India: Withholding Tax Default Bites The Payer After 10 Years

In a recent judgement (M/s Mass Awash Private Limited v CIT (International Taxation) [2017] 83 taxmann.com 306 (Allahabad)) (Judgment) a division bench of the Hon'ble Allahabad High Court (High Court) upheld recovery proceedings initiated against the payer for failure to withhold taxes from the payment which was made to a 'non-resident' 10 years ago.

Interestingly, section 201 of the Income-tax Act, 1961 (IT Act) provides that with respect to payments made to a 'resident', recovery proceedings cannot be initiated against the payer after the expiry of seven years from the end of the financial year in which such failure happened.

However, with respect to payments to a 'non-resident', no such limitation period has been prescribed. In this context, the High Court held that in the absence of any such statutory limitation period, while the proceedings had to be initiated within a 'reasonable period'; the action of the tax authorities (IT Department) was valid as the delay was justified and for bona fide reasons given the specific facts of the case.

Facts

  • An Indian company (Payer) had acquired a land parcel from five individual co‑owners, vide a sale deed dated 14 June 2005 (Sale Deed).
  • The Payer paid the sale consideration in tranches, some of which were made in FY 2003-04, FY 2004-05, and balance at the time of execution of Sale Deed (i.e. FY 2005-06).
  • One of the co-owners was a non-resident Indian (NR Seller); however, this fact was not disclosed to the Payer.
  • The NR Seller was represented through her Power of Attorney (POA) holder, who was also one of the co-owners. In the Sale Deed, the address mentioned of all the co-owners (including the NR Seller) were Indian addresses only.
  • While the Payer was obligated under section 195 of the IT Act to withhold applicable taxes on the capital gains realised by the NR Seller, the Payer did not withhold any tax from the payment of the sale consideration as it was unaware of the non-resident status of the NR Seller.
  • Incidentally, the NR Seller neither paid her share of the capital gains tax nor filed income-tax return in India.
  • Subsequently, the NR Seller's tax officer taxed her on the allocable capital gains.
  • On appeals, the first and second appellate authorities – the Commissioner of Income Tax (Appeals) [CIT(A)] and the Income Tax Appellate Tribunal (ITAT) respectively, vide orders dated 16 February 2012 and 28 June 2013 respectively, annulled the order passed by the tax officer. But, the CIT(A) and ITAT directed the IT Department to explore the possibility of recovering tax from the purchaser of property (i.e. the Payer) since it was liable under section 195 of the IT Act for withholding of taxes from payments made to the NR Seller. The IT Department received such directions only on 16 July 2015.
  • Within one month thereafter, in compliance of directions of the appellate authorities, the IT Department initiated recovery proceedings against the Payer by issuing a notice (Notice) under section 201(1)/201(1A) of the IT Act on 12 August 2015, i.e. more than 10 years after the purchase of property under the Sale Deed.
  • The Payer objected to the Notice on the ground of limitation (since the transaction involved was more than 10 years old) as well as on merits (since the Payer was unaware that the NR Seller was a non-resident as she had given her Indian address in the Sale Deed).
  • Rejecting all such objections, the tax officer passed an order against the Payer. Against this order and the aforesaid Notice, the Payer preferred a writ petition before the High Court.

Judgment of the High Court

Before the High Court, the Payer submitted that since the tax officer initiated the recovery proceedings after a lapse of more than 10 years, the same were barred by limitation. It argued that where no limitation period is prescribed in a statute, the competent authority is bound to act within a 'reasonable time' and that in such scenarios, actions taken after a long time, i.e. beyond 3, 4 or 5 years, would be without jurisdiction. To support its claim, the Payer placed reliance upon various judgments of the Hon'ble Supreme Court and various High Courts.

On the contrary, the IT Department's contention was that as it made all efforts to recover tax from the NR Seller, it resulted in delay for initiating proceedings against the Payer.

The High Court ruled as under:

  1. Re: Payer's contention that it was unaware of the non-resident status of the NR Seller

In the facts and circumstances of the case, the High Court rejected this contention of the Payer expressing that a prudent payer would have generally evaluated the contents of the POA, which authorised the attorney to act on behalf of the NR Seller.

  1. Re: Payer's contention that IT Department took time-barred action
  • The High Court noted that though in absence of any limitation period prescribed in the statute, action must be taken by the competent authority within a 'reasonable time'; what is 'reasonable time' would be a case specific determination and would depend upon whether the delay, if any, in exercise of power is for valid and bona fide reasons.
  • The High Court noted that though the IT Department approached the Payer after more than 10 years from the date of Sale Deed, its bona fide is established inasmuch as it first explored the possibility of recovering the entire tax from the NR Seller and it is only when the aforesaid probability was explored and failed, recovery proceedings were initiated against the Payer.
  • In this regard, the High Court also took note of the fact that the Notice was issued by the IT Department within 1 month of receiving the direction from the second appellate authority to proceed against the Payer.
  • In fact, the High Court expressed that the defence of the Payer that it was misrepresented by the NR Seller by not disclosing the fact of her non-resident status would equally be available to the IT Department for explaining the delay.

Comment

Given that the IT Act does not prescribe any limitation period for initiation of recovery proceedings against a payer for failure to withhold taxes from payments made to a 'non-resident', there had been some divergence of judicial views in this regard. For instance, while the Delhi High Court had prescribed a limited period of four years for this purpose, the Calcutta High Court had taken a contrary view. As against such views, in the instant case, the High Court expressed that it would not impose a fixed time and prescribe a period of limitation, which had not been prescribed by the Legislature in its wisdom. The High Court upheld the principle that in the absence of any such statutory limitation period, the IT Department can initiate such proceedings within a 'reasonable time', which would be fact specific – i.e. if the delay in exercise of power is for valid and bona fide reasons, the delayed exercise of power cannot be held invalid.

This Judgment becomes significant from the perspective of any M&A deal – be it a share purchase or an asset purchase etc – especially where the amount is paid to a 'non‑resident'. It fortifies the principle that in such cases, the payer must act in a prudent manner and evaluate its withholding tax obligations as non-compliance can have serious ramifications (such as initiation of recovery proceedings even after 10 years as held in the instant case!) for the payer. Resultantly, transacting parties should take care, inter alia, of this aspect as well and evaluate whether any express contractual protection is warranted in this regard.

The content of this document do not necessarily reflect the views/position of Khaitan & Co but remain solely those of the author(s). For any further queries or follow up please contact Khaitan & Co at legalalerts@khaitanco.com

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