While determining rate of tax for transactions with non-residents, the first thing to be looked into is

• Whether the transaction is taxable in India as per Section 9.
• If the answer is in the affirmative, then we check for existence of Double Taxation Avoidance Agreement (DTAA) between India and the country of the non-resident.
• If there is no DTAA between India and the country of the non-resident, then the rate as per Income Tax Act is to be applied.

If there exists DTAA between India and the country of the non-resident, it takes us to a whole new set of questions, such as, whether the rate as per DTAA or Income Tax Act is to be applied, will section 206AA override section 90(2) and whether the rate as per DTAA is required to be increased by surcharge and education cess. These aspects have been dealt with below.

(a) SECTION 90(2)

Section 90(2) of the Income Tax Act provides that where the Central Government has entered into an agreement with the Government of any other country for granting relief of tax, or the avoidance of double taxation, then in relation to an assessee to whom the provisions of the Income Tax Act apply, the provisions of the Income Tax Act would apply to the extent they are more beneficial to that assessee.

(b) SECTION 206AA

However, section 206AA starts with a strong non-obstante clause, “Notwithstanding anything contained in any other provisions of this Act” and goes on to state that the applicable rate for deduction of tax at source would be higher of the

1) rate specified in the Income Tax Act or

2) rate in force or

3) twenty percent,

where the recipient of any sum does not furnish his Permanent Account Number (PAN).

(c) SECTION 90(2) v 206AA - WILL SECTION 206AA OVERRIDE SECTION 90(2)?

More often than not, in transactions with non-resident, the non-resident would not have a PAN. So question arises whether in such circumstances, tax should be deducted at the rate prescribed in the applicable treaty or as per Income Tax Act, whichever is beneficial as specified in section 90(2) or at 20% as specified in section 206AA.

(i) Pune Tribunal - DTAA will prevail over section 206AA:In the case of DDIT (International Taxation) v Serum Institute of India Ltd [TS-158-ITAT-2015(PUN)-O] the assessee had deducted tax at source at the rate specified in DTAA in respect of payments to non-residents who did not furnish PAN. However the Assessing Officer treated tax deducted at source on such payments made by the assessee to non-residents who did not furnish PAN as ‘short deduction’ citing that the assessee should have deducted tax at the rate of 20% as per section 206AA.

The Pune Bench of the Hon’ble Income Tax Appellate Tribunal relying on the decision of the Hon’ble Apex Court in GE India Technology Centre Pvt. Ltd. v CIT [TS-201-SC-2010-O], wherein it has been held that the provisions of sections 4, 5, 9, 90 and 91 of the Income Tax Act and DTAA are the relevant provisions for determining tax to be deducted at source, concluded that assessee has correctly applied the rate of tax prescribed under the DTAA and not as per section 206AA because the provisions of the DTAA was more beneficial.

(ii) Hyderabad Special Bench - Provisions of DTAA, to the extent they are beneficial to the assessee, will override section 206AA by virtue of section 90(2):It is also to be noted that in the recent decision of the Hyderabad Special Bench in Nagarjuna Fertilizers and Chemicals Ltd v ACIT in [TS-5291-ITAT-2017(Hyderabad)-O], the very same issue came up for adjudication before the Hon’ble Special Bench and it has been categorically held that the provisions of DTAA, to the extent they are beneficial to the assessee, will override section 206AA by virtue of section 90(2). The Special Bench has concluded that an assessee cannot be held liable to deduct tax at higher of the rates prescribed in section 206AA in case of payments made to non-resident persons having taxable income in India in spite of their failure to furnish the Permanent Account Numbers.

(iii) Andhra Pradesh High Court - DTAA will prevail over the provisions of the Income Tax Act if the same is beneficial to the assessee – In the decision of the Hon’ble Andhra Pradesh High Court in CIT v Visakhapatnam Port Trust [TS-5297-HC-1983(ANDHRA PRADESH)-O], which was rendered even before section 90(2) was introduced vide the Finance (No.2 Act), 1991, it has been held that the terms of the DTAA agreement prevails over the provisions of the Income Tax Act when the same is beneficial to the assessee.

On the strength of the above decisions, it can be understood that section 206AA being a procedural section connected to deduction and collection of tax, cannot override the charging section being section 90(2). Hence tax is required to be deducted at the rate as per the applicable treaty or as specified in Income Tax Act, whichever is beneficial in accordance with section 90(2) and not as per section 206AA even when a non-resident recipient does not furnish PAN.

(d) DTAA RATE – SHOULD IT BE INCREASED BY SURCHARGE AND EDUCATION CESS?

Once we adopt the beneficial rate as per DTAA, the second issue which arises is whether the rate as per DTAA is required to be increased by surcharge and educational cess mentioned in the Finance Act. For this we have to look at the definition of tax given in the relevant DTAA.

For example, Article 2 of Indo-Japan DTAA states ‘tax’ shall include income tax and surcharge.

If the definition of tax in the DTAA includes surcharge, then the rate mentioned in DTAA need not be increased by surcharge. As far as education cess is concerned, it is to be noted that education cess is merely an additional surcharge. Hence according to Article 2 of Indo-Japan DTAA, the rate of tax already includes surcharge and education cess.

(i) Kolkata Tribunal and Mumbai Tribunal – When DTAA defines tax to include surcharge, education cess need not be added to the rate mentioned in DTAA since surcharge includes education cess:In this connection, reference is drawn to the decision of DIC Asia Pacific Pte Ltd v ADIT [TS-443-ITAT-2012(KOL)-O] rendered in the context of India-Singapore DTAA wherein while deciding the rate to be adopted as per the DTAA, it was held that the rate given in DTAA need not be increased by education cess as education cess is in the nature of additional surcharge. The relevant portion of the said decision is as follows:

“6. A plain reading of these provisions show that while interest and royalties can indeed be taxed in the source state, the tax so charged on the same, under Article 11 and 12, cannot exceed 15% and 10% respectively. The expression 'tax' is defined in Article 2(1) to include 'income tax' and is stated to include 'surcharge' thereon, so far as India is concerned. Article 2(2) further extends the scope of the 'tax' by laying down that it 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".

7. We find that educationcess was introduced in India by the Finance Act, 2004, and Section 2(11) of the Finance Act 2004 described it as follows:

(11) The amount of income-tax as specified in sub-sections (4) to (10) and as increased by a surcharge for purposes of the Union calculated in the manner provided therein, shall be further increased by an additional surcharge for purposes of the Union, to be called the "Education Cess on income-tax", so as to fulfil the commitment of the Government to provide and finance universalised quality basic education, calculated at the rate of two per cent of such income-tax and surcharge.

8. It is thus clear that the education cess, as introduced in India initially in 2004, was nothing but in the nature of an additional surcharge. It was described as such in the Finance Act introducing the said cess.

9. We have also noted that Article 2(1) of the applicable tax treaty provides that the taxes covered shall include tax and surcharge thereon. Once we come to the conclusion that education cess is nothing but an additional surcharge, it is only corollary thereto that the education cess will also be covered by the scope of Article 2. Accordingly, the provisions of Article 11 and 12 must find precedence over the provisions of the Income Tax Act and restrict the taxability, whether in respect of income tax or surcharge or additional surcharge - whatever name called, at the rates specified in the respective article. In any case, education cess was introduced by the Finance Act 2004, with effect from assessment year 2005-06 which was much after the signing of India Singapore tax treaty on 24th January 1994. In view of the specific provisions to the effect that the scope of Article 2 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.

10. For the reasons set out above, we are of the considered view that the education cess cannot indeed be levied in respect of tax liability of the appellant company. The assessee, therefore, deserves to succeed on this issue.”

In has been similarly held in the context of India-UAE DTAA in the case of Sunil V. Motiani v ITO (International Taxation) [TS-6855-ITAT-2013(MUMBAI)-O]

(ii) Cochin Tribunal and Kolkata Tribunal – Where the DTAA is silent about surcharge and education cess, the rate mentioned in DTAA to be applied as such: While in the above decisions the Courts have reasoned that when the definition of 'income tax' in the treaty is stated to include 'surcharge', the DTAA rate is not required to be increased by surcharge and education cess, the Hon’ble Cochin Tribunal in the case ofITO (International Taxation) v M Far Hotels Ltd. [TS-133-ITAT-2013(COCH)-O] has taken a liberal view and held that when the DTAA is silent about surcharge and education cess for the purpose of deduction of tax at source, the taxpayer may take advantage of that provision in the DTAA for deduction of tax since the provisions of DTAA would prevail over the Indian Income Tax Act.

The Kolkata Tribunal while dealing with the India UK-DTAA in DDIT (International Taxation) v BOC Group Ltd [TS-6106-ITAT-2015(KOLKATA)-O] has followed the decision of ITO (International Taxation) v M Far Hotels Ltd. (cited supra) and held that when the tax rate is prescribed under DTAA, then such tax rate shall have to be followed strictly without any additional taxes thereon in the form of surcharge or education cess.

So regarding the issue of whether the rate as per DTAA is required to be increased by surcharge and educational cess, from the above decisions, it can be understood that the when a specific rate is mentioned in DTAA, then such rate can be considered as inclusive of surcharge and education cess unless the treaty specifically states that the rates mentioned therein have to be increased by surcharge and education cess.