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CBDT issues important Instruction on the applicability of withholding taxes in certain cases

27 Mar 2014

The Central Board of Direct Taxes (CBDT) has issued an important Instruction (No 2/2014) on the controversy surrounding the applicability of withholding taxes in cases where only a portion of the payment made to non-resident involves an ‘income’ element. Taxand India discusses the Instruction and how it will affect taxpayers. 

The Instruction provides that references were received from field officers seeking clarity on the issue of withholding tax under section 195 of the Act, in light of various judicial precedents on the withholding tax requirement on payments to non-residents where only a portion of the sum remitted was liable to tax.

While the Supreme Court (SC) had heldthat withholding tax was applicable on the ‘sum’ paid in case an application was not filed with the Assessing Officer (AO) under section 195(2) of the Act, the Madras High Court had held that if the payee had reported a ‘loss’ position, the payer was not required to withhold taxes at the applicable rates, despite failing to obtain an order from the AO under section 195(2) of the Act. In doing so, the MHC had also applied the principle observed by the SC that taxes could not be recovered from the deductor wherein the payee had already discharged the tax liability.

Apart from the above decisions, the Authority for Advance Rulings had interpreted the SC’s decision and held that in respect of a composite contract, a look at approach should be adopted and not a look through approach under which a transaction is dissected into portions which are chargeable to tax in India and portions which are not. Therefore they concluded that an offshore supply of goods was also taxable as part of the entire transaction.

In summary, in view of the references received, the CBDT has instructed that in cases where the assessee does not withhold taxes under section 195 of the Act, the AO is required to determine the income component involved in the sum on which the withholding tax liability is to be computed. The payer would be considered as being in default for non-withholding of taxes only in relation to such income component. However the AO has been allowed to determine the appropriate proportion depending on the facts and circumstances of each case.

Your Taxand contact for further queries is:
Mukesh Butani
T. +91 124 3066 3010 

Also published in Thomson Reuters' Taxnet Pro, 28 March 2014

Taxand's Take

The Instruction has come as a significant relief to taxpayers. While the instruction  obviously does not allow a taxpayer to determine the income chargeable to tax, the language used in the said instruction requires the AO to treat the payer as being in default only to the extent of income component involved in the sum on which tax withholding was applicable.

Apart from providing clarity on composite contracts discussed above, the Instruction should also benefit transactions of share purchases wherein the issue of withholding taxes on gross payment as against withholding taxes on net capital gains has been an often debated matter.

Taxand's Take Author

Mukesh Butani
Taxand Board member

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