)(i) of

the act.

b) A partnership fi rm on the money borrowed pays interest to Mr. X

who is an Non–resident Indian. What are the compliances he has to

make for the payment of interest as per IT Act?

Interest paid to a non-resident is taxable under the provisions of Act as

mentioned in the case referred in (a) above.

Liability to deduct tax is as per section 195 of the Act.

The rate of TDS is 20% as provided in clause (E) of (b) of 1 to Schedule I –

Part-II.

This clause provides TDS rate for money borrowed by Government or Indian

concern in foreign currency.

In the above case, if the money borrowed by the fi rm is in Indian currency then

the rate of TDS on interest payment should be at 30% as provided in clause

(k) to above Schedule I and this rate is applicable for the above payment since

clause (E) provides for TDS rate for money borrowed in foreign currency and

there is no specifi c provision in Sch-I for TDS rate for interest paid for money

borrowed in Indian currency.

Filing of Form 15-H is not applicable to the above case since the interest

is paid/payable to Non-resident. Section 197A(1A) deals with furnishing of

declaration for non-deduction of tax only for the payments referred in section

194 and 194A of the Act. Section 195 has not been mentioned in section

197A(1A) and hence fi ling of 15-H/15-G is not applicable to the above case.

So irrespective of amount of payment, tax is to be deducted at the specifi ed

rate.

Applicability of DTAA: As mentioned in Example (a), DTAA provisions are

applicable.

Hence TDS is to be made by the fi rm on the interest payment otherwise the

interest will be disallowed u/s 40(a)(ia) of the Act.

c) A scheduled commercial bank pays interest to the depositor on

Non-resident ordinary deposit account (NRO Account). What are the

compliances, as per IT Act, the bank has to consider for the payment

of interest?

NRO Account: The existing accounts of Indians who become NRI’s and

Rupee deposit account opened by NRI by way of remittances from abroad

shall be treated as NRO Deposit Account.

As long as the depositor is Non-resident, the deposit opened by him will be

treated as NRO Deposit. After the Depositor become resident of India, the

deposit will be treated as domestic deposit.

Interest paid to a Non-resident Indian is taxable in India under the provisions

of the Act as mentioned in the case referred in (a) above.

Liability to deduct tax is as per section 195 of the Act.

The rate of TDS is 20% as provided in clause (A) of (b) of 1 to Schedule I –

Part-II.

As the money put in as deposit in banks are in the nature of Investments, the

rate of 20% will be the appropriate rate for deduction because any amount

deposited in bank is investment only. This rate will apply only to the income,

which are considered as investment income as per the IT Act.

For the purpose of this Schedule, investment income shall have the meaning

assinged to chapter XII-A of the Income tax Act.

In chapter XII-A, section 115 clause defi nes investment income as under:

“investment income” means any income derived, other than dividends referred

to in section 115-O, from a foreign exchange asset;”

Only Investment made out of foreign exchange asset is subjected to 20%,

otherwise higher rate of 30% is applicable, if money is deposited apart from

remittance of foreign exchange.

If the depositor made deposits otherwise foreign remittance, then TDS rate

should be at 30% as provided in clause (K) of Schedule I.

Filing of declaration in Form 15-G and 15-H is not applicable in view of the

reasons mentioned in (b) above.

In case if the deposit account is opened by Foreign Nationals (who are

resident in India as per section 6 of the Act) out of the remittances from foreign

countries, interest paid on the deposit is subjected to tax deduction at normal

rates as applicable to resident deposits. If they are Non-Resident during the

particular year, rate of deduction is 30%, since the benefi t available to NRIs

are not applicable to Non-Residents.

Applicability of DTAA: As mentioned in Example (a), DTAA provisions are

applicable.

Conclusion: - Payment of any income to Non-residents is to be carefully

considered since non-compliance of provision will lead to disallowance of

related expenditure. Further in case of NRIs rate of tax deduction provided in

DTAA will prevail over the rates as provided in specifi ed sections of the Act.

Taxability of income in India is one of the prime conditions for applicability of

this section and for this CBDT has issued circulars for certain types of income

which are not taxable in India. Further in the case of Indopel Garment (P)

Ltd Vs DCIT, Hon’ble ITAT-A Madras Bench (86 ITD 102), after elaborative

discussion decided the issue of chargeability of income in India and allowed

the appeal in favour of the Appellant. Sub sections (2) to (5) to section 195

provides for lower deduction/nil deduction with respect to payments to NRIs

and the same is also to be considered for applicable cases.