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CONCEPT OF GROSSING UP/ INCOME TO BE PAID “NET OF TAX”& SECTION 206AA

CONCEPT OF GROSSING UP/ INCOME TO BE PAID “NET OF TAX” & SECTION 206AA

1. Sec 206AA

The provisions of Section 206AA of the Income tax Act, 1961 have been reproduced hereunder:

Notwithstanding anything contained in any other provisions of the Act, any person entitled to receive any sum or income or amount, on which tax is deductible under Chapter XVIIB shall furnish his Permanent Account Number (PAN) to the person responsible for deducting such tax, failing which tax shall be deducted at the higher of the following rates, namely:

  • at the rate specified in the relevant provision of this Act; or
  • at the rate or rates in force; or
  • at the rate of 20%.

2. Section 195A: Concept of Grossing up/ Income to be paid “Net of tax”

Grossing up for computing TDS to be done in cases where the payer bears the tax liability. The grossing up is to be done with the rates in force.

For example 1: A Ltd want to send Rs. 1000 to a Non-resident company net of taxes. The rate of TDS as per IT Act is 10%, effective rate turns out to be 10.5575% after including surcharge & cess, then grossing up will be done at 10%.

PARTICULARS Rs.
Net payment 1,000
Rate in force as per section 2(37A) 10%
Grossed amount [Rs. 1,00,00,000 × 100 ÷ 100 – 10] 1,111.11
Tax deductible under section 195 at rates in force  i.e 10% 111.11
  • Issues:

Whether grossing up would be required to be done in case payment is made net of tax to a foreign company which does not have a PAN in India, considering the provisions of section 206AA??

Bosch Ltd. v. ITO (2013) 141 ITD 38/155 TTJ 354 (Bang.)(Trib.)

Facts: Assessee availed services of repairs of its machinery from non-residents which included assistance for preventive maintenance. Assessee made payment of repair charges without deducting tax at source . Assessing Officer held that the payments amounted to ‘fees for technical services’ hence the assessee was held liable deduct tax at source. The Assessing Officer also held that since non-resident recipients did not furnish its PAN to assessee –deductor , tax at source was required to be deducted at higher rate under section 206AA. Commissioner (Appeals) up held the order of Assessing Officer

Issue: Rate applicable for grossing up in absence of PAN for Non resident.

Held: On appeal the Tribunal held that, services in question were not mere repairs but were towards preventive maintenance German company was providing technical assistance and services, payments made for said services amounted to ‘fee for technical services’. Assessee was liable to deduct tax at source while making payments to non resident.
Tribunal also held that the provisions of section 206AA are applicable and the assessee is liable to deduct tax at the higher rate prescribed under section 206AA i.e. 20% . As regards the grossing up is concerned the Tribunal held that the grossing up of the amount is to be done at the rates in force for the financial year in which such income is payable and not at 20 percent as specified under section 206AA.

  • Should grossing up be done at applicable rates in force or at 20%?

While grossing-up u/s 195A, rates in force should apply and not the higher rate of 20% u/s 206AA.

  •  Other Issues:

A. Whether Sec 206AA overrides the treaty rates?

In case of Non-resident’s covered by tax treaties following further issues may arise on applicability of Sec 206AA:

(a) Whether sec 206AA applies where TDS Rates as per treaty is NIL?

(b) Whether provisions of section 206AA cannot operate to override treaty rates?

The similar matter came to be decided recently before a Pune bench of ITAT in case of Serum Institute wherein the issue to be decided was whether a resident who has to deduct the TDS of non-resident u/s 195 who does not have PAN can deduct tax at the rate prescribed in DTAA if the same is beneficial applying the provisions of Section 90(2) of the Act or whether Sec 206AA would apply which states that TDS is to be deducted at rates in force or rates specified in relevant provisions or 20 % whichever is higher.

Pune Bench in its order considered the decision of Bangalore tribunal which had stated that 206AA overrides the Income Tax Act, 1961. But whether treaty was also overridden by the provisions of 206AA was not before the Bangalore bench of tribunal.

The DTAA is entered into between 2 countries for the purpose of Avoidance of Taxation and whether machinery provisions of TDS under Chapter XVII-B could decide the rate of withholding as against what has been decided by the countries mutually under the agreement. It was held that section 206AA of the IT Act would not override provisions of a DTAA to the extent that the latter is more beneficial to a taxpayer.

  • Case Study:

For grossing up provision u/s 195A, tax chargeable shall be grossed up at the rates in force. “Rates in force” is defined in Sec. 2(37A) as the Rates of income-tax specified in the Finance Act or the rates specified in the DTAA, whichever is lower will be applicable rates in force by virtue of Section 90 or Section 90A.

Case 1: When PAN is available

Example 1: When rates of both Income tax & treaty are same but effective tax under income tax comes out be greater because of applicability of surcharge & cess:

Suppose rates as per IT Act is 10%, effective rate turns out to be 10.5575% after including surcharge &cess and the treaty rate is 10% (rates of treaty are not to be increased by surcharge &cess), then grossing up will be done at 10%.

PARTICULARS Rs.
Net payment 1,000
Rate in force as per section 2(37A) 10%
Grossed amount [Rs. 1,00,00,000 × 100 ÷ 100 – 10] 1,111.11
Tax deductible under section 195 at rates in force  i.e 10% 111.11

Example 2: When effective rates under Income Tax is lower than rates under treaty:

Suppose rates as per IT Act is 10%, effective rate turns out to be 10.5575% after including surcharge &cess and treaty rate is 15% (rates of treaty are not to be increased by surcharge or education cess), then grossing up will be done at 10.5575%

PARTICULARS Rs.
Net payment 1,000
Rate in force as per section 2(37A) 10.5575%
Grossed amount [Rs. 1,00,00,000 × 100 ÷ (100 – 10.5575)] 1,118.037
Tax deductible under section 195 at rates in force i.e. 10.5575% 118.037

Case 2: When PAN is not available

Suppose rates as per IT Act is 10%, effective rate turns out to be 10.5575% after including surcharge & education and treaty rate is 15 %( rates of treaty are not to be increased by surcharge or cess), then grossing up will be done at 10.5575%. Consequently, the payment will be grossed up by applying the rate of 10.5575 %. Deduction will be at rate higher of:

(i)    at the rate specified in the relevant provision of IT Act i.e.10.5575%

(ii)   at the rate or rates in force; i.e. lower of 10.5575% or 15%

(iii)  at the rate of twenty percent. i.e. 20%

i.e. at 20 % in this case

PARTICULARS Rs.
Net payment 1,000
Rate in force as per section 2(37A) 10.5575%
Grossed amount [Rs. 1,00,00,000 × 100 ÷ (100 – 10.5575)] 1,118.037
Tax deductible under section 195 read with section 206AA at the rate of 20 per cent  223.607

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