Background – TDS on payment to Non Resident
This post will give you good understanding regarding TDS on payment to Non Resident – Section 195. Tax deducted at source (TDS) or internationally known as withholding tax on payment to non resident is a peculiar area as compared to domestic TDS . You may do lots of googling but it may be worthless as international taxation required extra skill and understanding of Indian tax law, Double Tax Avoidance Agreement between India and foreign countries.
Dear readers, we have tried our best to make this post as simple as simple possible though the fact is that understanding of law and the application is different ball game.
Section 195 of Income Tax Act, 1961
Section 195(1) starts as
” (1) Any person responsible for paying to a non-resident, not being a company, or to a foreign company, any interest (not being interest referred to in section 194LB or section 194LC) or section 194LD or any other sum chargeable under the provisions of this Act not being income chargeable under the head “Salaries”) 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 : “
Now we will try to decode this section . See highlighted areas in above definition along with below table.
Any person responsible
To a non-residen or
a foreign company
any interest or
any other sum chargeable
under the provisions of this Act
at the time of credit or
whichever is earlier
Deduct income-tax thereon at the rates in force
Any other sum chargeable under the provisions of this Act:
Specialty of Section 195 is that above mention third column on “any other sum chargeable under the provision of this act”. Alike other domestic TDS provision e.g. Section 194-H which specifically talks about TDS on commission and brokerage, scope of section 195 is very wide so payer has to analyse whether payment made by him/her to non resident is chargeable to tax or not . Further there is no threshold limit provided or rates are prescribed under this section.
Characterisation of Income
So any income which is chargeable to tax is liable for TDS u/s 195. To move further it is important to first characterise income , what is exact nature of income e.g. interest, royalty or fees for technical service etc. It is important to read contract with supplier , discuss with concern user e.g. operation, technical , HR or IT team who has raised request for particular transaction with non resident or foreign company .You can check Purchase order also in this regard.
Scope of total Income :
Below mention flow will give idea whether income is chargeble to tax or not. e.g. in your case , it is royalty . Resident is liable to pay tax on their universal income however in case of non-resident , it has to clear some test to be taxed in india .This is explained as under :
Section 2(45) of the Act, inter alia, defines total income to mean-total amount of income referred to in section 5 of the Act.
Section 5 of the Act, inter alia, specifies that the total income of a non-resident shall include the following:
- Income received or deemed to be received in India, by or on behalf of the non-resident.
- Income accruing or arising to the non-resident in India.
- Income deemed to be accruing or arising to the non-resident in India.
- In other words, a non-resident is not liable to pay tax in India on any such income which accrues or arises outside India or which is received or is deemed to be received outside India.
- The terms “accrue” or “arise” have not been defined under the Act
Section 6 Residence in India:
Section 6(1) : The Residential Status of an Individual is to be determined on the basis of period of stay of the taxpayer in India and is computed separately for each year
Test of Residence
For an INDIVIDUAL – there are 2 basic conditions .Under Section 6(1), an Individual is said to be resident when he satisfies any one of the basic 2 conditions.
- He must be in India for 182 days or more in that relevant previous year. Or
- a) He must be in India for 365 days or more during 4 previous years immediately preceding the relevant previous year. AND b) He must be in India during that relevant previous year for a period of 60 days or more
If an Individual satisfies the test of residence then further TWO tests are to be made i.e. If an Individual is a resident in India, he may be either resident and ordinarily resident [R-OR] or resident but not ordinarily resident [R-NOR].
An Individual may be resident and ordinarily resident [R-OR] if he satisfies following 2 conditions.
- He has been resident in India for at least 2 out of 10 years immediately preceding the previous year. AND
- He has been present in India for a period of 730 days or more during 7 years immediately preceding the previous year.
An Individual is resident and not ordinarily resident [R-NOR] if it satisfies 1 or none of the above conditions.
As per section 6(3) a company is said to be a resident in India in any previous year, if it is an Indian company; or its place of effective management (“POEM”), in that year, is in India.
Section 9 – Income deemed to accrue or arise in India :
Section – 9 Specified category of income are deemed to accrue or arise in India although they may seem to accrue or arise outside India. This principle applies to all assesses irrespective of their residential status/nationality etc.
Above flow is given to have understanding of tax residence purpose however while you are making payment to foreign company or non resident , you should collect below documents to substantiate above test
- Tax Residency Certificate issued by his country
- No Permanent Establishment in India Certificate
- Copy of Tax Identification number
- Form 10F as prescribed under Income Tax rules for DTAA purpose.
Above documents are not exhaustive list but it is indicative to check residential staus. In case of non resident or forein company, TDS is liabile if it is further defind in Section 9. Royalty is clearly defines as under:
Royalty income [ Section 9(1)(vi)]
Royalty income earned by a non-resident is deemed to accrue or arise in India if it is payable by
- The Government
- A person resident in India.
Exception : Royalty payable in respect of any right, property or information used or services utilized for the purpose of
- A business carried on by such person outside India or
- Earning any income from any source outside India.
So Royalty is taxable as per Income Tax Act. I assume , agreement is made after the 31st day of March, 1976 and payable by Indian concern then rates of TDS is 10% plus surcharge and Health and Education Cess as applicable .
Double Tax Avoidance Agreement (DTAA)
As per Section 90, TDS has to be deducted as per Income tax act or as per DTAA between India and Foreign county whichever is beneficial to payer. e.g. you are making payment to Foreign company in Austria so You have to refer DTAA between India and Austria. DTAA is available on Income Tax website on below link: Please select county to check respective DTAA
You have to check DTAA ,whether payee is covered in definition of persons as Article 1 of DTAA or also known as treaty .Now refer specific article 12 on royalty which gives right to source country i.e. to Indian government from residence country i.e. Austria to tax royalty up to 10 % as per clause two.
So assume payee is company and payment of royalty is less than INR 10 Million (Rs. 1 crore) so effective tax rate as per Income Tax is 10.40% (10% Income tax + 4% Health and Education Cess ) while as per DTAA , it is 10% so in current case treaty rate is beneficial as per provision of section 90 so 10% is applicable subject to submission on above mention documents and filing of Form 15CA and 15CB(from CA) with authorised dealer bank while making payment . As per Rule 21AB , if information required for the purpose of Form 10F is contained in Tax Residency Certificate (TRC), Form 10F is not required for taking DTAA benefit.
Grossing Up of TDS:
In normal case, if TDS is liable to deduct, payment has to be made after deduction of tax however kindly check agreement or purchase order , if vendor required company to make gross payment and withholding tax has to be borne by payer, they payment is required process with grossing up . Kindly note this point regarding TDS on payment to Non Resident .
Conclusion- TDS on payment to Non Resident:
It may look very long post however let me tell you this is simple example for academic understanding of international tax and to give basic foundation in subject . I hope your lots of doubts are cleared regarding TDS on payment to Non Resident . Kindly take professional advise while making payment to non resident to check liability of withholding tax . In case payment is made without tds, payment will be disallowed under section 40 and liable for interest any penalty as per income tax act.
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