Direct Tax Alert - Beneficial tax treaty rate to prevail over section 206AA of the Income-tax Act, 1961

Background

Section 206AA of the Income-tax Act, 1961 (IT Act) provides that where the recipient does not provide Permanent Account Number (PAN) to the payer, then the payer is mandatorily required to withhold tax at the minimum rate of 20%. India has entered into Double Tax Avoidance Agreement (‘DTAA’ or ‘tax treaty’) with various countries to provide for concession tax rates. With the introduction of section 206AA in the IT Act, a question arises as to whether this provision will get attracted when the payment is made to an entity located in a jurisdiction which has a DTAA with India. In other words, whether minimum withholding tax rate of 20% under section 206AA would get attracted when the recipient is tax resident of a country (say Singapore) having a DTAA with India and the rate prescribed under such DTAA is say 10%.

Recently, the Ahmedabad Tax Tribunal¹ had an occasion to analyse whether section 206AA of the IT Act would prevail over the beneficial provisions of DTAA. We, at BDO in India, have summarised the ruling of the Ahmedabad Tax Tribunal and provided our comments on the impact of this decision hereunder:

Facts of the case

The taxpayer, a public limited listed company, is engaged in the business of manufacture and sale of pumps, rotating electric machines and other such electrical and engineering items. For the fiscal year 2013-14, the taxpayer had withheld tax (TDS) at 10% from the remittance made to a Czech Republic company. The said company had not provided its PAN to the taxpayer. During tax audit, the Tax Officer enquired as to why section 206AA of the IT Act was not attracted. The taxpayer contended that section 206AA of the IT Act is not applicable as the transaction is governed by Article 12 of the India and Czech Republic DTAA. As per Article 12, the applicable TDS rate is 10% and accordingly, it had withheld the tax. However, the Tax Officer did not accept the taxpayer’s plea thereby made addition of INR 12.96mn making the taxpayer liable to pay TDS at the rate of 20%. The First Appellate Authority upheld the order of Tax Officer. Aggrieved, the taxpayer filed an appeal before the Ahmedabad Tax Tribunal.

Tribunal ruling

The Ahmedabad Tax Tribunal held that the provision of section 206AA of the IT Act does not override the provision of Section 92 of the Act and hence the tax rate prescribed under the DTAA is rightly applied. While holding that DTAA will prevail over section 206AA of the IT Act, the Ahmedabad Tax Tribunal made the following observations:

• Though the IT Act specifies TDS at the rate of 20% under section 206AA of the IT Act, DTAA provisions would override the provisions of the IT Act since the provisions of DTAA are more beneficial.
• The circular² issued by the Central Board of Direct Taxes (CBDT) speaks that “specific provisions made in DTAA would prevail over general provisions contained in the IT Act”. This is a cardinal principle of law that when there is an agreement entered between two sovereign states than the provision which are more beneficial to taxpayer as per the sovereign agreements become applicable and the provisions of IT Act to the extent to be given a go by.
• Reference can be made to the specific recommendation made by the Justice Easwar’s Committee:

“Under the current provisions of section 206AA, tax is required to be deducted by the deductor at a higher rate as prescribed under the said section, where the deductee does not furnish his Permanent Account Number (PAN). This section was introduced with the objective that the furnishing of PAN was important with a view to trail the taxability of the payments in the hands of a non-resident. As regards non-residents, the Committee noted that in view of the specific provisions of section 115A and the provisions under the respective Double Taxation Avoidance Agreements (DTAAs) prescribing specific rates for tax deduction at source under section 195, there was no justification for providing deduction of tax at a higher rate than as prescribed under section 115A or under the respective DTAA. In fact, this provision has proved to be an impediment in terms of ease of business, as many non-residents prefer not to do business with Indian residents, if obtaining of PAN is insisted from them. The Committee was of the view that it should suffice if the concerned non-resident furnished to the deductor, in lieu of such Permanent Account Number, his tax identification number in the country or the specified territory of residence and in case there is no such number, then, a unique number on the basis of which the person is identified by the Government of the country or the specified territory of which such person claims to be a resident.”

• Section 90(2) of the IT Act provides that the provisions of DTAA would override the provisions of the IT Act in case where the provisions of DTAA are more beneficial to the taxpayer.
• The Supreme Court (SC) in the case of Azadi Bachao Andolan³ has upheld the proposition that the provisions of the DTAA would prevail over the general provisions of IT Act to the extent they are more beneficial to the taxpayer. Even the charging section 4 and section 5 of the IT Act which deals with the principle of ascertainment of total income under the IT Act are also subordinate to the principle enshrined in section 90(2) of the IT Act.

BDO comments

This is a welcoming decision and it further supports the decisions⁴ wherein it has been held DTAA will prevail over section 206AA of the IT Act. It is pertinent to note that section 90 of the IT Act has been amended to provide that the DTAA benefit will not be available if the Tax Residency Certificate and / or Form 10F is not obtained. Hence, the taxpayer at the time of granting the DTAA benefit, should ensure that these documents are available with it. In the absence of TRC / Form 10F, the taxpayer should apply section 206AA if PAN is not shared and thereby withhold tax at 20%. Furthermore, where the tax is withheld applying the provision of section 206AA of the IT Act and the recipient subsequently applies for PAN, the taxpayer (i.e. recipient) can claim refund of excess taxes withheld. For this support, can be found from the Pune Tax Tribunal’s decision in case of Calderys France⁵.

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