Tax withholding judgment poses dilemma for businesses

Withholding tax on payments to non-residents has been a bone of contention between the taxpayer community and the tax department. Until recently, the controversy related to whether income in the hands of a non-resident was taxable in India or otherwise. Indian entities remitting funds overseas in respect of the import of goods which were not taxable in India, for example, were not required to deduct tax at source or undertake other onerous compliance requirements.

In September 2009, Karnataka High Court in a case involving Samsung Electronics and others held that section 195 of the Income Tax Act, 1961 (ITA) casts an obligation on remitters to withhold taxes at source. Karnataka High Court, relying on the interpretation of the Supreme Court’s ruling in a case involving Transmission Corporation, also held that such an obligation would hold good irrespective of whether the payment was taxable in India in the hands of the non-resident recipient.

It observed that remitters need to establish that the failure to withhold was based on adequate reasoning. Where no taxes are withheld, the court ruled that the obligation cast under section 195 could be said to be obviated only if an order from the tax authorities was obtained. In addition, the court also ruled that remitters making tax-free payments without a supporting order from the tax department would be liable to pay taxes. This ruling effectively held that a withholding order from the tax authorities would be needed in almost all cases.

Pranay Bhatia is an associate partner at Economic Laws Practice where Balaji Balasubramanian is an associate. The firm is headquartered in Mumbai, and has offices in New Delhi, Pune and Ahmedabad.