Background

The Income-tax Act, 1961 (“IT Act”) contains various machinery provisions which enable tax authorities to recover tax dues from taxpayers. When payments are made to non-residents that are chargeable to tax under the IT Act, payers (both resident and non-resident) are obligated to withhold tax at applicable rates prior to remittance of funds. Typically, no such obligation arises if the payments are not subject to tax in India. Thus, there are times when taxpayers don’t withhold tax on payments, believing they should not be subject to tax under the IT Act. However, if the Indian tax authorities take a different view, they may initiate proceedings under section 201 of the IT Act against such taxpayers, i.e., the person responsible for withholding taxes.

Under section 201 of the IT Act, a taxpayer can be deemed to be an ‘assessee in default’ for failing to withhold applicable taxes on such payment. In such a scenario, inter alia, the tax due may be recovered from the defaulting taxpayer. While an order under section 201 must be passed within seven years after the end of the financial year in which the payment was made to an Indian resident, no such limitation period has been prescribed in case of payments made to non-residents. However, the principles of natural justice would still require such an order to be passed within a reasonable amount of time even in the case of non-residents. Recently, the Hon’ble Telangana High Court (“HC”), in the case of Dr. Reddys Laboratories Limited,[1]had an occasion to comment on this issue.  

Facts of the Case

In the said case, the taxpayer was an Indian company engaged in the business of manufacture and sale of pharmaceutical products (“Taxpayer”). The Taxpayer had entered into a trademark assignment agreement (“TAA”) with two foreign companies for purchase of certain trademarks for identical territories, including India. Under the TAA, the Taxpayer paid certain amounts to the said foreign companies during financial year 2015-16.

The tax authorities conducted a survey operation in December 2015 and found that the Taxpayer had not withheld tax on the payments made to the foreign companies under the TAA. Accordingly, proceedings under section 201 of the IT Act were initiated against the Taxpayer in January 2016. The Taxpayer submitted reply in response to the show cause notice issued by the tax authorities. Further, in October 2018, the Taxpayer, inter alia, argued that the proceedings were barred by limitation since, the reasonable period within which order under the said section could be passed had lapsed. However, the tax authorities disagreed with the Taxpayer and passed an order deeming the Taxpayer to be an ‘assessee in default’ under section 201 of the IT Act in December 2018.

Aggrieved, the Taxpayer filed a writ petition before the Telangana HC.

Decision of the Telangana HC

The Telangana HC first considered the Taxpayer’s plea regarding the period of limitation. The HC observed that while section 201(3) provides for a period of limitation of seven years in case of payments made to a person who is a resident in India, no time limit has been fixed for non-residents. The HC then pondered upon the legislative intent of the said provision and observed that no time limit has been prescribed in case of payments to non-residents since it may not be administratively possible to recover tax from a non-resident. This had also been clarified by the Central Board of Direct Taxes vide Circular No. 5 of 2010. Thus, the HC held that since, the legislature had consciously not prescribed any time limit for an order under section 201 to be passed in case of a non-resident, it would be wrong on its part to read such a limitation into it. However, it was also imperative that such an order qua a non-resident should be passed within a reasonable period.

The HC further noted that while what is ‘reasonable’ would be a factual determination, such a period could not be less than seven years, which has already been prescribed for residents. In the instant case, the survey operation was carried out in December 2015 and order under section 201 was passed on December 2018, i.e., within three years, which was a reasonable time.Thus, the HC dismissed the petition filed by the Taxpayer and held that the order of the tax authorities was not barred by limitation.

Significant Takeaways

Several courts have previously also held that a reasonable time limit has to be adopted in the absence of limitation period under section 201.[2] The Telangana HC’s view in the instant case is also supported by an earlier Allahabad HC[3] decision, which also did not prescribe a specific period of limitation in case of non-residents, but held that while exercising its power of judicial review, a court can evaluate whether power has been exercised by the competent authority within a reasonable time and whether delay, if any, is unjust, arbitrary or whimsical. If the delay is found to be for bona fide reasons, such exercise of power cannot be held to be invalid.

Interestingly, the Telangana HC has opined that a period of at least seven years, since, already available in case of payments made to residents, should also be available to non-residents. However, this observation appears to be obiter and should only hold a persuasive value.

Having said the above, these observations must be borne in mind while drafting and negotiating tax indemnity period in case of transactions involving payments to non-residents. While owing to the representative assessee risks (i.e., the payer being taxed as a representative of the non-resident recipient), tax indemnity period can be as high as 11 years, (i.e., the maximum period up to which assessment could be re-opened), parties generally tend to agree to a lower tax indemnity period having regard to various commercial and legal factors. Thus, the observation made by the HC adds to the list of factors to be considered at the time of negotiating on tax indemnity period. It would, hence, be advisable to have the relevant transaction documents, especially those involving payments to a non-resident, to be thoroughly vetted by a tax advisor to ensure that the interests of the parties are duly protected.  

[1] Ariba Inc. v. DDIT, International Taxation, Circle 1(1), New Delhi [TS-583-HC-2023(TEL)].  

[2] See Commissioner of Income Tax v. Hutchinson Essar-Telecom Limited [2010] 323 ITR 230 (Delhi HC); Commissioner of Income Tax v. NHK Japan Broadcasting Corporation [2008] 305 ITR 307 (Delhi HC); Bharti Airtel v. Union of India [2016] 76 taxmann.com 256 (Delhi HC); Deputy Commissioner of Income Tax v. Mahindra & Mahinda Limited [2014] 365 ITR 560 (Bombay HC).

[3] M/S Mass Awash Pvt. Ltd. v. Commissioner of Income Tax (International Taxation) & Anr. (Misc. Bench No. 1088 of 2016) (Allahabad HC).

AMENDMENT EXTENDING THE LIMITATION PERIOD UNDER SECTION 201 NOT RETROSPECTIVE

Oracle India Pvt. Ltd. [‘the assessee’] was held to be an assessee in default and was re-issued a notice u/s 201(1)/(1A) dated January 20, 2015 for TDS defaults for the AY 2008-09. Subsequently, an order dated March 17, 2015 was passed treating assessee in default.

The said notice was premised on the amendment introduced in Section 201(3) vide Finance (No. 2) Act, 2014, whereby the limitation to treat an assessee as one in default was increased to seven years from the end of relevant Financial Year. Earlier, for the same assessment year, a notice had been issued under the same provisions on February 17, 2014. The Delhi High Court vide order dated December 5, 2015 [WP(C) 2061/2014] had quashed the notice holding that the said notice was time barred in view of the provisions of Section 201(3) as it then existed.Aggrieved by the reissuance of notice u/s 201(1)/(1A), the assessee filed a writ petition before Delhi High Court.

Before the High Court, the assessee relied on the Supreme Court ruling in the case of S.S. Gadgil v. Lal & Co.[53 ITR 231(SC)] which has been subsequently followed in several other decisions of the Supreme Court including K.M. Sharma v. ITO [254 ITR 772 (SC)] and National Agricultural Cooperative Marketing Federation of India v. UOI [ 260 ITR 548 (SC)]. Based on these rulings, the assessee argued that the limitation prescribed by the Income Tax Act was not merely a period of limitation but that it imposed a fetter upon the power of the AO to take action under the said provisions.

In this context, it was submitted that since the power in respect of AY 2008-09 expired on March 31, 2011 in terms of Sec 201(3) as it then existed, it could not be revived unless the legislature specifically made a retrospective amendment to the same. The substitution of Section 201(3) by the Finance (No.2) Act, 2014 was with effect from October 1, 2014 and not with retrospective effect.

The High Court noted that Revenue had re-issued the notice in an attempt to take advantage of the amendment to Section 201(3) which was brought into effect from October, 2014. Taking note of the co-ordinate bench ruling in assessee’s own case quashing issuance of original notice u/s 201(1)/(1A), the High Court held that those proceedings which had ended and attained finality with the passing of the order dated December 5, 2014 of this Court in WP(C) 2061/2014 cannot now be sought to be revived through this methodology adopted by the Assessing Officer. Even otherwise, insofar as the Financial Year 2007-08 was concerned, the period for completing the assessment under Section 201(1)/201(1A) had expired on March 31, 2015. In light of above, the High Court quashed the notice reissued and order u/s 201 and allowed assessee’s writ petition.

[Source: TS-406-HC-2015(Del)]