TDS Under S.194-H Income Tax Act Won't Apply To Business Transactions Where Assessee Is Not Responsible For Paying Income : Supreme Court

“…we hold that the assessees would not be under a legal obligation to deduct tax at source on the income/profit component in the payments received by the distributors/franchisees from the third parties/customers, or while selling/transferring the pre-paid coupons or starter-kits to the distributors”, said the Bench of Justices Sanjiv Khanna and SVN Bhatti.

Background

The assessees/cellular mobile service providers had entered into franchise/distribution agreements with several parties in relation to their pre-paid connections. Under the agreements, they were selling start-up kits (including SIM cards) and recharge vouchers at a discounted price to these franchisee/distributors. The distributors in turn sell the kit to customers at the MRP or any price lesser than that and earn profit based on the margin from the price at which they purchased from the cellular service provider. 

The question that arose was whether the assessees shall deduct tax at source under Section 194-H of the Income Tax Act ("the Act") on income/profit component in the payments received by the franchisees/distributors from third parties/customers.

While the High Courts of Delhi and Calcutta held that the assessees were liable to deduct tax at source under Section 194-H of the Act, the High Courts at Rajasthan, Karnataka and Bombay held that Section 194-H of the Act was not attracted to the circumstances under consideration. Against these judgments, the Revenue and the assessees approached the Supreme Court.

Before the top Court, the assessees claimed that they were neither paying a commission or brokerage to the franchisees/distributors, nor were the franchisees/distributors their agents.

On the other hand, the Revenue's case was that the difference between 'discounted price' and 'sale price' in the hands of the franchisee/distributors, being in the nature of 'commission or brokerage', was the income of the franchisee/distributors. Therefore, the relationship between the assessees and the franchisee/distributor was of principal-agent and the assessees were liable to deduct tax at source under Section 194-H of the Act.

Court Observations

At the outset, it was noted that the obligation to deduct tax at source in terms of Section 194-H of the Act arises when the legal relationship of principal-agent is established. To answer whether relationship between parties is that of principal-agent, Section 182 of the Contract Act, 1872 is to be applied.

Referring to Section 182, the Court summarized the factors that shall be taken into consideration when examining whether a legal relationship of a principal and agent exists. The same has been discussed in detail in a separate article.

Thereafter, it observed that though the discounted price is fixed or negotiated between the assessee and the franchisee/distributor, the sale price received by the latter is within its sole discretion. "The assessee has no say in this matter."

Moreover, the income of the franchisee/distributor (difference between sale price received by the franchisee/distributor and the discounted price) is credited to the account of the franchisee/distributor when he sells the prepaid product to the end-user/customer. The assessee does not, the Court noted, pay or credit the account of the franchisee/distributor with the income by way of commission or brokerage on which tax at source under Section 194-H of the Act is to be deducted.

"The assessees are not privy to the transactions between distributors/franchisees and third parties. It is, therefore, impossible for the assessees to deduct tax at source and comply with Section 194-H of the Act, on the difference between the total/sum consideration received by the istributors/ franchisees from third parties and the amount paid by the distributors/ franchisees to them."

Interpreting Section 194-H, the Court added that deduction of tax at source in terms of the provision could not be extended and widened in ambit to apply to true/genuine business transactions, where the assessee is not the person responsible for paying or crediting income (such as the assessees in the present case who were not paying or crediting amount to the franchisee/distributors). "Explanation (i) to Section 194-H of the Act, by using the word “indirectly”, does not regulate or curtail the manner in which the assessee can conduct business and enter into commercial relationships", it said.

"...deduction of tax at source in terms of Section 194-H of the Act is not to be extended and widened in ambit to apply to true/genuine business transactions, where the assessee is not the person responsible for paying or crediting income."

As a word of caution, it was reminded that the deduction of tax provisions should be programmatically and realistically construed, and not as enmeshes or by adopting catch-as-catch-can approach.

"The deduction of tax provisions should be programmatically and realistically construed, and not as enmeshes or by adopting catch-as-catch-can approach. In case of a legal or factual doubt in a given case, the assessee can rely on the doctrine of presumption against doubtful penalisation. Whether or not the said doctrine should be applied, will depend on facts and circumstances of the case, including the past practice followed by the assessee and accepted by the department."

Notably, since assessees are not privy to the transactions between distributors/franchisees and third parties, the Revenue had suggested that the assessees should periodically ask for this information/data and thereupon deduct tax at source. This argument was rejected by the Court as far-fetched, "imposing unfair obligation and inconveniencing the assesses, beyond the statutory mandate."

Decision

Holding that Section 194-H was not applicable to the present case, the Court allowed the assessees' appeals against the Delhi and Calcutta High Court judgments, while it dismissed the appeals filed by the Revenue wrt the other judgments.