1. This appeal has been instituted by the assessee, a limited company against the order of the CIT(A) dated 22nd Nov., 1983, wherein he had confirmed the action of the ITO Under Section 195(2) of the I.T. Act for realization of the income-tax on the fees paid for technical services to M/s Hokushin Electric Works Ltd. on the basis of grossing up the tax with the fees.
2. The assessee company had applied for the no-objection certificate for remittance of 7,70,000 Yen to the non-resident company M/s Hokushin Electric Works Ltd. Japan, Tokyo. The I.T.O. examined the request with reference to the agreement between the two companies for the period covering from 10th Dec. to 21st Dec., 1979 and found that the Indian Company was to bear the taxes. The Indian equivalent of the foreign exchange was Rs. 29,627 and applying the provisions of clause 2(b)(iv)(B) of part II of the rate schedule of the Finance Act, which prescribed the rate of tax to be deducted at 40%, the ITO after grossing up the amount of tax with the net amount payable, arrived at the tax figure of Rs. 19,750, which amount he directed the assessee to deposit.
2.1 The assessee aggrieved by this directive order of the ITO passed Under Section 195(2) preferred appeals to the CIT(A). The CIT(A) considered the case of CIT v. American Consulting Corporation [1980] 123 ITR 513 (Ori.). He was of the view that the Mysore High Court ruling in the case of Tokyo Shibaura Electric Co. Ltd. v. CIT [1964] 52 ITR 283 was the direct authority on the subject as in that case of payment of royalty, it was held that thereal income by way of royalty was such amount as would, if the tax thereon had been deducted, have left the sum in the hands of the assessee and not the royalty payable plus the tax thereon. He also placed reliance on Sandwell & Co. v. ITO [1983] 6 ITD 183 (Cal.).
2.2 Before us the learned counsel Shri M.S. Syali placing reliance on the Andhra Pradesh High Court ruling in the case of CIT v.Superintending Engineer [1985] 152 ITR 753, submitted that his plea is only that the grossing up has to be limited to the tax on the technical services and not the tax on tax. The learned departmental representative only relied on the orders of the authorities below. 3.
We have given our very careful considerations to the arguments of the parties. As per the proposal of the non-resident company dated 4th June, 1979, which proposal had been accepted and given effect to by the assessee company, clause 7 provides "All taxes and any other charges and expenses leviable in India in connection with payments hereof shall be borne by the purchaser". This means that the foreign company shall be paid their dues as specified in their proposal and all taxes that might arise in respect of the transactions shall be the obligation and liability of the Indian Company. To put it in other words, the nonresident company shall receive the said amount net of taxes.
3.1 Section 115A was introduced with effect from 1st June, 1976. This was so introduced along with the modifications to the Section 9 whereby agreements entered into after 1-4-1976 were brought into the tax net.
Section 195(2) also was simultaneously modified with effect from 1-6-1976. Section 115A covered the incomes that are earned by a foreign company in India from dividends, royalty and technical services and prescribed the rate of income-tax payable on such incomes by the foreign companies. Section 195 fastened on the Indian Company the obligation to deduct the income-tax at the rates in force on the income payable by it to the non-resident company. It reads as under : (1) Any person responsible for paying to a non-resident not being a company or to a company which is neither an Indian company nor a company which has made the prescribed arrangements for the declaration and payment of dividends within India, any interest, not being "interest on securities", or any other sum, not being dividends, chargeable under the provisions of this Act, shall, at the time of payment, unless he is himself liable to pay any income-tax thereon as an agent, deduct income-tax thereon at the rates in force.
Provided nothing in this sub-section shall apply to any payment made in the course of transactions in respect of which a person responsible for payment is deemed under the proviso to Sub-section (1) of Section 163 not to be an agent of the payee.
(2) Where the person responsible for paying any such sum chargeable under this Act (other than interest on securities, dividend and salary) to a non-resident considers that the whole of such sum would not be income chargeable in the case of the recipient, he may make an application to the Income Tax Officer to determine, by general or special order, the appropriate proportion of such sum so chargeable, and upon such determination, tax shall be deducted under Sub-section (1) only on that proportion of the sum which is so chargeable.
(1) Subject to the provisions of Sub-section (2) where the total income of an assessee, being a foreign company, includes any income by way of - (b) royalty or fees for technical services received from an Indian concern in pursuance of an agreement made by the foreign company with the Indian concern after the 31st day of March, 1976, and approved by the Central Government, (iii) the amount of income-tax calculated on the income by way of fees for technical services, if any, included in the total income, at the rate of forty per cent.
4. The reading of the above sections make it clear that the non-resident company shall be liable for Indian income-tax at the rate of 40% on the income of fees for technical services received by it from the Indian Company.
In a situation, where the non-resident has agreed to discharge its obligation under the Indian Income-tax Act, i.e., it requires the Indian Company to pay it a certain gross amount of fee for technical services before any taxes, then the taxes payable shall be equal to 40% of such gross amount.
In a situation as in the instant case before us, where the non-resident company does not wish to be bothered of the Indian income-tax but demands the fee for technical services free of all taxes or net of all taxes, then it has to be taken to mean that such net amount payable is 60% of a certain gross amount, after deduction of tax at 40% of such gross amount. Therefore, in such situations, keeping the net amount as agreed to be paid as the starting point, calculations are needed to be made to arrive at a certain gross amount, from which gross amount, the tax at 40% when deducted, would leave the balance amount equal to the net amount payable. It is situations like these that have evolved the tax on tax basis which is applicable with reference to Section 115A.Non-resident company is paid Rs. 100 (gross) as fees for technical services and the non-resident is to bear all taxes under the Indian income-tax. The rate of income-tax being 40%, the tax payable would be Rs. 40, which would leave in the hands of the non-resident Rs. 60, net after all taxes.
Non-resident company is paid Rs. 60 (net) as fees for technical services and all taxes are to be borne by the Indian Company. The rate of tax still being 40%, and the amount payable, net of taxes is Rs. 60, the gross amount needs to be calculated, from which gross amount the tax at 40% when deducted would leave the net amount payable at Rs. 60.
In situation 1, the net amount of Rs. 60 was arrived at after deduction of Rs. 40 towards taxes from the gross amount of Rs. 100, therefore in situation 2 also the gross amount has to be Rs. 100 and the tax payable is Rs. 40.
Thus it can be seen from the above example that only when the tax payable is related to a gross amount, which amount when not so specified needs to be arrived at first, on which gross amount the tax payable at 40% when deducted, would result in the net amount (net of taxes) that is payable to the non-resident company.
5. Section 195 had been introduced only to facilitate the collection of income-taxes due on such technical services rendered by the non-resident company to an Indian company, through the Indian Company.
This is clear from the wordings contained therein "Any person responsible for paying to a non-resident...shall at the time of payment, unless he is himself liable to pay any income-tax thereon as an agent, deduct income-tax thereon at the rates in force". The purpose of facility is abundantly clear since it would be impossible to keep track of the foreign companies but would be easier to keep track of these nonresident companies through the Indian companies, which is why they had cast the obligation of deducting the tax while remitting the amount to the non-resident companies. The rate of tax in force as prescribed under the Finance Act was also 40%. In other words the tax that would become payable Under Section 115A should be the tax that needed to be deducted Under Section 195., This is further made clear by the words contained in Section 195 that the provisions would not apply to a situation where the Indian company is the agent of such foreign company as defined in Section 163.
Therefore, the Act visualises two situations, one, the Indian company acts as agent of the non-resident company and pays all the taxes that are due by the foreign company and two, the Indian company limits itself to the tax payable on the income that would become payable by it to the foreign company. The second situation is normally preferred by the Indian concerns ostensibly for the reason that the non-resident concern may have several agreements with various companies and no one company would like to be bothered for the taxes of the foreign company.
Once this situation is applicable, the Indian company would be liable to income-tax to the same extent as would be payable by the foreign company as if it were its sole income. Therefore, when the tax on lax basis has to be adopted with reference to Section 115A the same amount of tax being deductible by the Indian company Under Section 195, the basis of calculation has also to be tax on tax.
The logic is understandable as the Indian company agrees to bear the .taxes related to the transactions by agreeing to pay the non-resident the amount free of all taxes, and accordingly the amount of tax payable by the foreign company and the tax that needs to be deducted by the Indian Company Under Section 195 has necessarily to be one and the same figure.
This provision can be further compared with the tax that needs to be deducted at source from salaries Under Section 192 of the Income-tax Act. Responsibility of tax deduction had been transferred to several of the employers for the only reason that they would be capable of coordinating them and they are expected to deduct the tax from the salaries as if the employee's sole income is from salary only and that is why the strict provisions of penalty etc., have been prescribed for not discharging the obligations that had been cast on the employers.
6. The legislative intent was clarified in the circular issued by the Department of Revenue & Insurance, .Ministry of Finance, Government of India, bearing F. No. 484/31/74-FTD dated 27th Nov., 1974 [(1975) 98 ITR (St. page 19-20)]. This circular is reproduced herein for facility : Subject : Deductions of tax at source Under Section 195 of the Income-tax Act, 1961, from payments to non-residents.
I am directed to state that Section 195 of the Income-tax Act, 1961, imposes a statutory obligation on any person responsible for paying to a non-resident, any interest (not being "interest on securities") or any other sum (not being dividends) chargeable under the provisions of the Income-tax Act, to deduct the income-tax at the "rates in force", unless he is himself liable to pay income-tax thereon as an agent.
Payments to a non-resident by way of royalty for the. use of, or the right to use, any copyright (e.g., of literary, artistic or scientific work including cinematograph films or films or tapes for radio or television broadcasting), any patent or trade-mark etc., and payments for technical services rendered in India are some of the typical examples of sums chargeable under the provisions of the Income-tax Act to which the aforesaid requirement of tax deduction at source will apply. The term "rates in force" means the rates of income-tax specified in this behalf in the Finance Act of the relevant year. Where the person responsible for paying any such sum to a non-resident considers the whole amount thereof would not be income chargeable under the Income-tax Act in the case of the recipient non-resident, he may make an application Under Section 195(2) to the income-tax officer for determination of the appropriate portion of such payment which would be taxable and in respect of which tax is to be deducted Under Section 195(1).
The object of Section 195 is to ensure that the tax due from non-resident persons is secured at the earliest point of time so that there is no difficulty in collection of tax subsequently at the time of regular assessment. Failure to deduct tax at source from payment to a non-resident may result in loss of revenue as non-resident may sometimes have no assets in India from which tax could be collected at a later stage. ' 7. It is thus clear that the "rates in force" having been specified Under Section 115A in relation to the incomes of non-residents, to which only reference has been made in Section 195, the tax that would be payable by the non-resident if he were to be assessed directly, would be tax that needs to be deducted Under Section 195 of the Income-tax Act. To interpret it in any other manner would make the section nugatory.
Accepting the plea of the assessee of calculating the tax on the net amount payable and adding it to the net amount payable, the amount so arrived at to be the base for calculating the tax would leave a blank which is represented by the element of tax remaining uncollected or unrecovered which under any circumstances cannot be recovered from the foreign company because the foreign company may not have any assets available in India and the process of recovering tax through diplomatic and international channels may be a long drawn process and involving unnecessary expenditure of time and money on litigation. To accept the proposition placed by the assessee would mean allowing him not to fulfil his full obligation under the Income-tax Act. This would be, against law.
We are therefore of the opinion that the exercise done by the authorities below in grossing up the amount of tax on tax was riot only proper but it is what is warranted by the Act. We are therefore of the opinion that the present appeal by the assessee company has no merit and deserves to be dismissed.
8. Before we part with this appeal we would also refer to the legal authorities relied on by the assessee. The Calcutta High Court decision in the case of Superintending Engineer (supra) had placed reliance on the Orissa High Court ruling in the case of American Consulting Corporation (supra) for coming to the conclusion that the Section 195 did not contemplate the tax on tax basis. The Orissa High Court (supra) was considering whether the tax liability could be called a perquisite Under Section 28(1 )(iv) which came on the statute book by the Fin.
Act, 1964, for in that case the period pertaining was prior to the amendment i.e., of 1963 and accordingly it was held that it was not a perquisite. In that case their Lordships observed "The value of benefit or perquisite which arose to the corporation by way of its tax liability having been met by the company, the same has to be limited to the amount of actual tax due and in the circumstances grossing up was not permissible under the provisions of the Act". They also observed "The tax that would be leviable on the profits in the hands of the corporation was to be paid by the company". The Calcutta High Court was considering the period up to 1972 and in regard to the question of tax deduction Under Section 195(2) with reference to the portion chargeable to tax in India. They also accepted on principle that the tax that would be payable by the non-resident company would be the tax that needed to be deducted Under Section 195. They were confronted with the Mysore High Court ruling in the case of Tokyo Shibaura Electric Co.
Ltd. (supra) but they chose to follow the Orissa High Court ruling (supra), as they felt that this ruling correctly brought out the method of grossing up. They accordingly held that the tax payable alone should be added to the net amount payable to the non-resident and did not approve of the tax on tax basis.
8.1 We have quoted the relevant portions of Sections 115A and 195 as also she legislative intent in paras 3 & 6 above. The Calcutta High Court and the Orissa High Court had no occasion to consider the legislative changes and the legislative intent as brought out earlier, as they were not on the statute book then. The Legislature made it clear that it shall be the responsibility to ensure the payment of Indian income-tax by the Indian Company and the amount so be paid to the non-resident company being net after deferment of all taxes, the only possible way of arriving at such a net amount is to calculate such gross amount which after deducting therefrom the taxes, as would leave out the net amount as agreed to be paid by the Indian Company.
The Mysore High Court in the case of Tokyo Shibaura Electric Co. Ltd. (supra) had agreed with various rulings of the English courts which had examined the situation of payments net of taxes. They observed "The decision of the King's Bench in Jawarski v. Institution of Polish Engineers in Great Britain Ltd. [1951] 1 KB 768 (CA) is more on the point. In January 1943, the plaintiff a Polish subject entered into service of the defendant -- an official body under the Polish Government in London. The oral agreement of service as evidenced by a letter from the plaintiff to the defendants was that 'my remuneration will amount to 201 net per month payable in advance...' without any deductions which will be borne by the association'. Interpreting this agreement the court held that in order to find out the real remuneration of the plaintiff, the remuneration fixed should be grossed up to that sum which would leave the plaintiff the stipulated remuneration, tax-free". In view of the above reasons we are of the opinion that the rulings relied upon by the assessee are of no assistance to it.
8.2 We therefore hold that the action of the authorities below in grossing up the tax to such an extent as would leave the net amount as agreed to be paid after deduction of the tax from the gross amount including the tax was proper and in accordance with the provisions contemplated by Section 195 of the Income-tax Act. The tax calculated at Rs. 19,750 as deductible by the assessee company is accordingly upheld. The issue is accordingly decided in favour of the revenue and against the assessee. The appeal is dismissed.