The regime of tax deduction at source has been designed by the Indian legislature as a mechanism to ensure upfront collection of revenue. This framework becomes particularly important when payments are made to non-residents, where the risk of revenue leakage is higher because the payee may remit funds abroad. One of the most significant provisions in this regard is section 195 of the Income-tax Act, 1961, which governs deduction of tax at source on payments to non-residents.
In the context of transactions involving the purchase of immovable property from non-residents, section 195 assumes critical importance. Unless a lower deduction certificate has been obtained from the Assessing Officer, the purchaser is required to deduct tax at source on the sale consideration paid to a non-resident seller. A recent ruling of the Bangalore Bench of the Tribunal in the case of Nitesh Estates Ltd. v. Asstt. DIT (International Taxation) [2023] 30 ITR (Trib.)-OL 134 has reaffirmed the strict interpretation of this provision. The decision underlines that deduction is mandatory irrespective of the seller’s ultimate tax liability or whether the seller reports taxable income for the relevant year. We explored the legislative background of section 195, examined the Tribunal’s ruling in the Nitesh Estates case, and discussed the principle that emerges from the judgment.
Understanding Section 195 in the Context of Non-Residents
Section 195 requires any person responsible for paying to a non-resident any sum chargeable under the provisions of the Act to deduct income tax at the rates in force. The provision does not differentiate between payments that eventually result in taxable income and those which may be set off against losses. Instead, the trigger for deduction is the chargeability of the sum under the Act.
The provision is preventive in nature. Its objective is to ensure that income accruing to non-residents from Indian sources is not taken away from the Indian jurisdiction without first subjecting it to tax. By shifting the responsibility on the payer, the law attempts to create a checkpoint at the source of the payment.
In real estate transactions, this framework means that whenever an Indian resident purchases immovable property from a non-resident, the buyer is legally bound to deduct tax on the entire sale consideration, unless the seller has obtained a certificate authorizing lower deduction or nil deduction from the tax department.
Facts of the Nitesh Estates Ltd. Case
The case before the Bangalore Tribunal involved the purchase of immovable property by Nitesh Estates Ltd. from the well-known tennis player Mahesh Bhupathi. The central issue was whether the purchaser had defaulted in not deducting tax at source on the consideration paid to Bhupathi, who was a non-resident during the relevant assessment year.
The purchaser argued that they were not aware of the non-resident status of Bhupathi at the time of transaction. It was further contended that the seller had already filed his return of income in India, disclosed the capital gains, and, on computation, no tax was ultimately payable. Based on this, the purchaser claimed that no liability to deduct tax at source could arise.
Arguments Raised by the Purchaser
The purchaser placed reliance on the following reasoning:
- Lack of knowledge of the residential status of the seller meant there was no deliberate failure to deduct tax.
- Since the seller had offered the capital gains in his return and the computation resulted in nil tax liability, there was no revenue loss to the department.
- The intent of section 195 is to ensure that income chargeable to tax is subject to deduction, and in this case, the income had already been disclosed.
The purchaser therefore requested that they should not be treated as an assessee-in-default for non-deduction of tax.
Tribunal’s Findings and Ruling
The Bangalore Tribunal rejected the arguments advanced by the purchaser and ruled in favour of the department. The bench observed that the object of section 195 is to prevent the possibility of non-residents repatriating income without paying due tax in India. Once the payment is chargeable to tax under the provisions of the Act, the payer is under a statutory obligation to deduct tax at source.
The Tribunal made certain key observations:
- Knowledge of the seller’s residential status is not a defense available to the purchaser. The responsibility is absolute and arises by operation of law.
- Whether or not the seller eventually has a taxable income or whether he has carried forward losses is immaterial. The obligation to deduct is not dependent on the final tax liability of the seller.
- Deduction at source under section 195 is not contingent upon the computation of net income. Instead, it is based on the gross payment that is chargeable to tax.
- The payer cannot substitute the statutory mechanism by relying on the seller’s return or assessment.
Accordingly, the Tribunal held that Nitesh Estates Ltd. had failed in its obligation under section 195 and was liable to be treated as an assessee-in-default.
Principle Emerging from the Case
The ruling reiterates a crucial principle: when a payment made to a non-resident is chargeable to tax, deduction of tax at source by the payer is mandatory. It does not matter that the payee ultimately has no tax liability after computation of total income. It also does not matter that the payer was unaware of the payee’s residential status.
The Tribunal emphasized that the legislative intent behind section 195 is to create a safeguard for the exchequer. By requiring deduction at source, the law ensures that revenue is secured before funds are taken outside the Indian tax net. This intent would be defeated if the payer were allowed to escape liability on the ground that the non-resident has filed a return or has no taxable income in aggregate.
The Broader Legal Context
The judgment must be seen in light of the overall scheme of withholding provisions in the Income-tax Act. The TDS regime does not operate on the basis of final tax liability of the recipient but on the principle of advance collection. The payer is not expected to step into the shoes of the assessing authority and determine the net tax payable by the payee. Instead, the payer’s obligation arises the moment the payment is of a nature that is chargeable to tax in India.
This principle has been consistently affirmed by the judiciary. The Supreme Court in Transmission Corporation of A.P. Ltd. v. CIT (239 ITR 587) had held that section 195 requires deduction on sums chargeable to tax, and the payer cannot decide on his own that the payment is not taxable. If the payer believes that no tax or lower tax should be deducted, the proper course is to apply to the Assessing Officer under section 195(2) for determination. The ruling in Nitesh Estates Ltd. reinforces this jurisprudence and clarifies its application in property transactions involving non-residents.
Illustrative Example
Consider a situation where an Indian resident purchases a flat in Bangalore from a non-resident seller for Rs. 3 crore. Even if the seller has a cost of acquisition that wipes out any capital gain, the buyer is nevertheless required to deduct tax at source on the sale consideration under section 195.
If the seller wishes to avoid deduction because his computation results in no taxable income, he must obtain a certificate under section 197 authorizing lower or nil deduction. Without such a certificate, the buyer cannot escape liability by relying on the seller’s computation or return. This example highlights the rigidity of the mechanism and the importance of obtaining proper documentation in cross-border real estate transactions.
Implications for Purchasers
The ruling sends a strong signal to purchasers of immovable property from non-residents. Some of the immediate implications are:
- Purchasers must conduct due diligence on the residential status of the seller before executing a transaction.
- It is risky to assume that no deduction is required merely because the seller discloses the income in his return.
- The onus of compliance squarely lies on the purchaser, and ignorance of facts is not an acceptable excuse.
- In the absence of deduction, the purchaser may be treated as an assessee-in-default and made liable for the tax that should have been deducted, along with interest and potential penalties.
Linking with Proviso to Section 201(1)
The controversy gains additional complexity when read with the proviso to section 201(1). The proviso provides relaxation to payers who fail to deduct tax, provided the payee has furnished a return of income, included the payment in computing income, and paid tax thereon. This mechanism, coupled with certification through Form 26A, is intended to shield payers from being treated as assessees-in-default.
However, as will be explored, the wording of clause (iii) in the proviso and the requirements of Form 26A create ambiguity, particularly in cases where the payee’s overall income is nil or negative despite the receipt being taxable in nature. The Tribunal’s insistence in Nitesh Estates Ltd. that deduction is mandatory irrespective of the payee’s final tax liability highlights the tension between the substantive provision of section 195 and the relaxation under section 201(1).
Relaxation Mechanism under Section 201(1)
While section 195 places a strict obligation on the payer to deduct tax at source on payments to non-residents, the legislature recognized that this rigidity could create genuine hardships in cases where the payee has already discharged his tax liability. To address this, a relaxation was introduced by way of a proviso to section 201(1). This relaxation mechanism provides circumstances under which a payer who has failed to deduct tax at source may not be treated as an assessee-in-default.
The proviso, introduced with effect from 1 July 2012, initially applied only to payments made to residents. With effect from 1 September 2019, the benefit was extended to payments made to non-residents as well. This marked a significant development in aligning the compliance responsibilities of payers dealing with domestic parties and those dealing with cross-border transactions. We examine the working of the proviso, its legislative history, its linkage with Form 26A, and the ambiguities that have arisen in interpretation, particularly with reference to clause (iii).
Text of the Proviso to Section 201(1)
The proviso reads:
“Provided that any person, including the principal officer of a company, who fails to deduct the whole or any part of the tax in accordance with the provisions of this Chapter on the sum paid to a resident or on the sum credited to the account of a resident shall not be deemed to be an assessee in default in respect of such tax if such resident—
(i) has furnished his return of income under section 139;
(ii) has taken into account such sum for computing income in such return of income; and
(iii) has paid the tax due on the income declared by him in such return of income,
and the person furnishes a certificate to this effect from an accountant in such form as may be prescribed.”
Through the 2019 amendment, these conditions were extended to payments made to non-residents under section 195.
Legislative Objective
The relaxation is intended to prevent double recovery of tax and unnecessary penal consequences for the payer. If the payee has already reported the income, included the relevant payment in computation, and paid the resulting tax liability, then pursuing the payer for the same tax would amount to duplication. The proviso thus operates as an equitable safeguard for the payer.
However, the benefit is not automatic. It can be availed only if the payer produces a certificate from an accountant in Form 26A, confirming that the payee has satisfied all the prescribed conditions.
Role of Form 26A
Form 26A is a critical procedural component of this relaxation. It is a declaration certified by a chartered accountant on behalf of the payee, verifying that:
- The payee has filed his return of income,
- The specific receipt has been taken into account in the computation of total income, and
- Taxes due on such income have been paid.
For payments under the head of capital gains, the form requires specific disclosure of the amount of taxable income under that head. This makes it essential for the accountant to segregate the relevant transaction and confirm its inclusion in the return.
The form acts as evidence for the payer to demonstrate to the department that no revenue loss has occurred, thereby absolving him from liability under section 201(1).
Extension to Non-Residents in 2019
The extension of this relief to payments made to non-residents with effect from 1 September 2019 was a significant shift. Cross-border payments often involve practical challenges in ascertaining the ultimate tax liability of the recipient. By allowing the payer to rely on Form 26A certified by an accountant, the law provided a route for compliance relief.
However, the complexities are more pronounced in non-resident cases. Obtaining a certificate from a non-resident payee’s accountant, ensuring filing of returns in India, and securing confirmation of tax payments are often difficult in practice. These challenges have raised questions about the practical utility of the proviso in cross-border property transactions.
Ambiguity in Clause (iii)
Clause (iii) of the proviso requires that the payee should have paid the tax due on the income declared in the return. At first glance, this seems straightforward. But on closer reading, several interpretational issues arise:
- The wording requires payment of tax on income declared in the return. However, the income declared could include multiple heads such as salary, business income, capital gains, or other sources. The law does not explicitly state that the tax must be attributable to the specific receipt on which TDS was required.
- If the payee has capital gains income but also suffers losses under other heads, the net total income could become nil. In such a case, no tax is payable on the total income. Does this mean the condition in clause (iii) is not satisfied? Or does inclusion of the receipt in computation itself suffice?
- There is no reference in clause (iii) to negative income. The drafting does not consider a situation where the relevant head of income shows a gain but the overall income results in no taxable liability due to set-off of losses.
This ambiguity has created interpretational challenges and potential litigation.
Interaction with Form 26A Requirements
Form 26A, while intended to operationalize the proviso, has its own peculiarities. The form specifically asks the accountant to mention the amount of taxable income under the head of income in which the receipt is accounted for. For property transactions, this would be capital gains.
Here lies the difficulty:
- If the accountant certifies capital gains as taxable income but the overall return shows no tax liability, does the payer still get the benefit?
- The form does not require disclosure of whether the total income is positive or negative.
- The language suggests that it is sufficient if the receipt is included in the computation, regardless of whether the final taxable income is nil.
Thus, there is a mismatch between the legislative text of clause (iii) and the procedural format of Form 26A.
Tribunal’s Approach in Nitesh Estates Ltd.
The Bangalore Tribunal in Nitesh Estates Ltd. addressed this issue indirectly. It held that the payer cannot escape liability for non-deduction of tax merely because the payee’s ultimate tax liability is nil. The Tribunal observed that once the payment is chargeable to tax, the payer’s obligation is absolute.
The judgment did not delve deeply into the proviso to section 201(1) or the operation of Form 26A. However, the ruling highlights the tension between the substantive obligation under section 195 and the relaxation envisaged in section 201(1).
The Tribunal’s insistence that the payer’s duty arises irrespective of the payee’s final liability suggests that the relaxation mechanism cannot dilute the primary obligation. It can only provide relief in limited circumstances where the payee has discharged tax on the specific income.
Practical Examples of Ambiguity
Consider an illustration where a non-resident sells a property in India and earns capital gains of Rs. 50 lakh. At the same time, the non-resident has a business loss of Rs. 60 lakh from another Indian source. On computation, the total income becomes nil, and no tax is payable.
- Under clause (iii), the condition is that tax must be paid on the income declared. Since no tax is payable, does this condition fail?
- Under Form 26A, the accountant would certify that the capital gains of Rs. 50 lakh were included under the head of capital gains. This suggests compliance, even though no tax was paid.
- For the payer, this creates confusion: can he rely on the accountant’s certificate and escape liability, or does the literal requirement of tax payment defeat the relief?
This example underscores the drafting flaw and its practical consequences.
Policy Concerns
The legislative intent behind the proviso is clear—to prevent double recovery and provide relief to the payer when the payee has already fulfilled his obligations. However, the current wording risks undermining this objective.
- It places undue emphasis on the payment of tax rather than the inclusion of income.
- It does not address situations of loss or exemption where no tax is payable despite the inclusion of the income.
- It creates administrative challenges for payers, especially in cross-border transactions, where obtaining Form 26A itself can be cumbersome.
A more balanced approach would have been to frame the requirement as inclusion of the sum in the return of income, irrespective of whether tax is ultimately payable on the total income.
The Unusual Burden on Payers
Another criticism of the relaxation mechanism is the unusual requirement that the payer must procure proof of filing of return of income by the payee. In the case of non-residents, this expectation is particularly onerous.
Whether or not a payee has filed a return is information already available with the Income Tax Department. Requiring a payer to collect this information from the payee seems impractical and unnecessary. It burdens the payer with compliance tasks that are outside his reasonable control. In cross-border transactions, this expectation may create obstacles, as non-residents may not be willing or able to provide their Indian tax documents to purchasers.
Need for Clarification
Given the ambiguities, there is an urgent need for clarification, either through legislative amendment or by way of a circular from the Central Board of Direct Taxes. Such clarification should address the following points:
- Whether inclusion of the income in the return, even without tax payment due to losses or exemptions, is sufficient to satisfy clause (iii).
- Whether the accountant’s certification in Form 26A can be relied upon by the payer in such cases.
- Whether the payer can be absolved from liability even if the payee’s return results in nil taxable income.
Until such clarification is provided, the interplay between section 195, the provision to section 201(1), and Form 26A will continue to create uncertainty for taxpayers.
Broader Implications of the Proviso in Cross-Border Transactions
The interplay of section 195, section 201(1), and Form 26A has raised significant compliance challenges in cross-border property transactions. The central tension lies between the statutory duty of the payer to deduct tax at source and the conditional relief available if the payee has filed a return and discharged the tax liability. The lack of clarity in clause (iii) of the proviso and the practical difficulties in securing certificates from non-residents have led to interpretational disputes.
We expand on the broader implications of the proviso for taxpayers, with particular emphasis on cross-border property transactions, compliance burdens, policy concerns, and the judicial approach to these issues.
The Rigidity of Section 195 and its Policy Justification
Preventing Revenue Leakage
Section 195 embodies a strict obligation on the payer to deduct tax on payments made to non-residents. The logic is that once the funds leave Indian jurisdiction, the tax department loses practical control over them. This makes the mechanism of deduction at source an essential safeguard to prevent revenue leakage.
The Tribunal in Nitesh Estates Ltd. emphasized this point by noting that the legislature enacted section 195 precisely to prevent situations where sale proceeds could be taken abroad by non-residents without satisfying Indian tax obligations.
Irrelevance of Final Liability
The principle that deduction must occur irrespective of whether the non-resident ultimately owes tax has been consistently upheld. The payer is not expected to predict the final computation of taxable income in the hands of the non-resident.
Instead, the law requires deduction at the point of payment, shifting the burden onto the payee to claim refund or adjustment if tax was not actually payable. This design ensures certainty in revenue collection, though it may cause hardship in cases where tax deduction was unnecessary in retrospect.
The Relief Mechanism and its Narrow Scope
Conditional Nature of the Proviso
The relaxation under the proviso to section 201(1) is conditional. It is not an exemption from the duty to deduct tax, but rather a defense against being treated as an assessee-in-default if specific criteria are satisfied. The payer must still demonstrate compliance with the conditions, including producing a certificate in Form 26A.
Disjunction Between Policy and Wording
While the policy intent is to avoid double taxation, the wording of clause (iii) creates confusion by focusing on the payment of tax on income declared in the return. This narrow phrasing may lead to denial of relief even in cases where the income is properly disclosed but no tax is payable due to losses or exemptions.
Form 26A as a Compliance Tool
Evidentiary Function
Form 26A is central to the operation of the proviso. It acts as evidence that the payee has included the receipt in his return and discharged the tax liability. For the payer, submission of this certificate is the only statutory safeguard against being held in default.
Limitations of the Form
However, Form 26A does not align perfectly with the legislative text. It requires disclosure of taxable income under the specific head of income in which the receipt is recorded. It does not require confirmation that overall taxable income is positive. This creates a situation where the form could technically be satisfied even when no tax is payable on the total income.
This discrepancy has created confusion in practice and leaves payers uncertain about whether reliance on the form is sufficient defense.
Judicial Perspective
Tribunal’s Emphasis on Obligation of Payer
The Tribunal in Nitesh Estates Ltd. made it clear that the obligation under section 195 is independent of the payee’s ultimate liability. The payer cannot argue that no deduction was necessary simply because the payee eventually paid no tax. This strict interpretation underscores the protective role of section 195 for revenue interests.
Limited Consideration of Proviso
While the Tribunal did not directly analyze the scope of the proviso in detail, its ruling implies that the relief mechanism cannot override the fundamental obligation. The proviso can only shield the payer if the conditions are meticulously met, not as a general defense against failure to deduct.
Broader Judicial Trends
Other judicial precedents have also leaned towards strict enforcement of withholding obligations. Courts have typically held that payers must err on the side of deduction, leaving it to the payee to claim refund if entitled. This reinforces the narrow and conditional scope of the relaxation mechanism.
Practical Implications for Payers
Burden of Securing Compliance
Payers are required to secure from the payee proof of filing of return, inclusion of the income, and payment of taxes due. In the case of non-residents, this expectation is often impractical. Non-residents may be unwilling to share their Indian tax returns or accountant certificates with buyers, leaving the payer without the means to satisfy the proviso.
Exposure to Liability
If the payer cannot obtain Form 26A, he remains exposed to liability for the tax not deducted. This liability is in addition to interest and potential penalties. The burden is therefore heavy and often disproportionate, especially when the payee has in fact disclosed the income.
Administrative Challenges
In real estate transactions involving non-residents, buyers may be individual purchasers without sophisticated tax knowledge. Expecting them to navigate these complex requirements, liaise with non-resident sellers, and secure certified documents places a disproportionate compliance burden on ordinary taxpayers.
Policy Concerns and the Need for Reform
Misalignment with Intent
The purpose of the proviso was to ease the payer’s burden when the payee has already discharged tax obligations. However, the drafting flaws and practical difficulties have undermined this purpose. Instead of providing relief, the proviso has added a layer of complexity that may not be feasible to comply with in many cross-border cases.
Overlapping Information
Whether or not the payee has filed a return is already within the knowledge of the tax department. Requiring the payer to obtain this information independently is redundant and administratively inefficient. It imposes costs and burdens without advancing the objective of tax compliance.
Risk of Litigation
The ambiguities in clause (iii) and the mismatch with Form 26A are fertile grounds for disputes. Payers may face prolonged litigation to establish that they should not be treated as assessees-in-default, even where no revenue loss has occurred.
Comparative Perspectives
Other Jurisdictions
In several jurisdictions, withholding obligations are balanced by mechanisms where the revenue department itself verifies the tax compliance of payees. Payers are not burdened with collecting evidence of the payee’s filings. Instead, the department cross-checks the payee’s return with the information reported by the payer.
Lessons for India
Adopting a similar model in India would reduce unnecessary compliance burdens on payers. By leveraging information already available in its systems, the department could automatically relieve payers from liability once it is confirmed that the payee has discharged tax obligations.
Suggested Interpretative Approach
Liberal Reading of Clause (iii)
A purposive interpretation of clause (iii) would focus on whether the receipt has been included in the return of income, rather than on whether tax was ultimately payable. This reading aligns with the legislative intent of avoiding double recovery and would prevent undue hardship in cases of nil tax liability.
Reliance on Accountant’s Certificate
If the accountant certifies in Form 26A that the income has been included under the appropriate head, that should be sufficient to absolve the payer. The requirement of positive tax payment should not be strictly enforced where the inclusion condition is satisfied.
Administrative Clarification
The tax department could issue a clarificatory circular confirming that relief under the proviso is available even in cases where no tax was payable due to losses or exemptions. Such a clarification would harmonize the legislative intent with administrative practice.
Implications for Future Transactions
Need for Due Diligence
Payers in property transactions with non-residents must exercise heightened diligence. They should ensure at the outset that withholding obligations are complied with, or that Form 26A is obtained in due course. Legal and tax advice should be sought in such transactions to avoid exposure to liability.
Market Impact
The compliance burden and risks associated with transactions involving non-residents could deter domestic buyers. The fear of being saddled with additional tax liabilities may influence property markets and discourage legitimate cross-border investments.
Scope for Litigation
Until legislative or administrative clarity is provided, disputes over the scope of the proviso and the adequacy of Form 26A will continue to arise. Tribunals and courts will be called upon to interpret these provisions, potentially leading to inconsistent outcomes.
Conclusion
The legislative framework around section 195, section 201(1), and Form 26A was conceived to strike a balance between protecting the revenue interests of the state and ensuring that payers are not subjected to double or unnecessary liability. The obligation to deduct tax at source on payments to non-residents is rooted in the principle of preventing revenue from slipping beyond the jurisdiction of Indian tax authorities. The ruling in Nitesh Estates Ltd. reaffirmed that this obligation is absolute at the time of payment, irrespective of the payee’s final tax liability.
However, the relaxation introduced through the proviso to section 201(1) has not fully achieved its intended purpose. While it aims to provide relief to payers where the payee has already filed a return and discharged taxes, its wording, especially in clause (iii), creates ambiguity. The requirement that tax should be paid on the income declared in the return has been interpreted narrowly, leaving unresolved situations where the payee discloses the income but does not ultimately have taxable income due to losses or exemptions. Form 26A, which was meant to be the operational tool for this relief, does not perfectly align with the statutory language, further complicating compliance.
The practical challenges faced by payers, especially in cross-border real estate transactions, underscore the gap between legislative intent and administrative feasibility. Expecting individual buyers to obtain certified returns or accountant certificates from non-residents is often unrealistic. The burden imposed is disproportionate to the role of the payer in such transactions and increases the risk of litigation. Moreover, the tax department already possesses the information required to verify compliance, making the insistence on third-party certificates redundant.
Judicial pronouncements so far have emphasized strict compliance with withholding provisions, but they have also exposed the need for clarity. Without harmonization between the wording of the proviso, the requirements of Form 26A, and the underlying policy, both payers and payees are left in a state of uncertainty. This undermines the ease of doing business and creates barriers in legitimate cross-border transactions.
A more balanced approach would involve purposive interpretation of the proviso, administrative guidance to clarify that relief applies even in cases of nil tax liability, and reliance on information already available with the department. Drawing from international practices, the responsibility of verifying payee compliance could shift from the payer to the tax authorities. Such reforms would protect the revenue without imposing impractical burdens on payers.
In the current state, the law provides both a shield and a trap. It offers relief through Form 26A but makes it conditional on requirements that are often beyond the payer’s control. Unless clarified through legislative amendment or administrative circular, this slip-up will continue to generate litigation, uncertainty, and hardship. Aligning the proviso with its true intent is therefore essential for ensuring fairness, reducing disputes, and fostering compliance in both domestic and cross-border transactions.