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T. C. A. Ramanujam

T. C. A. Ramanujam on a recent High Court decision which has resolved a rate conflict between the DTAA and the I-T Act

TIMKEN India Ltd of Kolkata entered into an agreement with its American collaborator, Timken Company, on March 20, 1990, for acquisition and transfer of proprietary technical information in consideration of a lumpsum payment of Rs 3.7 core payable in a phased manner.

At the time the second instalment became payable, the Double Taxation Avoidance Agreement (DTAA) came into force — in September 1990 — between India and the US and notified in December 1990.

As per Article 12 of the Agreement, the knowhow payment was taxable at the rate of 20 per cent on the gross amount treating the same as royalty payment.

The second instalment become payable on the commencement of production. The first instalment was paid before the DTAA and TDS was made at 30 per cent. Section 115 A of the Income-Tax Act, 1961 provided for tax at 30 per cent.

The Commissioner of Income-Tax (CIT) insisted that the DTAA would have no application since the collaboration agreement between the Indian and American companies was entered into much before the DTAA came into force.

According to the Commissioner, the moment the collaboration agreement was concluded, the liability to pay income-tax had accrued irrespective of the date of actual payment or receipt. The company's application for TDS at 20 per cent was rejected.

The company challenged this order of the Commissioner in a writ petition before the court.

The court pointed out that the Indian company is saddled with the statutory responsibility under Section 195 of the I-T Act to deduct the tax accurately, applying the correct provision of law.

It referred to Section 195, which lays down that income-tax at source is deducted at the time of crediting of such income to the account of the payee or at the payment thereof, in cash or by issuing a cheque or draft.

The right to receive payment by the American company and the consequent obligation to pay by the Indian company arose between May and July 1991.

Under Section 195, tax is to be deducted on the date of actual payment. The basic concept is that the payee must have acquired a right to receive the income. There must be debt owed to him by somebody. Income becomes taxable when it accrues, arises or is received.

The court had to resolve the dispute regarding the tax rate on royalties. Section 2(37A) defines the rate of tax in force for purpose of TDS under Section 195 as the rate specified in Section 115 A or the rate specified in the Finance Act of the relevant year, whichever is applicable.

The Section was amended with effect from June 1, 1992, by the Finance Act, 1992, to provide that the rate of tax will be either the rate specified in the Finance Act of the relevant year or the one specified in the DTAA under Section 90.

As per Section 90(2), wherever the DTAA provision applies, the I-T Act shall apply to the extent they are more beneficial to the assessee. Section 90 (2) was incorporated into the Act by the Finance No (2) Act of 1991 and was effective from April 1, 1972.

The rate mentioned in the agreement, being more beneficial than the one in the Act, the Calcutta High Court ruled that the DTAA rate will prevail over Section 115 A (Timken India Ltd vs CIT — 2002 176 CTR 366). Else, said the High Court, there was no point in entering into an agreement for avoidance of double taxation. The Agreement will necessarily prevail over the provisions of the Act.

The court also referred to the notification issued by the Government — in November 1981 with regard to the DTAA with the UK and the circular of October 28, 1992, with regard to Canada — and held that the rate mentioned in the agreement shall be the governing factor for tax deduction.

The above ruling was handed out in May 2002. The position in law has been clarified by several High Courts. Whenever there is a conflict between the rate of tax as per the Finance Act or the I-T Act, on the one side, and the rate laid down under the DTAA, the tax deduction is to be made on remittances abroad at the lower of the two rates. India has DTAAs with about 80 countries.

Each of these Agreements has Articles laying down different rates of tax for various types of income such as dividends, technical services, royalties, business profits, and so on.

The principal officer responsible for making the remittance to the foreign collaborator must look into the various Articles and apply the correct rate of tax for deduction at source before making the remittance.

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