Obligation (in the hands of telecom companies) to withhold taxes
under Section 194H of the Income-tax Act, 1961 (IT
Act) on discounts given to SIM card distributors has been
a matter of long drawn dispute. Conflicting rulings have been
pronounced by different High Courts and the issue has now attained
finality by the judgment of the Hon’ble Supreme Court
(Apex Court) in the landmark case of
Bharti Airtel vs Assistant Commissioner of Income
Tax
(TS-135-SC-2024).
We have discussed this ruling of the Apex Court in the ensuing
paragraphs:
Facts of the case
Taxpayers in the present facts are cellular telephone service
providers who had entered into franchisee agreements with
distributors for selling start-up kits, which included SIM cards
and coupons, to end-users/ customers. As per the agreement,
distributors received these kits at a discounted price and sold the
same to end-users/ customers at the Maximum Retail Price
(MRP) mentioned on the kits. Distributors earned
their profits on the margin between the discounted price and
MRP.
According to the tax authorities, profit (margin between the
discounted price and MRP) earned by distributors is
‘commission’ paid to agents (under the franchise/
distributorship agreement) and hence the cellular telephone service
providers are liable to deduct tax at source (TDS)
under Section 194H of the IT Act.
Ruling
TDS under Section 194H of the IT Act
Section 194H of the IT Act provides that any person responsible
for paying any commission or brokerage to a resident will be under
an obligation to deduct taxes at the rate of 5% at the time of
credit to the account of such payee or payment, whichever is
earlier. Explanation (i) to Section 194H of the IT Act defines the
term ‘commission’ or ‘brokerage,’, which includes
any payment received or receivable, directly or indirectly, by a
person acting on behalf of another person for services rendered,
excluding professional services.
While interpreting this provision, Apex Court clarified that the
term “another person” means the “person
responsible for payment” to the person acting on behalf
of such another person. Accordingly, to invoke this provision,
payment (to the distributors) should be made only by the person on
whose behalf the distributors are alleged to be acting.
Intersection of TDS and law of Agency
Apex Court held that liability under Section 194H of the IT Act
arises when the business model is based on a principal-agent
relationship as Explanation (i) uses the expression “acting on
behalf of another person”. Thus, obligation to deduct tax in
terms of Section 194H of the IT Act arises only when a legal
relationship of principal-agent is established. The law of agency
is technical in nature and thus, the existence of a principal agent
relationship should be answered by applying Section 182 of the
Indian Contract Act, 1872.
Basis the analysis of the Indian Contract Act, 1872, Apex Court
laid down the following essential characteristics of a
principal-agent relationship:
- Agent has the legal power to alter the principal’s legal
relations with third parties, and the principal’s co-relative
liability to have his relations altered. - The principal exercises a degree of control over the
agent’s activities, albeit less extensive than that exerted
over a servant in a master-servant relation and is different from
rights and obligations arising under a principal-independent
contractor relationship. - It is a fiduciary relationship in which the agent consents to
act on behalf of the principal, subject to the principal’s
control. - Agent is liable to account for the business conducted on
principal’s behalf and is entitled to remuneration for the
services rendered.
The Apex Court, after going through the entire franchise
agreement held that obligations outlined in contracts with the
distributors did not exhibit fiduciary characteristics nor indicate
that the business conducted by distributors was on behalf of the
principal. Though the discounted price is fixed or negotiated
between the taxpayers and franchisee/ distributor, the sale price
received by the franchisee/ distributor is at the sole discretion
of the franchisee/distributor. The taxpayers have no control on the
sale price that may be charged by the distributors.
Income of the franchisee/ distributor, being the difference
between sale price received by the franchisee/ distributor and the
discounted price, is paid or credited to the account of the
franchisee/ distributor when the prepaid product (kit/ SIM cards)
is sold to the retailer/ end-user/ customer. The sale price and
accordingly income of the franchisee/ distributor is accrued/
received only through an arrangement between the franchisee/
distributor and third parties (ultimate buyers).
Accordingly, the taxpayers are not involved in paying or
crediting the account of the franchisee/ distributor with the
income by way of commission or brokerage on which TDS under Section
194H of the IT Act is alleged to have been deducted.
The word “indirect” is not sufficient to bring
genuine business relations under Section 194H of the IT
Act
It was the contention of the Revenue that such discount given by
taxpayers was covered within the ambit of the phrase
“payment received or receivable directly or indirectly by
a person acting on behalf of the other person” provided
in Explanation (i) of Section 194H of the IT Act.
It was argued that even if the franchisee/ distributor receives
payment in the form of income from the retailer/ end-user/
customer, it would require deduction of tax as the payment is
received indirectly from the taxpayers. Rejecting this
contention, the Apex Court held that the expression
“direct or indirect” used in Explanation (i) to
Section 194H of the IT Act is only to ensure that the person
responsible for paying does not dodge the obligation to deduct tax
at source, even when the payment is indirectly made by the
principal-payer to the agent payee.
Apex Court cautioned that the scope of TDS under Section 194H of
the IT Act should not be expanded to encompass genuine business
transactions where the taxpayer is not the person responsible for
paying or crediting the income. In this case, the taxpayer neither
pays nor credits income to the contracted party. Therefore, the
term “indirectly” in Explanation (i) does not regulate or
curtail the manner in which the taxpayer can conduct business or
engage in commercial relationships.
Guidelines for CBDT
Considering the significance and wide impact of TDS mechanism
incorporated under the provisions of the IT Act, Apex Court also
issued certain guidelines for Central Board of Direct Taxes
(CBDT) by observing that “The deduction
of tax provisions should be programmatically and realistically
construed, and not as enmeshes or by adopting catch-as-catch-can
approach….. When there is apparent divergence of
opinion, to avoid litigation and pitfalls associated, it may be
advisable for the Central Board of Direct Taxes to clarify doubts
by issuing appropriate instruction/ circular after ascertaining
view of the assesses and stakeholders. In addition to enhancing
revenue and ensuring tax compliance, an equally important aim/
objective of the Revenue is to reduce litigation. The instructions/
circular, if and when issued, should be clear, and when justified
– require the obligation to be made
prospective“.
Practical difficulties in deducting tax
Apex Court further observed that it is not possible for the
assesses to withhold taxes in compliance with Section 194H of IT
Act on the difference between distributor’s receipts from end
customers and the amount paid by distributors to the taxpayers.
This is because the taxpayers are not privy to the transactions
between distributors and end customers and therefore will not have
required information about the profits earned by distributors.
The Revenue authorities’ suggestion that the taxpayers
should regularly request information on distributors’ income
from selling prepaid coupons and then deduct tax was deemed
impractical and burdensome by the Apex Court. The Apex Court
further noted that such a requirement would impose undue
obligations on the taxpayers which is beyond the statutory mandate.
Additionally, complying with this request would be practically
impossible within the timelines prescribed under the law.
Conclusion on applicability of Section 194H
Apex Court while concluding on the controversy of applicability
of Section 194H, also deep dived into the legal position of a
distributor, who is regarded different from an agent. The
distributor buys and sells goods on its own account and the profit
margin is the difference between the purchase price and the sale
price like an independent contractor.
An independent contractor is free from control on the part of
its employer and is only subject to the terms of the underlying
contract. As against this, an agent is not completely free from
control, and the relationship to the extent of tasks entrusted by
the principal to the agent are fiduciary. Apex Court agreed that
while there may be some control of the principal over an
independent contract (depending upon the terms of the contract)
which may resemble the characteristics of an agent, but on an
overview of the entire relationship, all the tests specified in (a)
to (d) above may not be satisfied. Independent contractors operate
autonomously, even when employed to establish contractual
relationships with third parties.
Thus, the term ‘agent’ denotes a relationship that is
very different from that existing between an employer and its
independent contractor. The term ‘agent’ should be
restricted to one who has the power of affecting the legal position
of its principal by the making of contracts, or the disposition of
the principal’s property. Thus, the Apex Court held that it is
in the restricted sense in which the term agent is used in
Explanation (i) to Section 194H of the IT Act and concluded that
the provisions of Section 194H is not applicable to the facts of
the present case.
AL Comments
The Apex Court has delivered a landmark ruling on an issue which
has impacted the telecom industry for more than a decade. The Apex
Court has not only deliberated on specific nuances on applicability
of Section 194H but has also deep dived into the principal agent
relationship envisaged under the Indian Contracts Act, 1872,
characteristics of an independent contractor and what distinguishes
an agent from an independent contractor.
Guidelines by the Apex Court to CBDT to adopt measures to reduce
disputes in addition to enhancing revenue and ensuring compliance
will go a long way in avoiding protracted litigation. An
unambiguous law will not only lead to reduction in litigation but
will also enhance revenue and ease for taxpayers.
The content of this article is intended to provide a general
guide to the subject matter. Specialist advice should be sought
about your specific circumstances.
#Withholding #Tax #Obligation #Telecom #Companies #Relief #Honble #Supreme #Court #Withholding #Tax
