TDS on reimbursement of expenses

Indian tax law provides for deduction of tax at source on various types of incomes. Deducting tax at source is popularly known as "withholding tax".

Section 195 of Income Tax Act casts an obligation on a person, who makes a payment to a non-resident, to deduct tax at source at the time of making the payment or at the time of credit of such income to the account of the payee, whichever is earlier.

Section 195 contemplates deduction of tax at source only on such income as is chargeable to tax in India.

Thus if the payment is made for an amount which is outside the purview of the Income Tax Act, no tax will be required to be deducted.

Where the payment made does not wholly represent the taxable income, a question arises whether tax should be deducted on the gross amount of payment or only on such portion of payment, which represents taxable income for the purpose an application is to be filed with the assessing officer under Section 195 or Section 197 to determine the amount of tax to be deducted at source.

As far as the tax deduction at source on reimbursement of expenses is concerned, the problem becomes complicated because such payment may not contain any element of income.

Reference may be made to a Bombay High Court judgment reported in 245 ITR 823 wherein the assessee approached the assessing officer for issuing a no-objection certificate for remitting certain amounts to a foreign firm.

The said amounts represented reimbursement of airfare for the foreign technicians, their boarding and lodging and some other local expenses.

The assessing officer asked the assessee to deduct tax at source before issuing the no-objection certificate.

But the tribunal held that the assessee was only required to provide the basics: the technicians did not derive any benefit and therefore, no part of the expenses could be taken as payment in lieu of fees. Thus no TDS was necessary.

In the Commissioner of Income Tax vs National Radio & Electronics Co Ltd case, the Bombay High Court held that tax was not to be deducted at source under the provisions of Section 195 on the expenditure incurred by the assessee in India in providing facilities/reimbursement of living expense for foreign technicians during their stay in India. (See 261 ITR 24 (Stat)).

But in several cases courts have taken a contrary view. In the Steffen vs Commissioner of Income Tax case, 230 ITR 206 (AAR), the Indian company was required to pay daily allowances and travelling costs of the foreign technicians to its foreign collaborators.

The question raised before the Authority for Advance Rulings was whether payments towards living allowance and other costs be liable for deduction of tax at source or not.

The Authority held that there was no difference between the fees for engineering services and the fees relatable to the living allowances or travelling charges of the foreign technicians who would render the services. The Indian company was therefore, obliged to deduct tax at source at the applicable rates.

In view of the divergence of opinion, the apex court has admitted a special leave petition in the matter (See 261 ITR 24 (Stat)).

Therefore, until the controversy is settled by the apex court, Indian parties responsible for remittance abroad are advised to approach assessing officers under Section 195 (2) or 197 for deciding whether tax should be deducted or not.