A manufacturing company wants to pay royalty to a foreign company. Under section 115A read with section 195, tax is deductible at the rate of 10 per cent (effective rate is 10.5575 per cent after including surcharge and education cess). The rate under ADT Agreement is 15 per cent. The recipient foreign company does not have PAN. The entire tax liability will be borne by the payer company. According to section 206AA, tax will be deducted at the rate of 20 per cent. I want to know whether the same rate will be applied for grossing up under section 195A.
ANS:In the case given by you, tax is deductible at the rate of 20 per cent under section 206AA. To avoid tax deduction at 20 per cent, the recipient should have PAN. If the foreign company is not interested in applying for PAN, tax will be deducted at the rate of 20 per cent. Since payer company will have to bear the tax liability of the recipient, the amount of payment will be grossed up under section 195A. This section is applicable if the following conditions are satisfied –
- It covers any payment other than that refer to in section 192(1A).
- Tax chargeable on such income is to be borne by the person by whom income is payable.
- Such liability is to be borne by the payer under an agreement or other arrangement.
If these conditions are satisfied, then, for the purposes of deduction of tax under those provisions such income shall be increased to such amount as would, after deduction of tax thereon at the rates in force for the financial year in which such income is payable, be equal to the net amount payable under such agreement or arrangement.
If tax is to be borne by the payer, under section 195A grossing up is required. For this purpose, the amount of payment shall be increased by such amount as would after tax deduction at the rates (in force for the financial year), become equal to the net amount payable. In other words, for the purpose of grossing up the rate which is applicable is “rates in force”. Rates in force is defined by section 2(37A). For the purpose of section 195, sub-clause (iii) of clause (37A) of section 2 defines “rates in force” as follows –
“(iii) for the purposes of deduction of tax under section 195, the rate or rates of income-tax specified in this behalf in the Finance Act of the relevant year or the rate or rates of income-tax specified in an agreement entered into by the Central Government under section 90, or an agreement notified by the Central Government under section 90A, whichever is applicable by virtue of the provisions of section 90, or section 90A, as the case may be;”
For the purpose of grossing up, either the rate given by the Finance Act or the rate specified in double taxation avoidance agreement, whichever is lower is applicable. Nowhere section 195A requires for the purpose of grossing up the rate given by section 206AA. Consequently, the payment will be grossed up by applying the rate of 10.5575 per cent. The grossed amount will be subject to TDS at the rate of 20 per cent. Suppose, the amount of payment to the foreign company is Rs. 5 crore. Tax will be deducted as follows –
Rate in force as per section 2(37A)
Grossed amount [Rs. 5,00,00,000 × 100 ÷ (100 – 10.5575)]
Tax deductible under section 195 read with section 206AA at the rate of 20 per cent
Dr. Vinod K. Singhania