Section 195 of the Income-tax Act, 1961 plays a crucial role in the taxation framework involving non-residents. It mandates the deduction of tax at source (TDS) on payments made to non-residents, provided the payments are chargeable to tax in India. The provision is designed to ensure that tax liability on income earned by non-residents from sources in India is collected at the earliest point in time, which is typically when the payment is made or credited.
Scope and Applicability of Section 195
Section 195 applies to any person responsible for paying to a non-resident (including a foreign company) any sum that is chargeable under the provisions of the Income-tax Act, excluding salaries. The section is not limited to residents; even a non-resident who makes a payment to another non-resident, where such income is taxable in India, may come under its purview.
The wide ambit of Section 195 covers various types of payments such as interest, royalty, fees for technical services, dividends, and other income streams that are taxable under Indian law. The obligation to deduct tax arises regardless of whether the payment is made in India or abroad, as long as the income is chargeable to tax in India.
Importance of Chargeability
A fundamental prerequisite for applying TDS under Section 195 is that the sum payable to the non-resident must be chargeable to tax under the provisions of the Act. This concept was emphasized by the Supreme Court in the landmark GE India Technology Centre Pvt. Ltd. case, where it was held that the obligation to deduct tax arises only when the remittance contains an element of income that is chargeable to tax in India.
Therefore, it becomes essential for the payer to determine whether the payment being made constitutes income that is taxable in India. If the entire sum is not income, or only a portion of it is income, the tax should be deducted only on the income component, not on the gross amount.
Types of Payments Covered
Section 195 is applicable to a wide array of payments made to non-residents, provided such payments are taxable in India. Some of the common payments include:
- Interest payable on loans taken from foreign entities
- Royalty for use of intellectual property or technical know-how
- Fees for technical or professional services rendered
- Commission or brokerage
- Payments to foreign contractors or consultants
- Payments for import of software or digital goods where they qualify as royalty or FTS
It is essential to analyze the nature of the payment and refer to relevant judicial precedents and Double Taxation Avoidance Agreements (DTAAs) to determine the taxability.
Payer’s Responsibility and Due Diligence
The payer, who may be an individual, company, firm, or any other entity, is required to determine whether the payment made to a non-resident is taxable in India. This places an additional burden of tax analysis on the payer, as incorrect determination may lead to non-compliance, interest, and penalties.
In many instances, the payer may not be equipped to ascertain the exact nature of taxability or the correct rate of tax deduction. In such cases, the law provides a mechanism under Section 195(2), where the payer can approach the Assessing Officer to determine the appropriate proportion of the payment that is chargeable to tax, and accordingly deduct tax on that portion only.
Obtaining a Certificate under Section 195(2)
To ensure that tax is not deducted on the entire amount when only part of it is taxable, Section 195(2) empowers the payer to make an application to the Assessing Officer. Upon evaluating the facts and nature of the transaction, the Assessing Officer may issue a certificate specifying the amount that is chargeable to tax.
This certificate acts as a protective mechanism for the payer, who otherwise would be required to deduct tax on the entire gross amount, which may include non-taxable components such as cost reimbursements, out-of-pocket expenses, or goods value.
Application by the Payee under Section 195(3)
Apart from the payer’s application under Section 195(2), the non-resident payee can also apply under Section 195(3) to obtain a certificate authorizing the receipt of certain sums without deduction of tax at source.
This certificate is issued if the Assessing Officer is satisfied that the recipient has been regularly assessed, has a satisfactory tax compliance record, and meets the prescribed conditions. Such a certificate offers relief to non-residents who have recurring income streams from India but are not liable to pay tax due to loss carryforwards, treaty benefits, or exemptions.
Role of the Assessing Officer under Section 195(2) and 195(3)
The Assessing Officer plays a crucial role in facilitating the TDS mechanism for payments to non-residents. Under Section 195(2), the officer determines the proportion of payment that is chargeable to tax. Under Section 195(3), the officer grants a certificate of non-deduction to the recipient if eligible.
While processing these applications, the officer assesses several factors including the nature of the transaction, applicable DTAA provisions, historical tax compliance of the parties, and whether the transaction involves capital or revenue receipts. The aim is to ensure the right amount of tax is deducted without creating undue hardship for the parties.
Withholding Tax Rates under Section 195
The rates at which tax is to be deducted under Section 195 depend on the nature of income, the provisions of the Income-tax Act, and the relevant Double Taxation Avoidance Agreement. Some examples of applicable rates under the Act are:
- Interest: 20%
- Royalty: 10%
- Fees for technical services: 10%
- Dividend (other than those exempted): 20%
If the recipient is eligible for a lower rate under the DTAA, such lower rate can be applied, provided the recipient furnishes a valid Tax Residency Certificate (TRC) and other prescribed documents under Section 90(4) and 90(5).
Importance of Double Taxation Avoidance Agreements (DTAAs)
DTAAs play a significant role in determining the rate and scope of taxability of payments to non-residents. India has signed DTAAs with more than 90 countries, which lay down the taxing rights of each country for various income streams.
Under Section 90(2), a non-resident can opt for the provisions of the Act or the DTAA, whichever is more beneficial. For example, while the Act may provide a 20% rate for interest, the relevant DTAA may prescribe a lower rate of 10% or 15%, which can be availed by the non-resident if proper documentation is submitted. DTAAs also provide definitions for terms like permanent establishment, royalty, and fees for technical services, which are critical in evaluating taxability.
TDS Payment and Compliance Requirements
Once TDS has been deducted under Section 195, the payer is required to deposit the same with the government within the prescribed time limits. The tax deducted must be deposited using Challan No. ITNS 281.
Additionally, the deductor must file a TDS return in Form 27Q on a quarterly basis, reporting all payments made to non-residents and the tax deducted. After filing the return, the deductor must issue a TDS certificate in Form 16A to the non-resident payee. This certificate is essential for the payee to claim credit of the tax deducted.
Penal Consequences for Non-Compliance
Failure to deduct tax under Section 195, or short deduction, can lead to serious consequences for the payer. As per Section 201, the deductor is deemed to be an assessee-in-default for the amount not deducted or not paid. Interest under Section 201(1A) is also applicable, calculated from the date on which tax was deductible to the date of actual payment.
Additionally, penalties under Section 271C and prosecution under Section 276B may be levied for willful default. These provisions make it essential for payers to strictly comply with the TDS requirements.
Reimbursement of Expenses and TDS Implications
Reimbursement of expenses to non-residents has been a subject of litigation. In many cases, the tax authorities have treated reimbursements as part of the total consideration and have insisted on TDS under Section 195.
However, if the reimbursements are on actual basis and not in the nature of income, courts have held that TDS is not required. To avoid disputes, proper documentation and third-party evidence should be maintained to substantiate the nature of reimbursement.
Taxability of Software Imports and TDS
One of the frequently litigated issues under Section 195 involves the import of software from foreign vendors. The central issue revolves around whether such payment constitutes royalty, and hence subject to TDS. Courts have taken differing views depending on the facts and the nature of software (customized vs. off-the-shelf).
In many rulings, payments for off-the-shelf software have been treated as royalty, especially when copyright is granted. Consequently, TDS has been held applicable. Payers should exercise caution and consider judicial precedents as well as DTAA provisions before deciding on TDS applicability.
Introduction to Procedural Framework under Section 195
Section 195 of the Income Tax Act, 1961 is a critical provision that governs tax deduction at source on payments made to non-residents. While the provision mandates withholding tax on payments to non-residents that are chargeable to tax in India, the procedural framework for ensuring compliance is detailed and requires meticulous attention to documentation, certifications, and reporting obligations.
Obligation to Deduct Tax under Section 195
Any person responsible for paying a non-resident any interest or other sum chargeable to tax under the Act must deduct tax at source. This obligation arises at the time of payment or credit, whichever is earlier. Notably, this responsibility extends beyond individuals to encompass companies, partnerships, trusts, and even non-resident payers if the payment relates to an Indian source.
Key Compliance Steps for Deductors
Determining Taxability of the Payment
The deductor’s first step is to assess whether the sum payable is chargeable to tax in India. This involves checking the nature of the payment under the Income Tax Act as well as the applicable Double Taxation Avoidance Agreement (DTAA). Common payments subject to deduction include:
- Royalty or fees for technical services
- Interest
- Capital gains
- Commission or brokerage
- Contractual payments
- Professional fees
If the sum is not chargeable to tax under domestic law or DTAA, no deduction is required under Section 195.
Determining Rate of TDS
The TDS rate must be determined based on the rates prescribed under the Act or the DTAA, whichever is more beneficial to the non-resident. Deductions can be subject to additional levies such as surcharge and health & education cess. For example, under Section 115A, interest and royalty payments may be taxed at 10%, but DTAA provisions could offer a lower rate.
Obtaining PAN of the Non-Resident Payee
It is mandatory for non-residents to furnish their Permanent Account Number (PAN) to the deductor. Failure to provide a PAN may result in deduction at a higher rate of 20% or the prescribed rate, whichever is higher, under Section 206AA.
Certificate for Nil or Lower Deduction (Section 197)
A non-resident payee can apply for a certificate under Section 197 from the Assessing Officer for nil or lower deduction of tax. The deductor, upon receipt of such a certificate, may deduct tax accordingly. This certificate must be valid and applicable to the nature and amount of the transaction.
Certificate of Non-Taxability (Section 195(2) and 195(3))
Section 195(2) allows a payer to make an application to the Assessing Officer for determining the appropriate proportion of the payment that is chargeable to tax. This is relevant when only a part of the gross payment is taxable in India.
Alternatively, under Section 195(3), certain categories of non-residents may apply for a certificate authorizing them to receive sums without TDS. This typically includes foreign banks or insurers with Indian branches or established business connections.
Payment and Deposit of TDS
Time Limit for TDS Payment
TDS must be deposited to the credit of the Central Government:
- Within seven days from the end of the month in which the deduction is made (for non-government deductors).
- For payments in March, by 30th April.
The tax must be deposited using Challan No. ITNS 281, selecting the correct section code (e.g., 195) and type of payment.
Online Filing of TDS Return (Form 27Q)
For all payments made to non-residents (excluding salaries), TDS deducted under Section 195 must be reported in Form 27Q. This return is filed quarterly and includes information such as:
- PAN of deductee
- Nature and amount of payment
- TDS amount
- Rate of deduction
- Challan identification number
Form 27Q must be filed within prescribed timelines:
- Quarter ending 30th June – 31st July
- Quarter ending 30th September – 31st October
- Quarter ending 31st December – 31st January
- Quarter ending 31st March – 31st May
Late filing attracts penalties and interest under Sections 234E and 271H.
Issuance of TDS Certificate (Form 16A)
Deductors must issue Form 16A to non-resident payees within 15 days from the due date of filing Form 27Q. This certificate serves as documentary proof of tax deducted and includes:
- TAN and PAN of deductor and deductee
- Amount paid
- TDS rate and amount
- Challan details
- Date of deposit
The certificate is generated through the TRACES portal and is digitally signed or manually signed by the authorized person.
Withholding Tax on Specific Transactions
Remittance for Import of Goods
Payments for import of goods are generally not taxable in India, as the income does not accrue or arise in India. Thus, no TDS is required. However, due to varying practices and departmental scrutiny, many banks insist on a Chartered Accountant certificate in Form 15CB and a declaration in Form 15CA.
Remittance for Services (Technical, Managerial or Consultancy)
These payments often qualify as fees for technical services (FTS). Whether they are taxable in India depends on the make-available clause under DTAA. If the service does not result in a transfer of technical knowledge, it may not be taxable.
Royalty Payments
Royalties paid for use of intellectual property, software, or patents are usually taxable in India. DTAAs typically prescribe a concessional rate (10% or 15%) and payments must be accompanied by Form 15CA and Form 15CB.
Commission and Agency Fees
Payments of commission to foreign agents for services rendered outside India are typically not taxable under Indian law. However, conservative interpretations by some tax officers lead to insistence on withholding tax. Obtaining a certificate under Section 195(2) is advisable in such cases.
Filing of Form 15CA and Form 15CB
Applicability of Form 15CA
Form 15CA is a declaration to be furnished online before remittance to a non-resident. It contains details of the remittance, TDS applicability, and rate of deduction. It has four parts:
- Part A: If the remittance is below ₹5 lakh and chargeable to tax.
- Part B: If the remittance exceeds ₹5 lakh and is accompanied by a certificate under Section 195(2), 195(3), or 197.
- Part C: If the remittance exceeds ₹5 lakh and a certificate from a Chartered Accountant in Form 15CB is obtained.
- Part D: If the remittance is not chargeable to tax.
Applicability of Form 15CB
Form 15CB is a certificate from a Chartered Accountant certifying the nature of payment, taxability, TDS rate, and compliance with Section 195. It must be obtained before furnishing Form 15CA (Part C).
The submission of Form 15CA and Form 15CB is now integrated with the Income Tax e-filing portal, and copies must be furnished to the Authorized Dealer (Bank) at the time of remittance.
Practical and Operational Challenges
Difficulty in Determining Taxability
One of the major hurdles faced by deductors is in assessing the taxability of cross-border transactions. The provisions of the Act, DTAA interpretation, and evolving judicial precedents make this a highly technical area.
Accessing Section 195(2) or 195(3) Orders
While the law provides for applications for nil or lower deduction certificates, in practice the timeline for processing such applications may be prolonged, leading to business delays and cash flow challenges.
Banking Requirements and Compliance
Many banks demand Form 15CA and Form 15CB even when the payment is clearly not taxable. This conservative approach leads to unnecessary compliance, increasing time and cost burden for businesses.
Non-availability of PAN
Many non-resident payees do not have a PAN in India, especially in one-time or low-value transactions. Deductors then face the risk of higher TDS under Section 206AA, even when the DTAA prescribes a lower rate.
Consequences of Default
Failure to deduct or deposit TDS under Section 195 leads to serious consequences:
- Disallowance of expenditure under Section 40(a)(i)
- Levy of interest under Section 201(1A)
- Penalties under Section 271C
- Prosecution in severe cases under Section 276B
CBDT Guidelines and Clarifications
The Central Board of Direct Taxes (CBDT) has issued several circulars to clarify the application of Section 195. Circular No. 3/2015 explains the distinction between payments chargeable and not chargeable to tax. Circular No. 728 clarifies that TDS is applicable only when the sum is chargeable to tax.
Further, instructions have been issued to reduce unnecessary filings of Form 15CA/15CB for certain categories of payments such as:
- Imports
- Travel expenses
- Credit card payments
- Indian embassy expenses abroad
Role of DTAA and TRC (Tax Residency Certificate)
To claim the benefit of a DTAA rate, the non-resident must furnish a Tax Residency Certificate (TRC) from their country of residence. In addition to TRC, a self-declaration or Form 10F is generally required to satisfy the conditions of the treaty.
Failure to furnish a valid TRC could result in the denial of treaty benefits, leading to deduction at domestic rates.
Judicial Insight and Its Importance
Section 195 of the Income-tax Act, 1961, has been the subject of extensive judicial scrutiny over the years. As this provision deals with the complex issue of withholding tax on payments made to non-residents, its interpretation by the courts has significantly shaped the obligations of payers in India. This part of the article explores the major judicial pronouncements, key principles laid down by courts, and practical implications arising from them.
Landmark Judgments Impacting Section 195
Transmission Corporation of A.P. Ltd. vs. CIT (1999)
One of the earliest and most referenced cases concerning Section 195 is the decision of the Supreme Court in the Transmission Corporation case. The Court held that the obligation to deduct tax arises not only when the entire payment is income chargeable to tax, but also when a portion of the payment may be chargeable.
In such a case, the payer is required to deduct tax at source on the income component, and if unsure, must make an application under Section 195(2). This judgment significantly widened the scope of Section 195 and emphasized the importance of obtaining a certificate for lower or nil deduction in doubtful situations.
GE India Technology Centre (P) Ltd. vs. CIT (2010)
This Supreme Court decision brought some relief to payers. It was held that the obligation to deduct TDS under Section 195 arises only when the sum being paid is chargeable to tax under the Act. This clarified that there is no need to deduct tax on the entire payment unless the income component is clearly chargeable.
The GE India judgment reiterated the principle that TDS provisions under Section 195 must be interpreted in harmony with charging provisions of the Income-tax Act. It also reinforced that the obligation arises only if the payment is taxable in India.
Vodafone International Holdings B.V. vs. Union of India (2012)
Though not a Section 195-specific case, the Vodafone ruling by the Supreme Court impacted cross-border transactions and withholding tax obligations. The Court held that capital gains arising from the sale of shares of a foreign company (that indirectly held shares in an Indian company) between two foreign entities were not taxable in India.
This case highlighted the limitations of the tax department’s reach and emphasized the principle of substance over form in cross-border transactions. It eventually led to retrospective amendments in tax laws, clarifying the taxability of indirect transfers, and had a downstream effect on Section 195 applicability.
Engineering Analysis Centre of Excellence Pvt. Ltd. vs. CIT (2021)
This recent Supreme Court ruling was crucial for the software industry. The issue was whether payments made by Indian companies to foreign software suppliers (like Oracle, Microsoft) amounted to royalty and whether TDS was applicable under Section 195.
The Court ruled in favor of the taxpayers, stating that payments made for shrink-wrapped software or off-the-shelf software were not royalty and, hence, not taxable in India. Accordingly, no TDS under Section 195 was required. This decision resolved long-standing disputes in the software sector and set a precedent for similar cases.
Implications of Judicial Rulings on Payers
Burden of Determining Taxability
The courts have consistently held that the payer must assess whether a particular payment is taxable in India before applying Section 195. If it is not, there is no obligation to deduct tax. However, this determination must be based on careful evaluation of the facts, the nature of the payment, and the applicable tax treaties.
Failing to deduct tax when required can result in the payer being treated as an assessee-in-default. Therefore, judicial rulings place a significant onus on the payer to assess taxability accurately.
Role of Tax Residency Certificates (TRC)
TRCs have gained importance in the context of interpreting judicial decisions. If a payee furnishes a valid TRC, the payer may consider applicable tax treaty benefits while determining whether TDS is required. Judicial rulings have recognized the importance of TRCs in determining the applicability of tax provisions under the Act versus the treaty.
Use of Advance Rulings
The Authority for Advance Rulings (AAR) plays an essential role in resolving issues under Section 195. In case of ambiguity regarding taxability, the payer or the payee can seek a ruling from AAR. Judicial guidance has emphasized that such rulings, though not binding universally, help mitigate risks and provide clarity in complex international transactions.
Practical Challenges in Implementing Section 195
Identifying Chargeable Income
Determining the taxability of a cross-border payment is not always straightforward. Payments may relate to business profits, royalties, fees for technical services, or capital gains, each of which has different tax implications under both domestic law and tax treaties.
Misclassification may result in incorrect TDS deduction or non-compliance. To mitigate this, payers often rely on opinions from tax consultants or seek lower deduction certificates from the tax department.
Issues in Withholding on Gross vs. Net Amount
Section 195 requires deduction on the gross amount unless a certificate under Section 195(2) or Section 197 is obtained. This creates a cash flow issue for non-residents, especially where the income component is small or uncertain. Indian payers are often left balancing between the compliance burden and maintaining commercial terms with non-residents.
Determining the Place of Accrual of Income
The payer must also determine whether the income accrues or arises in India, or is deemed to do so under Section 9 of the Income-tax Act. For example, payments for services rendered entirely outside India may not be considered as income accruing in India, but facts such as business connection, source of income, or place of utilization of service may tilt the scale.
Judicial decisions such as the Ishikawajima-Harima case and the Engineering Analysis case provide interpretative aid in such matters.
Confusion Between Section 195 and Section 194J/194C
In some cases, there is overlap or confusion between Section 195 (for non-residents) and other sections like 194J or 194C (for residents). Payments for consultancy services, royalty, or technical services may be mistakenly categorized, leading to compliance errors. Courts have clarified that Section 195 applies exclusively to non-resident payees, and the residential status of the payee must be ascertained before applying the TDS section.
Practical Recommendations for Payers
Perform a Taxability Assessment for Each Payment
Before remitting payments to non-residents, it is crucial to evaluate whether such payment is income chargeable to tax in India. This assessment should consider:
- Nature of the transaction
- Place where the service is rendered
- Permanent Establishment (PE) of the recipient in India
- Double Taxation Avoidance Agreement (DTAA) applicability
This analysis should be documented and retained for audit or scrutiny purposes.
Obtain TRC and Other Relevant Documents
Always insist on obtaining a Tax Residency Certificate (TRC) from the payee. Additionally, secure a Form 10F, self-declaration, and beneficial ownership statement wherever applicable. These documents help establish treaty eligibility and support the decision not to deduct tax, if claimed.
Seek Lower or Nil Deduction Certificate Where Appropriate
If there is doubt regarding the chargeability or the quantum of taxable income, approach the Assessing Officer under Section 195(2) for a certificate authorizing deduction on the income component only.
This protects the payer from future disallowance or penalty. Alternatively, the payee can apply under Section 197 for a certificate for nil or reduced TDS rate.
Consider Advance Rulings for High-Value Transactions
In high-stake or ambiguous cases, applying for an Advance Ruling provides legal certainty. The rulings may not have universal applicability, but they are binding on the parties involved and offer useful judicial interpretation in unclear areas.
Maintain Strong Documentation and Audit Trail
Maintain an audit trail of all transactions involving non-resident payments. The documentation should include:
- Invoices
- Agreements or contracts
- Tax analysis memo
- Copies of TRC and Form 10F
- Remittance certificate
- Bank advice and TDS challans (if deducted)
This aids in defending the position during tax assessments or litigation.
Penalty Provisions and Risk Management
Consequences of Non-Compliance
Non-deduction or short deduction of TDS under Section 195 may lead to:
- Being treated as an assessee-in-default under Section 201
- Interest under Section 201(1A) at 1% per month from the date of deductible tax to the actual date of deduction
- Penalty under Section 271C up to the amount of tax not deducted
- Prosecution under Section 276B for willful failure to deduct tax
In addition, expenses for which TDS is not deducted may be disallowed under Section 40(a)(i) while computing taxable income.
Legal Remedies and Defenses
If the payer can demonstrate that the payee has paid tax on the income received, relief under the second provision to Section 201(1) may be available. This requires submission of Form 26A, certified by a Chartered Accountant.
This provision was introduced to avoid double taxation and hardship where the tax department already collected tax from the recipient.
Conclusion
Section 195 of the Income-tax Act, 1961 plays a critical role in ensuring tax compliance when payments are made to non-residents. Its objective is to facilitate tax collection at the source, preventing revenue leakage in cross-border transactions. Over the course of this series, we examined the key legal provisions, obligations of the payer, scope of income chargeability, TDS rates, certificate for nil or lower deduction, and the procedural aspects involved. The law requires the deductor to assess whether the payment made to a non-resident is chargeable to tax in India and deduct tax accordingly.
We also explored the practical compliance framework, including obtaining a TAN, filing Form 15CA/15CB, deposit of TDS within stipulated timeframes, issuing TDS certificates, and filing quarterly returns in Form 27Q. In addition, the consequences of non-compliance were discussed in detail, highlighting penalties, interest liability, disallowance of expenditure, and prosecution risks.
With increasing global integration and stricter regulatory oversight, it has become imperative for Indian businesses, professionals, and individuals to adhere to the procedural rigour under Section 195. Seeking professional guidance, maintaining proper documentation, and aligning with transfer pricing and DTAA provisions can help mitigate risks and ensure smooth compliance. This provision is not only about tax deduction; it reflects India’s broader approach towards effective taxation of cross-border transactions while honouring treaty obligations and international taxation standards.