The government has done away of the requirement of PAN in case of foreign payments, thus, now no TDS @ 20 % even without PAN in case of foreign payments. This can be seen as one more welcome step towards ease of doing business and rationalization of the tax deduction on payments made to foreign persons.
Clause 85 of the Bill seeks to amend section 206AA of the Income-tax Act relating to the requirement to furnish Permanent Account Number. The aforesaid section, inter alia, provides that any person who is entitled to receive any sum or income or amount on which tax is deductible at source under Chapter XVII shall furnish his Permanent Account Number to the deductor, failing which tax shall be deducted at the rate mentioned in the relevant provisions of the Act or at the rate in force or at the rate of twenty per cent., whichever is higher.
It is proposed to substitute sub-section (7) of the said section so as to provide that the provisions of the said section shall also not apply to a non-resident, not being a company, or to a foreign company. This amendment will take effect from 1st June, 2016.
There was a big anomaly over here, causing genuine hardships to all businesses and especially the technology-based startups in India.
Technology startups use expert services of freelancers and foreign corporations for many things on a day to day basis and are accordingly are required to make foreign payments on a regular basis. Services of domain experts are necessary and vital for these startups, both for developing innovative products and applications and also for providing world class services.
As per Income Tax Act, all foreign payments under head “Fees for Professional and Technical Services” are taxed at 10% if the recipient have Indian PAN, which is most unlikely for Individual and SME service providers of various countries, and at 20% rate in case Indian PAN is not available.
Further, the Government has entered into Double Taxation Avoidance Agreements (DTAA’s) with various Countries, which prescribes reduced rates of tax for residents of the other contracting state (10%-15% in most cases or even NIL in some cases, for fees for professional and technical services or Independent Personal Services or other payments also).
As per section 90 (2) of the Income Tax Act, 1961, to whomsoever DTAA is applicable, tax liability shall be the beneficial rate between the Income Tax Act and DTAA. Accordingly, in cases of payments to Non-Residents, to whom the DTAA is applicable, if the rate of tax as per DTAA is lower than the Income tax Act, the lower rate of taxes should naturally be applicable.
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However, the income tax department had construed that provisions of section 206AA (Prescribing 20% rate of TDS, in cases where PAN is not being furnished) to override section 90 (2) and all DTAA’s.
The Supreme Court of India in the revered case of Union of India vs. Azadi Bachao Andolan  263 ITR 706 (SC), had settled the long litigated matter in the year 2003, that, to whosoever section 90 (2) applies, the benefits of DTAA are to be provided, irrespective of what the other provisions of the Income Tax Act, 1961, says. It clearly said that the more beneficial provision between DTAA and domestic law shall be applicable to a person. DTAA is a bilateral agreement entered into between governments of two different countries for avoidance of double taxations and for sharing of information and other allied reasons. The agreement overrides the charging section itself and is powered by Article 73 of the Constitution of India. If DTAA says that a particular income cannot be taxed at a rate higher than 10%, it overrides all other provisions of the Income tax act, 1961.
This construction of the Income Tax Department and corresponding automation in TDS return filing system through the TRACES, has forced that any TDS deduction where PAN is not available should not be less than 20% (As prescribed in section 206AA of the Income Tax Act), thereby defeating all the DTAA’s. None of the DTAA’s mandates foreign nationals to have Indian PAN.
GENUINE HARDSHIP CAUSED TO MOST OF THE TECHNOLOGY STARTUPS AND OTHER COMPANIES
Most foreign nationals do not have Indian PAN nor do they intend to take the same. Further, they have a fixed service cost on which they do not allow any deduction. The Indian startup companies, who are in need of the expert services, were forced to do the followings:
- They pay the Non-Resident service provider their actual fee
- They are normally required to pay service tax @ 14.5% for import of services under Reverse Charge Mechanism
- They were required to Gross-up the fee and pay TDS @ 20% from their own pocket, thus straightaway further escalating the cost by 20%. The increased cost either squeezes the profit margin of the startup or throws them out of competition in global arena.
If they are allowed to take the benefit of DTAA’s even without PAN of the foreign recipient, they will end up paying taxes at a reduced rate or not paying taxes at all.
Now, the FM has done away with this anomaly and has proposed amendment in section 206AA itself, to exempt foreign persons from increased rate of 20% TDS in the absence of PAN. This exemption is subject to certain condition and possession of any other prescribed document, to be notified later. We will have to wait for further prescription by way of notification to get to know the exact requirements from foreign persons to claim this exemption.
Anyways, this is a very welcome move which will definitely benefit businesses in India and will keep the DTAA’s alive and valid.
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