Currently, tax department is issuing more than 7.5 million permanent account numbers (PANs) in a year through NSDL and, nowadays, PAN is being allotted in less than a week time. With increased modernisation of the Tax Department and electronic processing of tax returns non- quoting of PANs by deductees is creating serious problems in processing of tax returns and in granting credit for tax deducted at source. In order to strengthen the PAN mechanism, Hon’ble Finance Minister has introduced the provisions of the Section 206AA with effect from April 1, 2010, which mandates furnishing of PAN to the payer.
Provisions of the Section 206AA(1) prescribe following:
- The recipient entitled to receive any sum or income or amount on which tax is deductible under the Chapter XVII–B is expected to furnish her/his PAN to the payer.
- Absence of PAN requires payer to withhold tax at the higher of the following rates:-
- Rate specified in the relevant provision of the Act, e.g. 2 per cent under the Section 194C, 10 per cent under the Section 194H/194J, etc.
- Rate or rates in force as defined in the Section 2(37A), e.g. ratesspecified in the Schedule to the Finance Act; rates specified in the tax treaties.
- 20 per cent
- Higher of the above rates will also apply where PAN is found to be invalid or false.
- Declaration in Form 15G/H by a recipient for NIL withholding is not valid unless PAN is furnished in such a declaration.
- Certificate for withholding at lower or NIL rate under the Section 197 including in case of nonresident will not be granted by Tax authority unless the application contains PAN of the applicant/income recipient.
- The provision will apply, even if a recipient is not under an obligation to obtain PAN under the Section 139A or is a non-resident.
- The provision applies to all payers including non-resident payers.
- Payer and recipient will need to indicate PAN of recipient in all correspondence, bills, vouchers and other documents exchanged between them.
This article analyses certain issues which non resident tax payers may face while complying with the provisions of the Section 206AA.
Whether provisions of tax treaty will override the provisions of the Section 206AA?
Section 206AA is a non-obstante clause since it begins with ‘notwithstanding anything contained in any other provisions of this Act’. On the plain reading of the Section, it appears that provisions of the Section 206AA would be applicable on failure to furnish PAN and tax at the highest of three specified rates would be deducted from payment.
As per the provisions of the Section 90(2) of the Act, in case of a non-resident eligible for tax treaty, provisions of the Section 90(2) of the Act or provisions of the tax treaty whichever is beneficial to the assessee are applicable. However, the Section 206AA mandates furnishing of PAN by the recipient of income to the deductor. There is no special exclusion carved out for a non-resident recipient, even if the non-resident is not otherwise obliged to apply for and obtain PAN.
Accordingly, in case of non-residents covered by tax treaty, there could be two views on applicability of the Section 206AA to the extent it requires tax withholding at rate higher than the tax treaty prescribed rate.
The two possible views are:
- View 1: The provisions of the Section 206AA cannot operate to override treaty rates which are lower than 20 per cent.
- View 2: The provisions of the Section 206AA should cover payments to non-residents who have tax treaty shelter.
View 1: The provisions of the Section 206AA cannot operate to override treaty rates which are lower than 20 per cent.
- Section 90(2) of the Act provides that the assessee can opt to be governed by the provision of the relevant tax treaty or the provisions of the Act whichever is more beneficial to him.
- The avowed object behind insertion of the Section 206AA as stated in the Explanatory Memorandum is that ‘non quoting of PANs by deductees is creating problems in the processing of returns of income and in granting credit for tax deducted at source leading to delays in issue of refunds’. The object behind insertion nowhere talks of facilitating verification of treaty residency.
- The tax treaty is self contained code and is a mini legislation as accepted by the Hon’ble Supreme Court in the case of UOI vs. Azadi Bachao Andolan (263 ITR 706). The procedure of tax collection and recovery, therefore, has to be as aligned to such treaty provisions. If, as per the tax treaty, there is an upper limit on the tax that can be charged in the source jurisdiction, technically, the payer making payment should withhold no more than the treaty specified limit.
- The UN Model Commentary (as well as some of our tax treaties) contains a provision in the Article 10-12 stating that the Competent Authorities of the contracting States shall settle and mutually agree to the mode of tax collection for these articles. Application of the 20 per cent rate can be viewed as a unilateral act of India which is not in conformity with this provision where the States had agreed to do so mutually.
- Reference has to be drawn to the Central Board of Direct Taxes (‘CBDT’) Circular No 333 dated April 2, 1982, which reads:
“Where a DTAA provides for a particular mode of computation of income, the same should be followed,irrespective, of the provisions in the Income-tax Act .Where there is no specific provision in the agreement, it is the basic law, i.e., the Income-tax Act that will govern the taxation of income.”
Based on the above, it can be argued that the Section 206AA will not have overriding effect over the provisions of DTAA. Therefore, if treaty rates provides for lower rate than 20 per cent (under the Section 206AA), treaty rates would be applicable.
View 2: The provisions of the Section 206AA should cover payments to non residents who have tax treaty shelter
Section 206AA is a non-obstante clause, since it begins with ‘notwithstanding anything contained in any other provisions of this Act’. Accordingly, it can be argued that the provisions of the Section 206AA of the Act override provisions of the Section 90(2) of the Act.
- Section 90(2) is in relation to any relief of tax, whereas the Section 206AA stipulates for higher withholding of tax on non furnishing of PAN. It does not in any way alter the final tax liability or computation of the non-resident because the non-resident always has an option to file his return and claim the refund of excess taxes withheld.
- Support can also be drawn from the Para 26.2 on the Article 1 of OECD Model Commentary which provides as follows:
“A number of Articles of the Convention limit the right of a State to tax income derived from its territory.As noted in paragraph 19 of the Commentary on Article 10 as concerns the taxation of dividends, the convention does not settle procedural questions and each State is free to use the procedure provided in its domestic law in order to apply the limits provided by the Convention. A State can therefore automatically limit the tax that it levies in accordance with the relevant provisions of the Convention, subject to possible prior verification of treaty entitlement, or it can impose the tax provided for under its domestic law and subsequently refund the part of that tax that exceeds the amount that it can levy under the provisions of the Convention.”
Hence, provision of the Section 206AA of the Act will, at best, operate as ‘retain and refund’ system.
The recipient of income can obtain suitable refund along with interest by filing the return of income.
- Similar clarification is provided by the OECD Model Commentary on the Articles 10 and 11 which provide for concessional rate in respect of taxation of interest and dividend in source country. To illustrate, the Para 12 of Model Commentary on the Article 11 provides that:
“The paragraph lays down nothing about the mode of taxation in the State of source. It therefore leaves that State free to apply its own laws and, in particular, to levy the tax either by deduction at source or by individual assessment. Procedural questions are not dealt with in this Article. Each State should be able to apply to procedure provided in its own law.”
- The following extracts from the 1998 IFA report on “practical issues in application of double taxation conventions” do also support that for protecting interest of revenue, the nations favour adoption of system of requiring taxpayer to obtain identification numbers.
“There is a clear trend toward the national adoption of taxpayer identification numbers (TINs), and the reliance by the tax authorities on those numbers.……………..
Other countries have specific tax file numbers, and some one claiming resident status will be required to register for a number. In some cases non residents must also register if they wish to make a DTC claim.”
- Provisions are similar to the provisions in the US-IRS regulations wherein it is mandatory to obtain taxpayer identification number (TIN) for claiming tax treaty benefits. Based on the above, it can be argued that provisions of the Section 206AA of the Act will prevail over the Section 90(2) of the Act and hence non-resident will not be entitled to avail lower rates of tax withholding in accordance with the relevant tax treaty in absence of PAN.
In view of the above discussions, it appears that both the views have equal force.
Whether provisions of the Section 206AA are applicable in absence of liability of tax withholding?
As per provisions of the Section 206AA of the Act, PAN is required to be furnished by the recipient when any income or any sum or amount on which tax is deductible under the Chapter XVII-B. The relevant text of section is reproduced below:
“Notwithstanding anything contained in any other provisions of this Act, any person entitled to receive any sum or income or amount, on which tax is deductible under the Chapter XVIIB (hereafter referred to as deductee) shall furnish his Permanent Account Number to the person responsible for deducting such tax …….”
Thus, chargeability of income to tax and tax withholding thereon is an essential condition to trigger the Section 206AA of the Act. In case the transaction is not at all chargeable to tax (whether as per provisions of the Act or in view of the applicability of provisions of DTAA) in India for instance import of goods/capital equipments etc the same will not be subject to provisions of the Section 206AA of the Act.
Section 195 vs. Section 206AA – implications of Samsung Ruling
Tax withholding in respect of non-resident payees are governed by provisions of the Section 195 of the Act which uses the phrase – “any other sum chargeable under the provisions of this Act”.
Recently, the Karnataka High Court in the case of Samsung Electronics and Others (227 CTR 335), has
held that any payments in the nature of income per se to non-resident taxpayers would require tax withholding in accordance with provisions of the Section 195(1) of the Act unless a certificate has been obtained for lower or nil withholding of tax.
Whether Samsung ruling suggests that all the payments made to non-residents are covered within the ambit of provisions of the Section 195 and consequently all the income recipients has to obtain PAN or face the consequences of the Section 206AA?
Reference can be drawn from following judicial precedents wherein a view has been taken that provisions the Section 195 should have application only, when transaction is chargeable to tax in India and not on all the transactions.
- ABC Limited (2006) 289 ITR 438 – AAR
- CIT vs. State Bank of India 13 DTR 294 – Rajasthan HC
- Mahindra and Mahindra Limited 313 ITR (AT) 263 – Mum Trib. Special Bench.
- CIT vs. M/s Illinois Institute of Technology (India) Private Limited (321 ITR 95) – Karnataka HC
It is pertinent to draw the attention to the recent decision of the Delhi High Court in the case of Van Oord ACZ India (P) Limited – ITA No 439 of 2008, wherein it is held that taxes under the Section 195 of the Act are required to be deducted only when the income is chargeable to tax in India. Hon’ble High Court has observed that “The obligation to deduct the tax at source arises only when the payment is chargeable under the provisions of the Income Tax.” While delivering the judgement, High Court also observed that “even otherwise, because of our analysis of what (239 ITR 587) decides, we, with due respect, are not in agreement with some of the observations made in the aforesaid judgment of the Karnataka High Court.”
Recently, Special Bench of Chennai ITAT in the case of ITO vs. Prasad Production (ITA No663/ MDS/ 2003) held that provisions of the Section 195 of the Act are not applicable when no part of payment made to non-resident is chargeable to tax in India.
Support can also be drawn from recently-nserted provisions of the Section 195(6) of the Act read with circular no. 4 of 2009, which allows payer to remit the funds based on a certificate obtained from a
chartered accountant and without obtaining no objection certificate from the tax officer.
In view of the above discussions, a possible view is emerging that taxability of the transaction is the primary condition for the application of provisions of the Section 195 of the Act. Hence, in the cases when the provisions of the Section 195 are not applicable a view can be adopted that there is no need to obtain a PAN and consequently provisions of the Section 206AA is not applicable.
If higher taxes are deducted in accordance with provisions of the Section 206AA of the Act whether the same will be creditable in the relevant overseas country?
In order to avoid double taxation of income, generally the tax treaties contain elimination of double taxation clause wherein the recipient country provide credit for specified taxes paid on income in the source country. The taxes eligible for credit are defined in the respective treaties.
Most of the treaties prescribe that tax credit is available in respect of taxes payable in accordance with the provisions of the convention i.e. relevant tax treaty. By way of example, relevant provisions of tax treaty between India and United Kingdom and India and USA are reproduced hereunder:
Tax treaty between India and the UK use the wordings “Indian tax payable under the laws of India and in accordance with the provisions of this convention” while treaty between India and the USA uses the words “income-tax paid to India by or on behalf of such resident..”. Thus, literal interpretation of the both the treaties may result in non-allowance of higher taxes deducted in case of the UK and allowance of the same in the USA. However, the same is subject to conditions, if any, provided under the domestic law of relevant country.
Provisions similar to India-UK treaty exists in number of the treaties entered into by India, e.g treaties with Germany, France, Australia, etc. Thus, when taxes are not paid/deducted in accordance with the provisions of tax treaties but at higher rate than rate prescribed in tax treaty, there is a possibility of denial of tax credit in the home country. For instance:
A UK company, not having obtained PAN in India, renders technical services to an Indian company. As per
the provisions of the Section 206AA, the Indian company would be required to deduct tax at the rate of 15 per cent as specified under the DTAA or at the rate of 20 per cent whichever is higher. The Indian company, therefore, would deduct tax at the rate of 20 per cent. However, as the rate specified under the India-UK DTAA is 15 per cent, the tax authorities in UK may limit the grant of credit of tax deducted in India to only 15 per cent as against the tax deducted at the rate of 20 per cent. This would result into a loss for the foreign company to the tune of 5 per cent of its gross receipts from India.
In view of above, availability of credit has to be analysed on the basis of provisions of the specific tax treaty in question or as per the domestic laws of the relevant overseas countries. It is pertinent to note that it is possible to claim refund for the excess tax deducted in accordance with provisions of the Section 206AA of the Act
by filing a return of income in India. For example, in case of FTS transaction, tax is required to be deducted @ 10 per cent in accordance with provisions of the Section115A or relevant tax treaty, and if tax is actually deducted @ 20 per cent in view of provisions of the Section 206AA of the Act, it is possible for non-resident to claim refund of excess tax deducted in India by filing return in India.
• It is apprehended that provisions of the Section 206AA will not be welcomed by numerous overseas companies or non-residents who do not have regular or recurring transactions with Indian entities. If the non-residents are having one-of transaction with India, it is likely that they will force Indian company/payer to enter
into tax protected contract to avoid hassles of obtaining PAN, tax compliances, etc and in turn the same may increase the cost of services for Indian companies.
- Non-residents are hesitant in obtaining tax registration fearing probing by Indian tax department in other global transactions which is not connected with India.
- Indian companies making payments to the overseas service providers should explain and convince non-resident payees to apply for PAN, as the same has now become necessity.Advisable to scrutinize taxability of each and every transaction minutely before concluding on the tax withholding position based on judicial precedents to avoid consequences of dis allowance, interest or penalty.
- Indian companies should factor in the additional cost, if any, in case of tax-protected contracts while negotiating with the non-residents.
- Revenue authorities will be able to track the non compliance in respect of filing of tax returns in India by non-residents.
(Contributed by the Committee on International Taxation of the ICAI.Comments can be sent to firstname.lastname@example.org)