Withholding tax (TDS) on payment of commission to a foreign agent for providing services outside India

Background:

Due to rapid expansion of business outside India, various entities in India may require the services of the non-resident agents to perform various activities outside India for the purpose of establishing business outside India. Such activities may involve identification of the customers, suppliers etc. To perform such activities, Indian entities generally engage the local agents who are well aware of the market at such place. Generally, these local agents do not have any connection in India. It may be noted that this post deals with a situation where no part of the activities of the non-resident is carried out in India. Therefore, an attempt is made in this post to analyse the taxability of commission income in the hands of such non-resident agent and withholding tax requirement in the hands of the resident payer.

Understanding the provisions of the Indian Income tax law:

Section 4 of the Indian Income tax law is the charging section which empowers the Income Tax Authorities to levy tax on the total Income of all persons at the rate applicable for such year under the Finance Act. Relevant extract of section 4 is produced here below for better understanding:

“4. (1) Where any Central Act enacts that income-tax shall be charged for any assessment year at any rate or rates, income-tax at that rate or those rates shall be charged for that year in accordance with, and 1[subject to the provisions (including provisions for the levy of additional income-tax) of, this Act] in respect of the total income of the previous year 2[* * *] of every person

:Provided that where by virtue of any provision of this Act income-tax is to be charged in respect of the income of a period other than the previous year, income-tax shall be charged accordingly.

(2) In respect of income chargeable under sub-section (1), income-tax shall be deducted at the source or paid in advance, where it is so deductible or payable under any provision of this Act”

Sub section (2) above casts responsibility on the payer to deduct tax on payment of any amount which constitutes income chargeable to tax in India in the hands of recipient under sub-section (1) above. Therefore, the payer would be required to withhold tax only if the commission income is chargeable to tax in the hands of the non-resident agent. Accordingly, it is important to understand the sources of income which can be brought to tax in the hands of non-resident. For this purpose, it is pertinent here to analyse the words/phrase “Total Income” as stated in sub section (1) above.

 “Total income” is defined in section 2(45) of the Indian Income tax law which states that total income means income as per the scope defined under section 5 of the Indian Income tax law which is computed according to the provisions of the Indian Income tax law.

Section 5 of the Indian Income tax law defines the scope of total Income. As the agent is a non-resident, section 5(2) of the Indian Income tax law would be relevant to analyse. Section 5(2) states the following incomes shall be taxable in India for non-residents:

• Income received in India or deemed to be received in India

• Income accrue or arise in India or deemed to accrue or arise in India.

Point (a) above would not be relevant in case the non-resident agent has received the income outside India. Further, in case all the activities in connection with provision of services are performed outside India, the income generated out of such activities could not be construed to accrue or arise in India. However, it is recommended to analyse the terms of contract to arrive to the conclusion that income does not accrue or arise in India. As a next step, one has to analyse whether the commission income fall under the scope of “Income deemed to accrue or arise in India” which has been defined in section 9 of the Indian Income tax law. Section 9 broadly includes following incomes:

• All income accruing or arising, whether directly or indirectly, through or from any business connection in India or

• Through or from any property in India or

• Through or from any asset or source of income in India or

• Through the transfer of a capital asset situate in India

• Income from salary if it is earned in India.

• Income chargeable under the head “Salaries” payable by the govt. To a citizen of India for services outside India.

• A dividend paid by Indian company outside India.

• Income by way of Interest

• Income by way of royalty

• Income by way of fees for technical services.

Commission income in the hands of the non-resident agent would fall under the character of business income. Therefore, nature of Income listed above from point (b) to (j) would not be applicable. Consequently, business income could be taxable in India only if the non-resident has business connection in India. Generally, a non-resident could be said to have a business connection in India if the following facts emerge from its operations:

• There exists a relation between the profit generating activities of the non-resident and the activities carried out in India which assists in earning profit to such non-resident.
• Such relation must be real and intimate.

It may be noted that the relation mentioned above may come into existence in many ways. Some of the those are listed below:

• Through physical presence in India (like branch office, project office etc.)
• Through dependent agent in India.
• Through employees of the non-resident providing services on behalf of the non-resident employer.
• Through activities in connection with construction projects in India.

The above list is not exhaustive. The definition of business connection is very broad and any activity in India may trigger a business connection if it is closely related to or inextricably linked to the business of the non-resident. In the “Introduction” part of this post, it is mentioned that no activity whatsoever is carried in India in relation to the business of the non-resident. Accordingly, as no activity is carried in India, the question of existence of business connection would not arise.

Mere entering into a contract with the Indian entity to provide services to such entity outside India, could not be construed to create a business connection in the hands of the non-resident agent.Therefore, the commission income in the hands of agent is also not coming under the scope of “Income deemed to accrue or arise in India”. Accordingly, section 5 is failed to include any income in the hands of non-resident agent and resultantly, charging section is also failed to operate.

On the basis of above it can be concluded that this commission Income is not chargeable to tax in India in the hands of non-resident agent and therefore there is no liability in the hands of the payer to deduct tax on payment of such commission.

It may not be out of place to note that section 195 of the Indian Income tax law also points out that TDS on payment of any sum to a non-resident is required to be deducted if the amount paid is chargeable to Tax in India in the hands of recipient of such sum. Therefore, question of deducting tax comes into picture only when the amount paid is taxable in India in the hands of recipient. For the sake of proper understanding, relevant extract of section 195 has been produces here below:

“195. 1[(1) Any person responsible for paying to a non-resident, not being a company, or to a foreign company, 17[any interest (not being interest referred to in section 194LB or section 194LC)] 20[or section 194LD] 2[***] or any other sum chargeable under the provisions of this Act (not being income chargeable under the head “Salaries” 3[***]) shall, at the time of credit of such income to the account of the payee or at the time of payment thereof in cash or by the issue of a cheque or draft or by any other mode, whichever is earlier, deduct income-tax thereon at the rates in force”                    

As the commission Income is not chargeable to tax in the hands of non-resident agent as discussed earlier in this post, liability under section 195 of the Indian Income tax law does not arise.

Brief reference of judicial pronouncements under Income Tax Law

Please note that in various cases, it has been held that income from any services provided by the non-resident outside India which does not have any business connection in India, would not be taxable in India. In the case of  Commissioner of Income Tax v. Toshoku Limited (1980) 125 ITR 525, supreme court has held as under:

“While dealing with Section 9(1) of the Act, the Supreme Court in Commissioner of Income Tax v. Toshoku Limited, (1980) 125 ITR 525, on considering a transaction where tobacco was exported to Japan and France and sold through non-resident assessees who were paid commission, held as under: ‘8. The second aspect of the same question is whether the commission amounts credited in the books of the statutory agent can be treated as incomes accrued, arisen, or deemed to have accrued or arisen in India to the non-resident assessees during the relevant year. This takes us to s. 9 of the Act. It is urged that the commission amounts should be treated as incomes deemed to have accrued or arisen in India as they, according to the department, had either accrued or arisen through and from the business connection in India that existed between the non-resident assessees and the statutory agent. This contention overlooks the effect of cl. (a) of the Explanation to cl. (i) of sub-s. (1) of s. 9 of the Act which provides that in the case of a business of which all the operations are not carried out in India, the income of the business deemed under that clause to accrue or arise in India shall be only such part of the income as is reasonably attributable to the operations carried out in India. If all such operations are carried out in India, the entire income accruing therefrom shall be deemed to have accrued in India. If however, all the operations are not carried out in the taxable territories, the profits and gains of business deemed to accrue in India through and from business connection in India shall be only such profits and gains as are reasonably attributable to that part of the operations carried out in the taxable territories. If no operations of business are carried out in the taxable territories, it follows that the income accruing or arising abroad through or from any business connection in India cannot be deemed to accrue or arise in India (See CIT v. R. D. Aggarwal and Co. [1965] 56 ITR 20 (SC) and Carborandum Co. v. CIT [1977] 108 ITR 335 (SC) which are decided on the basis of s. 42 of the Indian I.T. Act, 1922, which corresponds to s. 9(1)(i) of the Act). 9. In the instant case, the non-resident assessees did not carry on any business operations in the taxable territories. They acted as selling agents outside India. The receipt in India of the sale proceeds of tobacco remitted or caused to be remitted by the purchasers from abroad does not amount to an operation carried out by the assessees in India as contemplated by cl. (a) of the Explanation to s. 9(1)(i) of the Act. The commission amounts which were earned by the non-resident assessees for services rendered outside India cannot, therefore, be deemed to be incomes which have either accrued or arisen in India. The High Court was, therefore, right in answering the question against the department”.

Further in the Landmark case of GE India Technology Centre Pvt Ltd Vs CIT 327 ITR 456, has held that it is not required to deduct TDS on payment to non-resident if the same is not chargeable to tax in India in the hands of non-resident.

In the case of The Commissioner of Income Tax Versus Kikani Exports Pvt. Ltd 369 ITR 96, Madras High Court has held that the assessee is not liable to deduct tax at source when the non-resident agent provides services outside India on payment of commission. Here in this case assessee has engaged a selling agent outside India for sale of exported goods. It has also been held that the same income cannot be treated as fees for technical services and can at best be called as a service for completion of the export commitment.

Conclusion

In light of the above discussion, it is probable that tax withholding is not required under the provisions of the Indian Income tax law for payments of commission to non-resident agent for the services provided by him outside India.