DECEMBER 16, 2014

By Lukose Joseph, CA & Anil P Nair, CA

INCOME TAX is withheld from payments to Non Residents if the income is chargeable to tax in India. This is done either as per the respective provisions of the Income Tax Act, 1961 or as per the Double Taxation Avoidance Agreements (DTA) with the country of Non Residents.

Along with such taxes and surcharge if any, should we also withhold Education Cess?

The answer is sometimes, yes and sometimes, no! Let us meditate on this a little more.

Education cess (hereinafter also called Cess) was first introduced in our country through Finance Act, 2004. The noble objective of the Government is explained in the Finance Act, Sections 2 (11) and (12).

According to Section 2 (11), the amount of income-tax as increased by the applicable surcharge shall be further increased by an additional surcharge to be called the "Education Cess on income-tax", calculated at the rate of two per cent of such income-tax and surcharge so as to fulfil the commitment of the Government to provide and finance universalised quality basic education.

Further, according to Section 2 (12), the amount of income-tax as increased by the applicable surcharge shall also be increased by an additional surcharge to be called the "Secondary and Higher Education Cess on income-tax", calculated at the rate of one per cent of such income-tax and surcharge so as to fulfil the commitment of the Government to provide and finance secondary and higher education.

However, both sub sections have a similar proviso in that nothing contained here shall apply to cases in which tax is to be deducted or collected at source on income paid to a domestic company and any other person who is resident in India.

Hence payments to Non Residents are NOT exempted and hence will need to withhold Cess. It arrives that withholding/deducting taxes from payments to Non Residents will need to include Cess.

But with many countries, DTA are in place and the DTA specifies the rates for withholding tax. Do we need to withhold Cess in addition to the rates in DTA?

Section 2 (37A) (iii) of the Income Tax Act, 1961 defines ‘rate of tax':

"for the purposes of deduction of tax under section 195 , the rate or rates of income-tax specified in this behalf in the Finance Act of the relevant year or the rate or rates of income-tax specified in an agreement entered into by the Central Government under section 90 , or an agreement notified by the Central Government under section 90A, whichever is applicable by virtue of the provisions of section 90, or section 90A , as the case may be".

Hence the rates of tax are either the rates in force or as specified in the agreement.

In, DIC Asia Pacific Pte Ltd vs. ADIT - 2012-TII-78-ITAT-KOL-INTL, Tribunal held that if DTA caps tax rate, education cess is not payable by foreign assessee.

"the scope of Article 2 (of DTA with France) shall also cover "any identical or substantially similar taxes which are imposed by either Contracting State after the date of signature of the present Agreement in addition to, or in place of, the taxes referred to in paragraph 1", and in view of the fact that education cess is essentially of the same nature as surcharge, being an additional surcharge, the scope of Article 2 also extends to the education cess".

But in above, if one does not follow DTA, then it follows that one need to withhold Cess. Also on payments to Non Residents in countries with which India is not having a DTA, while withholding even at the higher rates applicable, one need to add Cess.

Why would one want to 'unfollow' DTA?

For payments to Non Residents some sections mention special rates under the Income Tax Act, 1961.

See Table:

We find that on payments to Non Residents, it is better to avail the above; being rates much lower than the prescribed rates in force under DTA rates in certain cases, despite their obvious liability to pay Cess. As per Section 90 (2) of the Income Tax Act, DTA overrides the provisions of the Income Tax Act. But the assessee cannot be denied the benefit of a lower rate under the relevant Section, if a claim is raised.

Let us conclude that Education Cess need not be withheld where DTA is applicable but will have to be deducted in other cases. DTA generally specifies withholding tax rates only for Dividend, Interest, Royalties and Technical Fees. If payments are made to Non Residents in countries with which DTA exists, one need to study the individual cases and decide the tax rates.