Tax Withholding at deemed value: Interplay of S. 195 read with S. 50CA of the IT Act


Introduction


In the Master Class post where Section 195 of the Income-tax Act, 1961 (hereinafter 'IT Act') was applicable (in cases where payments were made to Non-Residents) I took a view that withholding obligation shall arise on the Section 50CA (of the IT Act) value which is the most conservative position for the payer/deductor. This post discusses, in brief, the scope of Section 195 of the IT Act in as much as examining the value at which withholding obligation arises, whether such value needs to be arrived at keeping in mind the Section 50CA value or the amount actually discharged. [Here it is assumed that Section 50CA value > consideration discharged] 

To give a background to this controversy, Section 50CA was inserted in the IT Act vide Finance Act, 2017 which mandates that in case of a seller, where the consideration received/ accruing on account of transfer of a capital asset being shares of an unlisted entity, is less than the Fair Market Value (hereinafter 'Tax FMV') of such unlisted shares (i.e. value as prescribed under Rule 11UAA of the IT Rules wherein the valuation method for Rule 11UA of the IT Rules is adopted), the tax FMV shall be deemed to the full value of consideration received/accruing as a result of such transfer.

For a better understanding the issue at hand Section 50CA and Section 195(1) are reproduced herein below: 

"50CA. Special provision for full value of consideration for transfer of share other than quoted share.—Where the consideration received or accruing as a result of the transfer by an assessee of a capital asset, being share of a company other than a quoted share, is less than the fair market value of such share determined in such manner as may be prescribed, the value so determined shall, for the purposes of section 48, be deemed to be the full value of consideration received or accruing as a result of such transfer.
Explanation.—For the purposes of this section, "quoted share" means the share quoted on any recognised stock exchange with regularity from time to time, where the quotation of such share is based on current transaction made in the ordinary course of business." 

"Other sums.

195. (1) Any person responsible for paying to a non-resident, not being a company, or to a foreign company, any interest (not being interest referred to in section 194LB or section 194LC) or section 194LD or any other sum chargeable under the provisions of this Act not being income chargeable under the head "Sal
aries") shall, at the time of credit of such income to the account of the payee or at the time of payment thereof in cash or by the issue of a cheque or draft or by any other mode, whichever is earlier, deduct income-tax thereon at the rates in force :"

View 1: Withholding tax liability under Section 195 should be based on fair value of consideration computed as per Section 50CA

Section 50CA provides that where the consideration received or accruing for transfer of shares (other than quoted shares) is less than the Tax FMV of such shares, for the purposes of Section 48, the Tax FMV shall be deemed to be the full value of the consideration received or accruing on such transfer.

As per section 195, the liability to deduct tax arises in the hands of a person who is responsible for paying any sum chargeable under the provisions of the Act to a non-resident. The Memorandum to Finance Bill 2017 (page 22) states that such Tax FMV shall be deemed to be the full value of the consideration for the purposes of computing income under the head "Capital gains". Therefore the sum chargeable to tax is actually the sum calculated in accordance with Section 50CA, i.e the Tax FMV. 

Hence, on a plain and literal interpretation of the above sections, a view emerges that where Section 50CA is triggered for computation of capital gains in the hands of the seller, the withholding tax liability under section 195 would need to be based on such deemed fair value of consideration and not the actual value of consideration discharged for such acquisition.

View 2: Withholding tax obligation under Section 195 should be based on actual consideration discharged to the Non-Resident

The deeming fiction provided under section 50CA is similar to the deeming fiction provided in Section 50C or could also be compared to the transfer pricing provisions.

As an example to Section 50C read with Section 194-IA, Section 194-IA restricts the scope of withholding of taxes on payment made for the purchase of immovable property to the agreed consideration paid or payable – in the absence of reference to any deeming fiction. Similarly, with respect to Section 50CA, if the intention of the legislature was otherwise, there should have been the corresponding amendment brought in Section 195 to state that the withholding obligation should be based on Tax FMV  computed as per Section 50CA.

Though this may not be a perfect analogy, I am of the view that where any price adjustment is made by the TPO the same shall not have any adverse impact on the withholding tax implications since such adjustment is a subsequent event and the language of Sec 195(1) suggests that the obligation to withhold tax would be on income that is included in the sum payable (and not on a notional adjustment to the income chargeable).

Section 195(1) requires that the person responsible for paying to a non-resident, not being a company, or to a foreign company, any sum chargeable to tax under the Act, shall, at the time of credit of such income to the account of the payee or at the time of payment thereof in the manner stated, whichever is earlier, to deduct tax thereon at the rates in force

Excerpt of Section 195 of the IT Act is reproduced herein below: 
"...at the time of credit of such income to the account of the payee or at the time of payment thereof in cash or by the issue of a cheque or draft or by any other mode, whichever is earlier, deduct income-tax thereon at the rates in force"

The words, "at the time of credit of such income" and  “deduct income-tax thereon” in section 195(1) of the IT Act seem to suggest that the reference is to the amount credited or paid to the payee by the payer.  

As the gains arising through the transaction whether in the credit or payment would be the gains based on the actual consideration received or accruing for the transfer of the shares and would not be the gains deemed to accrue or arise or be received on the application of section 50C, withholding tax obligation need to be deducted with reference to the consideration that is actually paid by it.

Further,  as per Hon'ble Supreme Court of India in the case of CIT v. Vegetable Products Ltd. has held that where two views are possible, the view in favor of the assessee has to be preferred.

Therefore, withholding obligation arising on actual consideration discharged seems a better view. Having said the above, in absence of any judicial precedents in this regard this matter would invariably be litigated.  


Comments