What was the controversy?
Little over a week back, the Supreme Court (SC) rendered a verdict clubbing a batch of 104 civil appeals in relation to withholding tax i.e. tax deduction at source (TDS) provisions under the Income Tax law.
The controversy circled around two principal issues:
Whether the Indian law can fasten a TDS obligation on a non-resident employer with respect to services rendered by its employees in India and;
Whether the Revenue can levy penalty for non-compliance of TDS obligation?
Whereas the Court answered the first question in favour of the Revenue, the second was in favour of the tax payer.
It is important to note the taxability of income in the hands of the employee was never in doubt. At best, some of the employer firms took a view they are not liable to comply with TDS obligation on the ground the employees were paid in the home country (foreign jurisdiction) and hence, it was extra-territorial.
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This was particularly true with respect to several Japanese employers (forming majority of the batch of appeals), who under the umbrella of Japanese Chamber of Commerce and Industry (JCCI) volunteered to pay tax on such offshore/home income of Japanese employees working in India.
Understanding with JCCI
Though the SC has disposed several appeals under a single order, the facts of each case were different. For the record, in the late 90’s the Japanese community true to its non-litigative philosophy, with an intent to buy peace, submitted a memorandum to the Jurisdictional Tax Commissioner to cease Tax surveys in offices of Japanese companies in return for voluntary tax payments. Further, a tacit understanding, in good faith and spirit, that the tax administration shall not impose the rigor of penalty and other coercive measures under the law was part of an unwritten compromise.
It is important to point out that such voluntary declaration and tax payments were made at varying points in time, when the Revenue launched vigorous survey operations for tracking down TDS defaulters. The appeals that came up before the SC dealt with situations where, in some cases, the Revenue had sought information in pursuance to survey and in some cases, survey operations were not initiated. Hence, the overall objective to approach the tax administration including the apex body, CBDT was to buy peace in exchange of amnesty from penalty and prosecution.
Though, there are judicial precedents in such situations entailing voluntary admission based on verbal understanding, the tax administration seems to have reneged on its understanding by imposing penalty on the Japanese employers for failure to comply with TDS obligation. Such penalty orders were however subsequently reversed by the Tax Tribunal.
Debate on extra-territorial Jurisdiction
Most important question before the Court was whether the TDS provisions, which are machinery provisions for enforcing collection of tax, can be applied independent of charging provisions. Given that the chargeability of income was not in doubt, the Court held that the Income-tax Law is an integrated code and hence, the taxing and machinery provisions are to be construed as inseparable.
The SC citing constitutional provisions held it is permissible for the Indian Income-tax Law to apply extra-territorially, in the context of TDS obligations on non-resident employers. The court’s observation on extra-territorial jurisdiction is restricted (to salary payments) and cannot apply in general. Though, the order does not make reference to the ongoing Vodafone controversy, it is ostensibly guided towards it.
It is important to note Article 245 of the Constitution empowers the Legislature to enact laws with extra-territorial jurisdiction. However, there is no decided case by the apex court on this aspect, though while referring the Electronic Corporation matter (on extra-territorial jurisdiction) to the constitution bench, the division bench expressed opinion Income-tax Act has extra-territorial operation. However, in view of withdrawal of appeal by Electronics Corporation, the law is not settled.
Some unanswered questions
The Apex Court did not find it appropriate to rule on the question raised in relation to dual employment with the non-resident foreign company and the Indian entity. Under the law, an employee with dual employment has a choice of declaring the salary received from one employer to the other, and only then, the other employer would be obliged to apply the TDS provisions on such declared salary.
It was argued in the case that the employees did not exercise such an option. However, the decision of the Court is silent on this aspect. The Court also did not dwell upon the concept of economic employer versus legal employer. Lately, OECD has been advocating the concept of economic employer to overcome difficulties on treaty related reliefs.
No penalty for bonafide belief
On the levy of penalty, the Court appreciating the tax-deductors were under a bonafide belief TDS would not apply on foreign salary and since the issue was at a nascent stage, quashed the penalty. Following the principle of tax payers demonstrating ‘reasonable cause’ and that penalty has to be levied for ‘good and sufficient reasons’, the Court upheld the decision of Tax Tribunal and High Court. This focuses attention on inadequacy of clarity on cross-border tax disputes, which have surfaced in the recent past. The intense litigation and the languid manner in which amendments and clarifications are issued leave the ground open for virulent tax battles. The SC’s emphasis on principle of ‘bonafide belief’ on controversial tax aspects would certainly come as a relief to tax payers.
Whereas, a right to appeal is a fundamental right, at a philosophical and practical level, I question the wisdom of the tax payer and tax administration in pursuing such litigation. I would hesitate in labeling the litigation frivolous, but it could have been avoided. If tax administration and tax payers had a tacit understanding on amnesty from penal provisions, why was there a change in mind?
If the levy of interest is mandatory as the taxability of income under question was never in doubt, why did the taxpayer litigate on whether withholding tax provisions should apply? I wonder why India’s competitiveness for doing business gets impacted? I guess, amongst other factors, long drawn court battles contribute to it and there are lessons to learn from such experiences.
The author is a partner with BMR Advisors and views expressed are personal