Net of tax agreements face rigour of PAN mechanism

Statutory provisions relating to Permanent Account Number exist since 2001. However, to strengthen the PAN mechanism, Section 206AA was introduced by Finance Act (No.2) 2009. This section provides that any person whose receipts are subject to deduction of tax at source shall be required to mandatorily quote his PAN to the person responsible for deducting TDS. In case the deductee fails to intimate the PAN to the deductor, then the deductor shall be required to deduct TDS at following rates:

Rates prescribed in the Income-tax Act or in the Finance Act, OR at the rate of 20% whichever is higher

In other words, if the person fails to intimate the PAN to the deductor, TDS will be at a minimum rate of 20%.

These provisions come into force from 01st April, 2010.

The aforesaid provision is creating an unintended hardship to many assessees including foreign enterprises. In many cases foreign companies do not want to be involved in income-tax proceedings in India. Therefore, when they enter into contract with Indian parties, they generally resort to “net of tax” arrangement.

Under net of tax arrangement, Indian tax which is payable by the foreign company is actually borne by the Indian company. The Indian Income-tax Act contains a specific section, namely section 195A, to deal with net of tax arrangement. As per section 195A when the tax is to be borne by the person who is to remit income to a foreign company, then, for the purposes of deduction of tax at source, such income is increased to such amount as would, after deduction of tax, be equal to the net amount payable under the agreement. This procedure is popularly called as ‘Grossing-up’ of income.

It is obvious that a foreign company which makes net of tax arrangement in India is generally not interested to apply for PAN in India. In such cases therefore, the tax on remittance to foreign companies is atleast 20 per cent. This issue is particularly important because in most of the cases foreign companies’ income is taxable @ 10%, but in the absence of PAN, tax has to be deducted @ 20 per cent.

The issue may also be looked at from another angle. Taxability of non-residents in India is subject to the provisions contained in the Tax Treaties entered into by Government of India with other countries. After introduction of Section 206AA, a question arises whether the tax required to be withheld will be as per the rate mentioned in the Tax Treaty or as per Section 206AA?

It may also be mentioned here that, foreign enterprises have been specifically exempted from the requirement to obtain PAN.

Section 139A(8)(d) specifies the class of persons to which provisions of section 139A which deals with PAN are not applicable. This section has authorized CBDT to specify such a class. The CBDT in Rule 114C(b) has specified that provisions of section 139A are not applicable to non-residents. It is thus clear that there is no obligation on the non-residents to obtain PAN in India.

There is an apparent contradiction between the provisions of section 206AA requiring PAN if tax is to be withheld as per the normal provisions of the Act, and section 139A(8)(d) read with rule 114C(b) which provides that Non-residents are not required to obtain PAN in India.

Further, section 206AA disturbs the legal position of tax-treaties made by India with other countries. As per section 90(2), the provisions of tax-treaties supersede the provisions of Income-tax Act. Thus where the rate of tax prescribed in a tax-treaty is lower than 20%, a confusion will prevail as to whether the rate provided in section 206AA will prevail or the rate of the tax-treaty will be applicable.

It is therefore felt necessary that Government should have a re-look at section 206AA and make suitable amendments therein so that net of tax agreements remain outside the purview of that section.

The author is a Sr. Partner in S.S. Kothari Mehta & Co.

Email: hp.agrawal@sskmin.com