Tax Withholding by Non-residents

Tax Withholding by Non-residents on Payments to Residents - Controversy Reignited!

Background

Whether a non-resident is also required to comply with the tax withholding obligations enshrined under Indian tax law has been a long-standing controversy. The issue arose because withholding tax provisions, such as Section 194J of the Income-tax Act, 1961 (‘the Act’) casts as obligation to withhold taxes on “any person responsible” for making the prescribed payments to a resident. Further, with no express or implied exemption or exclusion being provided for non-resident payers, the provisions appear to include them within the ambit and fasten withholding tax obligations upon non-residents responsible for making prescribed payments to residents in India.

However, it has been a widely adopted position that non-residents, not having any place of business or any other presence in India, are not required to undertake such compliance. This position was largely based on principles emanating from certain pronouncements of the Hon’ble Supreme Court. In the case of GVK Industries Ltd. (332 ITR 130), the Hon’ble Supreme Court opined that the Parliament is empowered to make laws with respect to aspects or causes that occur, arise or exist, or may be expected to do so, within the territory of India, and also with respect to extra-territorial aspects or causes that have an impact on or nexus with India. However, any laws enacted by Parliament with respect to extra-territorial aspects or causes that have no impact on or nexus with India would be ultra vires.

Similarly, while determining the liability of a non-resident to withhold taxes under Section 195 of the Act in the case of Vodafone International Holdings B.V. (341 ITR 1), the Hon’ble Supreme Court mentioned that laws made by a country are intended to be applicable to its own territory, but that presumption is not universal unless it is shown that the intention was to make the law applicable extra territorially.  The  Supreme Court went on to analyze the withholding tax provisions enshrined under the Act and held that the intention of the Parliament was to make these provisions applicable only to residents having a tax presence in India. This landmark judgment triggered a lot of amendments, including a specific amendment under Section 195 of the Act to fasten withholding tax compliance obligation on non-residents in respect of taxable payments made to other non-residents.

Reliance was also placed on CBDT Circular Number 726 of 18 October 1995 wherein it was clarified that non- residents who do not have any agent or business connection or permanent establishment in India may not be subject to provisions of Section 194J of the Act in respect of fees paid through regular banking channels to any chartered accountant, lawyer, advocate or solicitor who is resident in India.

Based on the above, it was generally opined that a non-resident, not having any place of business or any other taxable presence in India, would not be required to comply with the withholding tax provisions of the Act, while making payments to Indian residents.

Recent amendments made by Finance Act 2020

With the aim of widening and deepening the tax net, Section 194-O was inserted under the Act to provide for tax withholding @ 1% by e-commerce operator on payment made to e-commerce participant. Consequential amendment has been made under Section 204 of the Act according to which “person responsible for paying” now includes a non-resident as well, with effect from 1 April 2020.

While the amendment under Section 204 appears to be consequential to the introduction of Section 194-O, nothing in the Memorandum suggests the limited applicability of this change. As mentioned above, other withholding tax provisions, such as Section 194J of the Act, also casts the obligation to withhold taxes on the “person responsible for paying”. Now with the amendment in Section 204 of the Act to include non-residents

within the ambit of “person responsible for paying”, technically, non-residents may be required to comply with the tax withholding obligations under the provisions of the Act.

 

Potential impact

While it may be argued that being a consequential amendment it should be read in a restricted manner and confined to Section 194-O of the Act, but the literal language does not seem to provide any such restriction on its applicability. Further, as a cardinal rule of interpretation, in the absence of any ambiguity in the language, reference to the Explanatory Memorandum to the Finance Bill 2020 is not warranted. Accordingly, since various other withholding tax provisions such as Section 192 (salary payments), 193 (interest on securities), 194A (other interest), 194J (fee for professional or technical services), 194C (contractual payments), 194I (rent), 194H (commission or brokerage) of the Act etc. also refer to the phrase “person responsible for paying”, non-resident making such payments to a resident in India may now be liable to withhold taxes as per these provisions, with effect from 1 April 2020. Needless to add,  compliance obligations in the form of obtaining tax registrations, deposition of taxes, filing of withholding tax returns and issuance of withholding tax certificates shall also be applicable on such non-resident.

Apart from the compliance obligations, a bigger impact may be on account of the cash flow ramifications that may arise on account of withholding taxes being applicable. IT/ ITES service providers, back office service providers and shared services centers of multinational groups in India may face significant cash flow challenges on account of such tax withholding, where the withholding tax rate may go up to about 10% (being the applicable withholding tax rate for fees for professional services).

Possible consequences of non-compliance

The amendment to Section 204 of the Act has been made applicable with effect from 1 April 2020 and thus, the compliance obligation is already in place. Non-compliance could potentially attract recovery of the taxes required to be withheld by the non-resident along with interest and penalties. While the recovery of withholding taxes may be challenged where the Indian resident payee/ recipient has already deposited the requisite taxes on its income and filed a tax return [refer decision of Hon’ble Supreme Court in the case of Hindustan Coca Cola Beverages (P.) Ltd. vs. CIT (293 ITR 226)], the exposure of levy of interest and penalty may continue to remain. Furthermore, such recovery could also be made from any agent or person treated as an agent of the non-resident in India as per Section 163 of the Act, which could potentially be the Indian resident receiving the payments from the non-resident.

Way forward

It may be advisable for non-residents making payments to Indian residents to review the requirement of tax withholding in light of the above amendment, evaluate alternative stands and firm up the position to be adopted going forward.

One may also argue that fastening of this additional compliance obligation on non-residents is directly at odds with the Government’s intention of promoting ease of doing business. Accordingly, industry groups/ organizations/ relevant stakeholders may also consider approaching the relevant authorities to seek their intervention and request for suitable clarification/ relaxation.

However, any quick resolution/ clarity on this aspect may not be expected. Hence, there may not be any time left to wait and watch. It is time to take some action and firm up positions!