Section 194-H of IT Act

Supreme Court: In appeals pertaining to liability to deduct tax at source under Section 194-H of Income Tax Act, 1961 (‘1961 Act’) against telecom companies regarding amount payable under franchise/distributorship agreements, the Division Bench of Sanjiv Khanna and SVN Bhatti, JJ. held that Section 194-H of 1961 Act was not applicable to them since they did not control the income of such franchise/distributors.

The issue pertained to the liability to deduct tax at source under Section 194-H of Income Tax Act, 1961 (‘1961 Act’) on the amount which according to the Revenue is a commission payable by the assessees to an agent under the franchise/distributorship agreement between the assessees and franchisees/distributors, while as per the assessees, they were neither paying a commission or brokerage to the franchisees/distributors, nor the franchisees/distributors were their agents. The High Courts of Delhi and Calcutta have held that the assessees were liable to deduct tax at source under Section 194-H of 1961 Act, whereas the High Courts of Rajasthan, Karnataka and Bombay have held that Section 194-H of the Act is not attracted to the circumstances under consideration.

The Court perused Section 19-H of the 1961 Act regarding Commission or brokerage, imposing obligation to deduct tax at source, whose explanation (i) defines the expressions ‘commission’ or ‘brokerage’. The Court explained that “Payment is received when it is actually received or paid. The payment is receivable when the amount is actually credited in the books of the payer to the account of the payee, though the actual payment may take place in future. The payment received or receivable should be to a person acting on behalf of another person.”

The Court hinted towards the legislative intent including indirect payment to ensure that the net cast by section was plugged and not avoided, and does not dilute the requirement of payment to be on behalf of ‘the person responsible for paying’. The Court explained that the payment/credit in the account should arise from the obligation of ‘the person responsible for paying’, and payee has to be the person having the right to receive payment from ‘person responsible for paying’. When such a condition is satisfied, it does not matter if such payment is made ‘indirectly’.

The Court expressed that the services rendered by an agent to the principal should not be in the nature of professional services as per Explanation (i) to Section 194-H of the 1961 Act, which also restricts application to services rendered in the course of buying and selling goods, or regarding any transaction relating to any asset, valuable article, or thing, not being securities. The Court further explained that latter part of the said Explanation was a requirement and a pre-condition, which should not be read as diminishing or derogating the requirement of principal-agent relationship between the payer and the payee/recipient.

The Court referred to Singapore Airlines Ltd. v. CIT, (2023) 1 SCC 497 and hinted towards the settled principle that “the expression ‘acting on behalf of another person’ postulates the existence of a legal relationship of principal and agent, between the payer and the recipient/payee. The law of agency is technical. Whether in law the relationship between the parties is that of principal-agent is answered by applying Section 182 of the Contract Act, 1872.” Based on this, the Court explained that when a legal relationship of principal-agent is established, the obligation to deduct tax at source arises in terms of Section 194-H of 1961 Act.

The Court went on to peruse Section 182 of Contract Act illuminating the concept of agent’ and ‘principal’ and explained that Agency is a triangular relationship between principal, agent and third party, which may be understood by examining the inter se relationship between principal and third party, and the agent with third party. The Court laid down aspects to be considered while examining the existence of such a relationship:

a) “Legal power vested with the agent to alter his principal’s legal relationship with a third party and the principal’s co-relative liability to have his relations altered;

b) Exercise of a degree of control by the principal over the conduct of activities of the agent, being less than the control exercised by a master on his servant, and different from the rights and obligations in case of principal to principal and independent contractor relationship

c) Task entrusted by the principal to the agent to result in a fiduciary relationship, being the manifestation of consent by one person to another, to act on his/her behalf, subject to his/her control, and the reciprocal consent by the other person for doing the same;

d) Since the business done by the agent is on the principal’s account, the agent is liable to render accounts thereof to the principal. The agent is entitled to remuneration from the principal for the work he performs for the principal.”

The Court further pointed towards three other relevant aspects, first being the difference between ‘power’ and ‘authority’, second being the agent’s primary task to enter contracts on behalf of his principal or to dispose of his property, and third being that the substance of relationship notwithstanding the nomenclature, having primary importance. Magnifying the importance of true nature of the relationship, the Court explained that “An agent is distinct from a servant, in that an agent is subject to less control than a servant, and has complete, or almost complete discretion as to how to perform an undertaking.” The Court cited Bhopal Sugar Industries Ltd. v. STO, (1977) 3 SCC 147 to highlight the said difference, supported by catena of cases.

The Court discussed complex contracts incorporating multiple rights and obligations and commented that “the true factual position must be investigated to determine whether a relationship of agency has come into existence between a set of parties or individuals.”

Coming back to the instant facts, the Court noted that the assessees were cellular mobile telephone service providers in different circles as per license granted under Section 4 of the Indian Telegraph Act, 1885. For carrying out their business, the assessees need to comply with the conditions of license, rules and regulations of Department of Telecommunications (‘DoT’) and the Telecom Regulatory Authority of India (‘TRAI’). The Court explained that the service providers in the instant matter had wide latitude to select the business model they wish to adopt in their dealings with third parties, subject to statutory compliance being made by the operators.

As per the business model adopted by the telecom companies, the users could avail post-paid and prepaid connections, and the instant matter pertained only to the business operations under prepaid model, wherein, the end-users had to pay for services in advance, which can be done by purchasing recharge vouchers or top-up cards from retailers. For a new prepaid connection, the customers or end-users purchase a kit, called a start-up pack, which contains a Subscriber Identification Mobile card, commonly known as SIM card, and a coupon of the specified value as advance payment to avail the telecom services.

The assessees in the instant matter entered into franchise or distribution agreements with several parties, who sell start-up kits and recharge vouchers of specific value at a discounted price to the franchisee/distributors based on the price printed on the packs. The assessees claimed that the said discounted amount was not a ‘commission or brokerage’ under Explanation (i) to Section 194-H of 1961 Act. Contrary to this, the Revenue claimed that the difference between ‘discounted price’ and ‘sale price’ in the hands of the franchisee/distributors being in the nature of ‘commission or brokerage’ is the income of the franchisee/ distributors, the relationship between the assessees and the franchisee/distributor is in the nature of principal and agent, and therefore, the assesses are liable to deduct tax at source under Section 194-H of the Act.

The Court referred to relevant clauses of the franchisee/distributor agreement with Bharti Airtel Limited and pointed out that the franchisee/distributor was appointed for marketing of prepaid services and appointing the retailer/outlets for sale promotion. The retailers/outlets for sale promotion were appointed by the franchisee/distributor and not the assessee. The Court further highlighted the franchisees/distributors having agreed not to undertake activities mentioned in the agreement for any other competitive cellular mobile telephone service provider in the business, who in turn have to comply with statutory, regulatory and municipal permissions while conducting their business, to indemnify and keep indemnified the assessee against any and all costs, expenses and charges imposed on the assessee because of any action by a statutory, regulatory or municipal authority due to non-compliance by the franchisee/distributor.

The Court further explained that the franchisee/distributor must maintain a suitable establishment for conduct of business and performing obligations, and adhere to policies communicated to it from time to time while doing so. They employ adequate employees for performing its obligations, and all contractual and statutory payments, including wages, are to be paid by the franchisee/distributor. It further highlighted when assessee may call upon the franchisee/distributor to make alterations, modifications in furniture, air conditioning equipment, etc., and such costs are borne by the franchisee/distributor. The franchisee/distributor follow guidelines and directions of assessee and at no point the right/title/interest in prepaid cards passes on to them, but with the assessee. The franchisee/distributor are solely responsible for safe keeping and shortage of prepaid start-up kits, etc., and the assessee is not liable for any loss, pilferage or damage to the same. Upon termination, the franchisee/distributor has to return all advertising and promotional material to the assessee, who in turn is not liable for any loss of profits/compensation/prospective profits etc. The franchisee/distributor collects agreement/contract forms after obtaining customer signatures, which are duly completed and forwarded to the assessee for verification and record.

The Court acknowledged Revenue’s submission that the prepaid SIM cards remained the assessee’s property while franchisee/distributor held no right/title/interest on the same, but highlighted that this was a mandate of license issued by DoT, because the right to use and possess the SIM card is handed over to the end-user/customer who installs the same in his/her phone to avail telecommunication services. The Court expressed that the contractual obligations of franchisees/distributors did not reflect fiduciary relationship or business done on principal’s account, since they earn when they sell the prepaid products, profits being the difference between the sale price received from customer and discounted price at which they acquired the product.

Since Revenue claimed that the tax at source as per Section 194-H was to be deducted on the difference between printed price and the discounted price, that was incorrect according to the Court since Revenue could not insist franchisee/distributor to sell the products at printed price and not below that. The sale price and the income of franchisee/dstributor is determined by themselves and the third parties, while the assessee does not credit their account with the income through commission/brokerage on which tax at source would be deducted under Section 194-H of 1961 Act.

The Court expressed that “The expression “direct or indirect” used in Explanation (i) to Section 194-H of the Act is no doubt meant 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 agentpayee. However, 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.” Coming to instant facts, the Court clarified that assessees neither pay nor credit any income to the person with whom they contracted with. It added that “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. Neither does the word “indirectly” create an obligation where the main provision does not apply. The tax legislation recognises diverse relationships and modes in which commerce and trade are conducted, albeit obligation to tax at source arises only if the conditions as mentioned in Section 194-H of the Act are met and not otherwise.” Thus, the Court rejected the applicability of Singapore Airlines (supra) in the instant matter.

The Court clarified that the legal position of a distributor and agent was not similar, for a distributor is an independent contractor, not being a communicator between principal and the third party unlike an agent, free from control of his employer. The Court thereby held that Section 194-H of 1961 Act was not applicable to assessee in the instant matter.

[Bharti Cellular Ltd. v. Assistant Commissioner of Income Tax, 2024 SCC OnLine SC 198, decided on 28-02-2024]

Judgment authored by: Justice Sanjiv Khanna

Know Thy Judge| Supreme Court of India: Justice Sanjiv Khanna

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