SKP Tax Alert
6 April 2015 | Volume 8 Issue 1
The higher rate of tax prescribed by the Income Tax Act cannot override the Tax Treaty Rate

Background
Section 206AA of the Income Tax Act, 1961 (ITA) provides for withholding of tax in the absence of Permanent Account Number (PAN) furnished by the receiver of the income at the highest of the following rates:
  • Rate prescribed in the Income tax Act or
  • Rate prescribed in the Double Tax Avoidance Agreement (DTAA)
  • Flat rate of 20%
This has proved to be a dampener for non-residents since its introduction especially for those who do not have regular or recurring transactions with Indian entities and are subjected to tax at the rate of 20%.

This section was introduced to penalise those who do not obtain and furnish their PAN details to the deductor and it overrides other provisions of the ITA. However, the introduction of this new law had created a conflict in section 90(2) and section 206AA of the ITA. Section 90(2) of the ITA provides that when the tax treaty provisions are more beneficial than the provisions of the ITA, the taxpayers may apply the provisions of the treaty. However, Section 206AA of the ITA begins with a non-obstante clause i.e. 'notwithstanding anything contained in any other provisions of this Act.' Thus, it was unclear whether the tax treaty benefit prevails over section 206AA of the ITA.

Recently, the Pune Income Tax Appellate Tribunal (Pune ITAT) in the case of Serum Institute of India Limited (SIPL), ITA No.792/PN/2013 (Assessment Year: 2011-12) has addressed this uncertainty on whether the provisions of  section 206AA overrides section 90(2) which provides tax treaty shelter to non-residents. The  tribunal held that while section 206AA is not a charging section, it contains procedural provisions dealing with collection of taxes and hence, Sec 206AA which provides for a higher rate of tax (20%) in cases where  PAN details are not provided, does not override Sec 90(2) of the Act.

Facts of the case
  • SIPL was incorporated under the Companies Act, 1956 and engaged in the business of manufacturing and sale of vaccines.
  • During the year under consideration ( FY 2010-11), SIPL carried out certain remittances to a non-resident on account of interest, royalty and fees for technical services and had deducted taxes as per the rate mentioned in the applicable tax treaty despite the absence of PAN details.
  • The tax authorities had treated such deductions as cases for 'short deduction' i.e. for the difference between 20% (under section 206AA at the rate of the applicable tax treaty) and raised a demand on SIPL along with interest u/s 201(1A).
  • SIPL had preferred the appeal before Commissioner of Appeals [CIT(A)]
  • CIT(A) accepted the position of SIPL and deleted the addition on  grounds that section 206AA cannot override the tax treaty.
  • The tax authorities preferred appeal against the order of CIT (A) before Pune ITAT.
Key Issues before Pune ITAT
  • Whether section 206AA of ITA overrides section 90(2) i.e. rates prescribed under the applicable tax treaty?

In the ensuing paragraphs the issue, contentions and the ruling of the Pune ITAT have been discussed.

SIPLís contention
  • Section 90(2) provides that whichever rate benefits the assessee will be applicable. This rate may be prescribed by ITA or the tax treaty. Section 206AA mandates a higher rate of withholding, which is not beneficial to the assessee. Accordingly, rates as per the applicable tax treaty should apply.
  • Section 206AA of the Act would not override the provisions of section 90(2) of the Act.
  • Section 206AA is not a charging section; it is just a procedural provision for withholding of taxes.  
Tax Authorities' contention
  • Section 206AA clearly states that, 'notwithstanding anything contained under ITA'and thus it overrides ITA. Accordingly, section 206AA also overrides section 90(2).
  • The case being discussed features an absence of PAN details for non-residents, thus withholding should have taken place at the rate of 20% according to section 206AA.
Pune ITAT Ruling
  • Section 206AA has been included in Part B of Chapter XVII-B which deals with the collection and recovery of tax deduction at source. This chapter contains provisions which are procedural in nature and are not charging provisions. 
  • The Supreme Court held that in the case of CIT vs. Eli Lily & Co., (2009) 312 ITR 225 (SC) and GE India Technology Centre Pvt. Ltd. vs. CIT, (2010) 327 ITR 456 (SC), withholding taxes as per section 195 of ITA will be applicable only on the income that is taxable.
  • Even sections 4 and 5 of the ITA which deal with charging of income are subject to Section 90(2) and are subordinate to it. If the charging provisions itself are subordinate to Section 90(2), how can the procedural provisions of section 206AA override section 90(2)?
  • Accordingly, the tax authorities cannot invoke section 206AA for a higher rate of withholding in case of payments to non-residents. 
SKP's comments

This is a welcome ruling from the Pune Tribunal, which not only provides a relief to non-residents engaged in business with Indian entities but also for those Indian taxpayers who have entered into grossing-up tax arrangements (where the withholding tax is borne by the Indian taxpayer) with foreign entities where foreign companies do not apply for PAN in India and are entitled for DTAA benefits.
However, the Pune Tribunal has not commented on the decision of the Bangalore bench in the case of Bausch in which it was held that if the recipient has not furnished the PAN, the higher rate specified u/s 206AA would apply.  Further, if the view adopted by the Pune ITAT is followed then the provisions of Section 206AA would become completely redundant and would not apply to non-residents from those countries which have tax treaties. This however, was never the intention of law and hence is not the correct principle of law. In fact, the memorandum explaining the provisions of section 206AA read with Rule 114 of the Income Tax Rules suggest that  any person, including non-residents, who is entitled to receive any sum or income or amount, on which tax is deductible in any financial year is required to obtain a PAN. Therefore, one would have to weigh the options carefully and one should not jump to the conclusion that a non-resident is not required to obtain a PAN while availing the concessional rate specified in the treaty. Thus, it would be interesting to find out which view is adopted by the other Tribunals or the High court.    

 

SKP
19 Adi Marzban Path | Ballard Estate | Fort | Mumbai 400 001 | India   
+91 22 6730 9000 |
skp.tax@skpgroup.com | www.skpgroup.com

Mumbai | Pune | Hyderabad | New Delhi | Chennai | Bengaluru

LinkedIn
Twitter
Facebook
Google+
ABOUT THIS TAX ALERT
This SKP Tax Alert contains general information existing at the time of its preparation only. It is intended as a news update and is not intended to be comprehensive nor to provide specific accounting, business, financial, investment, legal, tax or other professional advice or opinion or services. This tax alert is not a substitute for such professional advice or services, and it should not be acted on or relied upon or used as a basis for any decision or action that may affect you or your business. Before making any decision or taking any action that may affect you or your business, you should consult a qualified professional adviser and also refer to the source pronouncement/documents on which this tax alert is based. It is also expressly clarified that this tax alert is not a solicitation or an invitation of any sort whatsoever or a source of advertising from SKP Group or any of its entities to create any adviser-client relationship.

Whilst every effort has been made to ensure the accuracy of the information contained in this tax alert, this cannot be guaranteed, and neither SKP Group nor any related entity shall have any liability to any person or entity that relies on the information contained in this publication. Any such reliance is solely at the user's risk.


2015 SKP Group. All rights reserved.