This decision was rendered by the High Court in a matter involving the question of whether the importers of shrink wrapped software were required to withhold tax at source on the payments to the non-resident software vendors. The revenue contended that the payment for import of software falls within the definition of 'royalty' under the Income-tax Act, 1961 ('IT Act') and also under the applicable Tax Treaties and therefore, the payment required tax withholding at the rate of 10%/15%. The Income-tax Appellate Tribunal ruled favouring the importers by holding that the transaction was akin to an import of goods and hence, did not warrant any withholding. The Revenue appealed to the Karnataka High Court against the decision of the ITAT.
The High Court reversed the decision of the ITAT and held that the Indian importers of software should have withheld tax at source. More importantly, the Court held (relying on a Supreme Court ruling in the case of Transmission Corporation) that as payers, the Indian importers could not have unilaterally taken a view on the tax liability of the non-resident vendors and therefore, tax withholding ought to have been done. This conclusion was on the basis that the tax withholding provisions in the IT Act (and the obligations associated therewith) stand on a different footing as compared to the substantive provisions dealing with determination of tax liability of the non-residents. The High Court ruled that the taxes withheld are only tentative and the non-resident is at liberty to demonstrate that the payments received were not liable to tax in India and accordingly, claim a refund of the taxes withheld at source. The High Court also held that if an application is made by the Indian importer to the concerned revenue officer seeking relief from the obligation to withhold tax at source, either in the form of a complete dispensation from tax withholding or in the form of reduction of taxes to be withheld, even then the revenue officer cannot venture into determining the tax liability of the non-resident in granting relief to the importer. The court held that the relief which can be given by the revenue officers is very limited, confined to aspects such as determining the percentage/quantum of payment that will be subject to tax deduction at source. The court also held that consequently, the powers of the appellate authorities are also limited in a withholding tax dispute. The court however, stopped short of deciding whether the payment towards import of software can be categorised as royalty payments under the IT Act.
The software trade has learnt to deal with a complex maze of direct and indirect tax issues and was hoping for relief from the High Court, and the disappointment of the industry players as they are coming to grips with the High Court's decision is apparent. Yet, the decision has larger implications and in several ways is a game changing one. The decision implies that every import payment, be it of goods or services, is subject to tax withholding, unless a specific dispensation is sought from the revenue officers. Even if such an application is made to the concerned Revenue officer, based on the findings of the court, the officers will find their hands tied and be unable to grant substantial relief. Moreover, the process of determination of the quantum of tax withholding by the revenue officers will be time consuming and cumbersome.
In most cases, cross border trade of goods and services pertain to cases where the non-resident vendors have no presence in India. Calling upon these vendors to file a return of income in India and claim a refund of the taxes withheld is a huge ask. With such onerous tax compliances, non-resident vendors will be deterred from doing business in India, or more simply, the costs of the withholding will have to be borne by the Indian importers resulting in a cascading impact on their costs. In 1997, the Central Board of Direct Taxes ("CBDT") did away with the requirement of obtaining a no objection certificate from the revenue authorities for import payments, if the importer furnished an undertaking accompanied by a chartered accountant's certificate certifying whether appropriate taxes have been withheld at source.
This procedure remains in force and the CBDT recently streamlined the process by making most steps on-line. This aspect does not seem to have been considered by the High Court and in many ways, the findings are beyond the case that the revenue itself made out before the Court. The parties aggrieved by the High Court decision are expected to make an appeal before the Supreme Court, and the business fraternity would keenly await the outcome on this all important matter. Until then, this decision adds to the growing list of tax complexities and uncertainties that businesses in India have to grapple with.
(Abhishek Goenka is Partner, BMR Advisors, the views are personal. Sharath Rao, Manager, contributed to the article.)