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March 2018

Deduction of tax at source on reimbursements - An unsettled debate!

Introduction

The question as to whether tax has to be deducted at source on expenditure reimbursed to both residents and non-residents has been a subject matter of judicial scrutiny on various occasions. Even though, it is judicially accepted that the reimbursement of expenditure does not constitute ‘real income’ of the payee [see Endnote 1], the liability to deduct tax on reimbursements has been a subject matter of dispute and as discussed in following paragraphs, the issue of tax deduction at source on reimbursement of expenditure is far from settled.

 

Root of controversy

As per the IT Act [see Endnote 2], the payer is liable to deduct tax at source on payments which are chargeable to tax in India and where the provisions of IT Act provide for tax deduction at source on such stream of income. Further, as upheld by Supreme Court, the liability to deduct tax is on the gross sum paid by the payer [see Endnote 3].

The root of the controversy regarding tax deduction on reimbursement can be traced to the difference in claim of the taxpayer and taxman. While the former claims that the receipts in the form of reimbursement of expenditure do not fall in the realm of the term ‘income’, the latter claims that the gross receipts (including reimbursements) form part of total income even though owing to computation mechanism, the reimbursement may not lead to a tax liability in the hands of the payee. Owing to such divergent view, the taxman contest that the payer should deduct tax on gross sum paid (including reimbursements), even though, owing to the computation mechanism, the payee may not have to pay tax on receipts from reimbursement.

 

Contrary Rulings

Recently the Kolkata Bench of Tribunal [see Endnote 4] has held that the payee of reimbursements only acts as a conduit owing to which the sum reimbursement is not exigible to tax in the hands of the payee.  However, in another case [see Endnote 5], the interpretation supplied by the Bangalore Bench of Tribunal is diametrically opposite to that of the Kolkata Bench wherein the Bench held that the liability to deduct tax cannot be circumvented by making payment through the intermediary and not making the payment directly to the ultimate beneficiary. Although, the latter judgment was rendered in the context of management charged paid to a resident, but the rationale should apply in respect of payments made to both residents and non-residents. It is worth mentioning that although, there are plethora of the judgments on the subject, but these judgments have been consciously chosen to highlight the difference of interpretation on the subject.  Thus, even though the issue is not res-integra, the difference in judicial interpretations has led to complications and uncertainties regarding liability to deduct tax on such payments.

 

Departmental Circulars

CBDT had issued a Circular [see Endnote 6] wherein it was stated that since the provisions contained in Chapter XVII-B fasten a liability to deduct tax on ‘any sum paid’, the reimbursements cannot be reduced from the gross sum payable to compute the liability to deduct tax at source. However, Delhi Bench of ITAT [see Endnote 7] has held that the liability to deduct tax on gross sum, as clarified in the aforesaid circular will apply only if there is a composite bill which does not differentiate between the reimbursement and other sum. Thus, there are contrary views with regards to departmental clarification as well.

 

Relevance of privity of contract and nature of income

The privity of contract will play a pivotal role in determining the liability to deduct tax at source. In a case, where the privity to contract lies between the payer and the ultimate service provider, the intermediary will only act as a conduit or agent of the payer. In such a case, it is worth pondering as to whether the payer is absolved of its liability to deduct tax on the underlying sum merely because the payment is routed through the intermediary. However, in a case, where the payer’s privity of contract lies with the intermediary, so much so, that the payer is liable to reimburse the intermediary the sum expanded by it on behalf of the payer, the possibility of deduction of tax cannot be ruled out. Even in such cases, the liability to deduct tax may arise owing to the nature of income paid to intermediary. To illustrate this scenario, reference may be drawn to the judgment of Delhi High Court [see Endnote 8], wherein the payer had reimbursed the salary of seconded employees to the payee. In this regard, the Court held that since the technical services are exigible to tax on gross basis, the payer ought to have deducted tax at source. Further, in cases relating to apportionment of expenditure, an allegation of disproportionate cost sharing may lead to liability to deduct tax in the hands of the payer. 

 

Conclusion

The liability to deduct tax at source on reimbursement of expenditure is a fact specific issue. Where the underlying payments are subjected to tax deduction at source, there are further issues like claim of credit of tax, inclusion of sum in total income, cash flow issues (in case where tax is deducted both by intermediary and payer) etc., that are likely to creep in. Further, the payer may also be required to fulfil certain compliances like obtaining back-to-back invoice to prove the lack of profit element, declaration under Rule 37BA(2) etc. It is therefore advisable that the precise facts of a case are kept in mind rather than applying a rule of thumb. The issue regarding tax deduction at source on reimbursement of sums should be examined at the stage when the transaction is contemplated to avoid any adverse implications at a later point of time.

[The author is a Senior Associate, Direct Tax Practice, Lakshmikumaran & Sridharan, New Delhi]

 

Endnotes:

  1. Tejaji Farasram Kharawalla Ltd.: [1968] 67 ITR 95 (SC) and A.P. Moller Maersk A S [2017] 392 ITR 186 (SC)
  2. Section 4(2) of Income-tax Act, 1961
  3. Transmission Corpn. of A.P. Ltd.: [1999] 239 ITR 587 (SC)
  4. Timken Company: [2017] 88 taxmann.com 21 (Kolkata - Trib.)
  5. Tungabhadra Steel Products Ltd.: ITA No. 984/Bang/2017
  6. Question No. 30 in Circular No. 715 dated 08th August 1995
  7. Dr. Willmar Schwabe India (P.) Ltd.: [2005] 95 TTJ 53 (Delhi)
  8. Centrica India Offshore Pvt. Ltd.: [2014] 364 ITR 336 (Delhi)

 

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