Global Tax Alert | 13 March 2014

India’s CBDT clarifies tax withholding obligation on payments made to nonresident

  • Share

Executive summary

India’s Central Board of Direct Taxes (CBDT), the apex administrative authority for direct taxes in India, has issued Instruction No. 2/20141 (Instruction) to the Indian Tax Authority on the issue of whether tax withholding is required on the whole sum being remitted to a nonresident (NR) or only with reference to the portion of the remittance representing the sum subject to tax in India under the Indian Tax Laws (ITL). In light of certain judicial developments in India, the CBDT has directed the Tax Authority to determine the appropriate portion of payments which is subject to tax in India and, accordingly, a payer can be treated as a defaulter only for not withholding tax on such portion of the payment which is subject to tax in India under the ITL.

This Tax Alert summarizes the Instruction issued by the CBDT.

Detailed discussion

Background

Under the ITL, the withholding tax provisions impose an obligation on any person responsible for paying (payer) to an NR any interest or any other sum subject to tax in India, to withhold taxes therefrom at the rates in force. In a situation where the payer believes that only a portion of the entire amount paid to the NR is subject to tax under the ITL, such payer may make an application to the Tax Authority to determine the appropriate portion of such sum which is so subject and it may withhold tax on the portion of the sum so determined as subject to tax. If the payer fails to comply with the withholding tax obligations, there is exposure to an interest and penalty levy on the payer which is deemed to be an “assessee-in-default” (AiD) under the ITL.

There have been controversies in the past on: (i) whether withholding obligation is triggered on payments made to NRs if the sum is not subject to tax under the ITL. (ii) whether, with regard to the transactions (such as those resulting in capital gains or trading receipts) where only the portion of total remittance represents taxable gain, withholding is required with respect to the gross amount or only the taxable portion.

The following represent significant developments in this regard:

  • In the case of Samsung Electronics and others (Samsung), the Karnataka High Court took the view that any remittance made to an NR would be subject to withholding tax under the ITL, regardless of its taxability in India, unless a specific application is made to the Tax Authority for determination of tax to be withheld under the ITL.
  • The Supreme Court (SC), in a landmark ruling in the case of GE India Technology (GE), held that the withholding tax obligation for payments to NRs applies only if the payments are subject to tax in India. Whereas, in respect of composite payments, the ITL requires that tax be deducted only in respect of the appropriate portion which represents the taxable amount. The SC also held that if the payer is fairly certain, then the payer can make its own determination of the taxable amount and restrict its tax withholding obligation to such an amount. The Samsung ruling was set aside by the SC.
  • Incidentally, without considering the SC ruling in the case of GE, in a subsequent decision in the case of Chennai Metropolitan Water Supply and Sewerage Board2 (CMWSSB), the Madras High Court ruled that, in the absence of a specific withholding certificate from the Tax Authority, the payer is obliged to withhold taxes on the entire amount of payment made to an NR recipient which was a loss-making company.

In view of the above judicial decisions, clarifications were being sought from the CBDT as to whether the tax is to be deducted on the whole sum being remitted to every NR or whether the tax deduction may be on the portion representing the sum subject to tax, particularly if no application has been made by the payer to the Tax Authority to determine the amount on which tax is required to be withheld. It is pursuant to this that the CBDT issued its Instruction.

Instruction

The CBDT, after examining the matter in light of the varying decisions [viz., GE, Transmission Corporation and CMWSSB (supra)], has directed the Indian Tax Authority to act as follows:

  • In a case where proceedings are initiated against the payer for failure to withhold taxes under the provisions of the ITL, the Tax Authority shall determine the appropriate portion of the sum subject to tax under the ITL to ascertain the tax liability with respect to which the payer shall be deemed to be an AiD. By implication, the payer can be treated as an AiD only in respect of such appropriate portion of the sum determined to be subject to tax.
  • Furthermore, the appropriate portion of the sum will depend on the facts and circumstances of each case.
  • The appropriate portion needs to be determined by the Tax Authority after taking into account the nature of remittances, income component therein or any other fact relevant to such determination.

Implications

The Instruction to the Indian Tax Authority is as a positive development. This Instruction clarifies that withholding tax liability of the payer is with reference to the sum subject to tax under the provisions of the ITL. Furthermore, the consequences of default proceedings for non-withholding under the ITL would be limited only to such tax liability. Accordingly, a payer cannot be treated as an AiD for non-withholding from payments which are not subject to tax under the ITL. This clarification is in line with the SC decision in the case of GE (supra). Furthermore, for remittances where only a portion may be subject to tax in India (e.g., a portion of a composite contract or capital gains income), payers may determine their withholding tax liability with reference to the taxable portion of the remittance, if the payer is fairly certain about such determination. However, considering the consequences of a tax withholding default, the payer may prefer to be cautious and may continue to approach the Tax Authority where the determination of taxability or portion of the taxable sum is not fairly certain.

Endnotes

1. Instruction No.2/2014 [F.No.500/33/2013-FTD-I]dated 26 February 2014.

2. [348 ITR 530].

For additional information with respect to this Alert, please contact the following:

Ernst & Young LLP (India), Mumbai
  • Sudhir Kapadia
    +91 22 6192 0900
    sudhir.kapadia@in.ey.com
Ernst & Young LLP (India), Hyderabad
  • Jayesh Sanghvi
    +91 40 6736 2078
    jayesh.sanghvi@in.ey.com
Ernst & Young LLP (United Kingdom), Indian Tax Desk, London
  • Nachiket Deo
    +44 20 778 30862
    ndeo@uk.ey.com
Ernst & Young Solutions LLP, Indian Tax Desk, Singapore
  • Gagan Malik
    +65 6309 8524
    gagan.malik@sg.ey.com
Ernst & Young LLP, Indian Tax Desk, New York
  • Tejas Mody
    +1 212 773 4496
    tejas.mody@ey.com

EYG no. CM4253