In the Air India Limited case, the Delhi High Court has, once again, reiterated that for payments made by an Indian tax resident to a non-resident, the Indian payor will be correct in applying the withholding tax rate prescribed under the double taxation avoidance agreement (“DTAA”), if the provisions of the DTAA are more beneficial than the provisions of India’s Income-tax Act, 1961 (the “IT Act”). This ruling is important as Section 206AA of the IT Act provides that if a permanent account number (“PAN”) is not furnished by a payee (including a non-resident), the applicable withholding tax rate will be increased to 20% or the rate in force, whichever is higher.
The issue with respect to deduction of tax at source at 20% even where a DTAA benefit is available has been unnecessarily litigated in several tax tribunals and courts (see below some key rulings).
- The Ahmedabad tribunal, in the Quick Flight Ltd case, held that where tax has been deducted on the basis of the beneficial provisions of a DTAA, the provisions of Section 206AA of the IT Act cannot be invoked and that the tax assessing officer cannot insist on a 20% tax rate given the overriding provisions of Section 90(2) of the IT Act.
- The Bangalore tribunal, in the Wipro case, held that the tax withholding provisions under the IT Act have to be read in conjunction with the provisions of the DTAA for computing the tax liability on a particular sum and when the recipient is eligible for DTAA benefits, there is no scope to apply a tax deduction at 20%.
- The Bangalore tribunal, in the Bosch case, held that the provisions of Section 206AA of the IT Act override the other provisions of the IT Act, and hence, a non-resident whose income is chargeable to tax in India will have to obtain a PAN.
- The Pune tribunal, in the Serum Institute case, held that Section 206AA of the IT Act being a procedural section cannot override the beneficial provisions of a DTAA.
- The Bangalore tribunal, in the Infosys BPO Limited case, followed the decision of the Pune tribunal despite the contrary view of the coordinate bench in the Bosch case.
- The Chennai tribunal, in the Pricol Limited case held that Section 206AA of the IT Act does not override the provisions of Section 90(2) of the IT Act, and accordingly, the rate of tax deducted at source prescribed in the tax treaty shall prevail.
- The Delhi High Court, in the Danisco India case, held that where tax has been deducted on the basis of the beneficial provisions of a DTAA, the provisions of Section 206AA of the IT Act cannot be invoked.
Under Indian tax law, a foreign company can be required to obtain a PAN from Indian tax authorities, if it earns income that is chargeable to tax from a source in India, as for example, royalty income, consultancy fee, technical service fee, support service fee, interest income, capital gains on sale of shares or by virtue of the foreign company having a permanent establishment in India. Therefore, we have seen foreign companies obtaining and furnishing a PAN (or submitting other prescribed documents in Form 10F) to an Indian payor to avoid the higher withholding tax rate prescribed under Section 206AA of the IT Act.
From an Indian taxpayer’s perspective, while computing profits and gains from business, certain expenditures can be disallowed, and one of the reasons for such disallowance is that the requisite tax amount has not been deducted at source or there is some non-compliance under Section 206AA of the IT Act while making such payment. Disallowed expenditure attracts tax at 30%, and interest, penalty and prosecution provisions also get triggered.
Therefore, notwithstanding the favorable rulings mentioned above, it is advisable for foreign companies to obtain a PAN and avoid getting into unnecessary discussions with the Indian counterparty on why a lower withholding tax rate is applicable on any particular transaction. To clarify, obtaining a PAN does not mean that a foreign company has taxable income in India. It also does not mean that a foreign company is required to mandatorily submit a corporate tax return in India. The only potential downside can be that as the PAN will be in the database of the Indian tax authorities, they may seek responses from the foreign company on its Indian business activities; but if there are none, that should not be an issue.
About the Author
Ravi S. Raghavan has more than 25 years of experience in corporate tax advisory work, business re-organizations, international taxation (investment and fund structuring, repatriation strategies, treaty analysis, advance rulings, exchange control regulations, FPI taxation), tax litigation services and other tax issues (including withholding taxes, capital gains tax, permanent establishment concerns, employee taxation, and tax holiday schemes).