Friday, 5 December 2014

Karnataka HC rules discount allowed to distributors for prepaid SIM cards and recharge vouchers not liable for withholding as commission or brokerage

We are pleased to release a Tax Alert which summarizes a recent ruling of the Karnataka High Court (HC), in a bunch of appeals of telecom companies (Taxpayers) , on the issue of whether discount allowed to Channel Partners (Distributors) on sale of prepaid Subscriber Identification Module (SIM) cards and recharge vouchers (referred collectively as SIM cards for brevity) is liable for withholding tax under the provisions of the Indian Tax Laws (ITL) as “commission or brokerage” for acting as agents of the Taxpayers.


On an analysis of the terms of the agreement between the Taxpayers and the Distributors, the manner of presentation of discount in the invoices raised and the treatment accorded in the books of account by the Taxpayers, the HC concluded that the relationship between them is on a principal-to-principal basis and the discount allowed is in the nature of trade discount and not commission. Furthermore, the HC held that, although telecom companies render services to ultimate subscribers and SIM cards are only devices to access such services, the sale of SIM cards to the Distributors represents a sale of right to service. While a service can only be rendered and not sold, what is sold to the Distributors is the “right to service”, which is capable of being sold, and such “right to service” is acquired by the Distributors on a principal-to-principal basis.

It is, by now, well-accepted that existence of a “principal-agency” relationship between a payer and a payee is essential to trigger withholding obligation on “commission or brokerage”. The tests for ascertaining existence of a “principal-agency” relationship are also laid down in a catena of judicial precedents. The dispute surrounds the application of the principles to the facts and the nature of arrangement in a particular case.

Prior to the present ruling, the Delhi, Kerala and Calcutta High Courts had ruled that the distribution arrangement for prepaid SIM cards attracts withholding for the telecom company on the difference between the MRP and the sale price to the distributor since the distributor merely acts as a link between the telecom company and the ultimate customer and the distributor is able to bind the two parties. In the present ruling, on factual analysis of the nature of the relationship between the parties, the HC has ruled that withholding obligation is not attracted since there is a sale of SIM cards to the Distributors, which are liable to the risk of loss or damage to such products, and the Distributors are not authorized to bind the telecom company to the ultimate customer. The HC also held that, although the SIM card, by itself, does not have any value and is integral to the provision of telecom service, nevertheless, it constitutes a right to service which can be sold.

The present ruling highlights the significance of factual analysis of the nature of the arrangement to determine existence of a “principal-agency” relationship and the consequent trigger of withholding obligation. It also places emphasis on the accounting treatment accorded in the books. The ratio of the ruling, particularly the distinction drawn between “service” and “right to service”, may be of relevance in other cases where a similar dilemma arises.

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