Obligation (in the hands of telecom companies) to withhold taxes under Section 194H of the Income-tax Act, 1961 (IT Act) on discounts given to SIM card distributors has been a matter of long drawn dispute. Conflicting rulings have been pronounced by different High Courts and the issue has now attained finality by the judgment of the Hon’ble Supreme Court (Apex Court) in the landmark case of Bharti Airtel vs Assistant Commissioner of Income Tax (TS-135-SC-2024).
We have discussed this ruling of the Apex Court in the ensuing paragraphs:
Facts of the case
Taxpayers in the present facts are cellular telephone service providers who had entered into franchisee agreements with distributors for selling start-up kits, which included SIM cards and coupons, to end-users/ customers. As per the agreement, distributors received these kits at a discounted price and sold the same to end-users/ customers at the Maximum Retail Price (MRP) mentioned on the kits. Distributors earned their profits on the margin between the discounted price and MRP.
According to the tax authorities, profit (margin between the discounted price and MRP) earned by distributors is ‘commission’ paid to agents (under the franchise/ distributorship agreement) and hence the cellular telephone service providers are liable to deduct tax at source (TDS) under Section 194H of the IT Act.
Ruling
TDS under Section 194H of the IT Act
Section 194H of the IT Act provides that any person responsible for paying any commission or brokerage to a resident will be under an obligation to deduct taxes at the rate of 5% at the time of credit to the account of such payee or payment, whichever is earlier. Explanation (i) to Section 194H of the IT Act defines the term 'commission' or 'brokerage,', which includes any payment received or receivable, directly or indirectly, by a person acting on behalf of another person for services rendered, excluding professional services.
While interpreting this provision, Apex Court clarified that the term “another person" means the "person responsible for payment” to the person acting on behalf of such another person. Accordingly, to invoke this provision, payment (to the distributors) should be made only by the person on whose behalf the distributors are alleged to be acting.
Intersection of TDS and law of Agency
Apex Court held that liability under Section 194H of the IT Act arises when the business model is based on a principal-agent relationship as Explanation (i) uses the expression “acting on behalf of another person”. Thus, obligation to deduct tax in terms of Section 194H of the IT Act arises only when a legal relationship of principal-agent is established. The law of agency is technical in nature and thus, the existence of a principal agent relationship should be answered by applying Section 182 of the Indian Contract Act, 1872.
Basis the analysis of the Indian Contract Act, 1872, Apex Court laid down the following essential characteristics of a principal-agent relationship:
a. Agent has the legal power to alter the principal's legal relations with third parties, and the principal’s co-relative liability to have his relations altered.
b. The principal exercises a degree of control over the agent's activities, albeit less extensive than that exerted over a servant in a master-servant relation and is different from rights and obligations arising under a principal-independent contractor relationship.
c. It is a fiduciary relationship in which the agent consents to act on behalf of the principal, subject to the principal’s control.
d. Agent is liable to account for the business conducted on principal's behalf and is entitled to remuneration for the services rendered.
The Apex Court, after going through the entire franchise agreement held that obligations outlined in contracts with the distributors did not exhibit fiduciary characteristics nor indicate that the business conducted by distributors was on behalf of the principal. Though the discounted price is fixed or negotiated between the taxpayers and franchisee/ distributor, the sale price received by the franchisee/ distributor is at the sole discretion of the franchisee/distributor. The taxpayers have no control on the sale price that may be charged by the distributors.
Income of the franchisee/ distributor, being the difference between sale price received by the franchisee/ distributor and the discounted price, is paid or credited to the account of the franchisee/ distributor when the prepaid product (kit/ SIM cards) is sold to the retailer/ end-user/ customer. The sale price and accordingly income of the franchisee/ distributor is accrued/ received only through an arrangement between the franchisee/ distributor and third parties (ultimate buyers).
Accordingly, the taxpayers are not involved in paying or crediting the account of the franchisee/ distributor with the income by way of commission or brokerage on which TDS under Section 194H of the IT Act is alleged to have been deducted.
The word “indirect” is not sufficient to bring genuine business relations under Section 194H of the IT Act
It was the contention of the Revenue that such discount given by taxpayers was covered within the ambit of the phrase “payment received or receivable directly or indirectly by a person acting on behalf of the other person" provided in Explanation (i) of Section 194H of the IT Act.
It was argued that even if the franchisee/ distributor receives payment in the form of income from the retailer/ end-user/ customer, it would require deduction of tax as the payment is received indirectly from the taxpayers. Rejecting this contention, the Apex Court held that the expression “direct or indirect” used in Explanation (i) to Section 194H of the IT Act is only to ensure that the person responsible for paying does not dodge the obligation to deduct tax at source, even when the payment is indirectly made by the principal-payer to the agent payee.
Apex Court cautioned that the scope of TDS under Section 194H of the IT Act should not be expanded to encompass genuine business transactions where the taxpayer is not the person responsible for paying or crediting the income. In this case, the taxpayer neither pays nor credits income to the contracted party. Therefore, the term "indirectly" in Explanation (i) does not regulate or curtail the manner in which the taxpayer can conduct business or engage in commercial relationships.
Guidelines for CBDT
Considering the significance and wide impact of TDS mechanism incorporated under the provisions of the IT Act, Apex Court also issued certain guidelines for Central Board of Direct Taxes (CBDT) by observing that “The deduction of tax provisions should be programmatically and realistically construed, and not as enmeshes or by adopting catch-as-catch-can approach.…. When there is apparent divergence of opinion, to avoid litigation and pitfalls associated, it may be advisable for the Central Board of Direct Taxes to clarify doubts by issuing appropriate instruction/ circular after ascertaining view of the assesses and stakeholders. In addition to enhancing revenue and ensuring tax compliance, an equally important aim/ objective of the Revenue is to reduce litigation. The instructions/ circular, if and when issued, should be clear, and when justified – require the obligation to be made prospective”.
Practical difficulties in deducting tax
Apex Court further observed that it is not possible for the assesses to withhold taxes in compliance with Section 194H of IT Act on the difference between distributor’s receipts from end customers and the amount paid by distributors to the taxpayers. This is because the taxpayers are not privy to the transactions between distributors and end customers and therefore will not have required information about the profits earned by distributors.
The Revenue authorities' suggestion that the taxpayers should regularly request information on distributors' income from selling prepaid coupons and then deduct tax was deemed impractical and burdensome by the Apex Court. The Apex Court further noted that such a requirement would impose undue obligations on the taxpayers which is beyond the statutory mandate. Additionally, complying with this request would be practically impossible within the timelines prescribed under the law.
Conclusion on applicability of Section 194H
Apex Court while concluding on the controversy of applicability of Section 194H, also deep dived into the legal position of a distributor, who is regarded different from an agent. The distributor buys and sells goods on its own account and the profit margin is the difference between the purchase price and the sale price like an independent contractor.
An independent contractor is free from control on the part of its employer and is only subject to the terms of the underlying contract. As against this, an agent is not completely free from control, and the relationship to the extent of tasks entrusted by the principal to the agent are fiduciary. Apex Court agreed that while there may be some control of the principal over an independent contract (depending upon the terms of the contract) which may resemble the characteristics of an agent, but on an overview of the entire relationship, all the tests specified in (a) to (d) above may not be satisfied. Independent contractors operate autonomously, even when employed to establish contractual relationships with third parties.
Thus, the term ‘agent’ denotes a relationship that is very different from that existing between an employer and its independent contractor. The term ‘agent’ should be restricted to one who has the power of affecting the legal position of its principal by the making of contracts, or the disposition of the principal’s property. Thus, the Apex Court held that it is in the restricted sense in which the term agent is used in Explanation (i) to Section 194H of the IT Act and concluded that the provisions of Section 194H is not applicable to the facts of the present case.
AL Comments
The Apex Court has delivered a landmark ruling on an issue which has impacted the telecom industry for more than a decade. The Apex Court has not only deliberated on specific nuances on applicability of Section 194H but has also deep dived into the principal agent relationship envisaged under the Indian Contracts Act, 1872, characteristics of an independent contractor and what distinguishes an agent from an independent contractor.
Guidelines by the Apex Court to CBDT to adopt measures to reduce disputes in addition to enhancing revenue and ensuring compliance will go a long way in avoiding protracted litigation. An unambiguous law will not only lead to reduction in litigation but will also enhance revenue and ease for taxpayers.
Authors: Vidushi Maheshwari and Vishesh Gupta
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