Supreme Court: TDS on Foreign Transfers Cannot Exceed 10%

On Tuesday, in an important judgment, the Supreme Court said that TDS (Tax Deduction at Source) on payments made to foreign companies cannot be more than 10%, as allowed under different DTAA (Double Tax Avoidance Agreements). The decision puts to rest a long-standing dispute between the income tax department and several information technology companies, including Mphasis, Wipro and Manthan Software Services.

The apex court held that provisions of the Income Tax Act, 1961, must be read harmoniously with the DTAA when calculating tax liability. When a foreign recipient qualifies for treaty benefits, the rate of TDS specified in the DTAA (often 10%) will prevail. Any higher deduction demanded by the tax authorities would be inconsistent with the terms of the treaty, the court observed.

The court clarified that it would not allow the income tax department's request to enforce a higher 20% TDS (Tax Deducted at Source) under Section 206AA of the Income Tax Act. The department claimed that the companies did not provide their PANs (Permanent Account Numbers), so the 20% rate should apply by default. However, the Supreme Court affirmed that the DTAA’s concessional rate takes precedence when its provisions are applicable.

Upholding the Karnataka High Court’s 2022 ruling, the bench noted that the DTAA rates, ranging between 10% and 15% depending on the country, must prevail over domestic law in case of conflict. The court emphasised that allowing taxation at rates higher than those agreed upon internationally would undermine India’s treaty obligations and create uncertainty for cross-border transactions.

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The Supreme Court also took reference to its earlier viewpoint, which supports the Delhi High Court's July 2022 decision. This decision stated that Section 206AA cannot override the rules of DTAA. Both rulings highlight that when a treaty benefits apply, they protect taxpayers from the higher withholding tax rates set by domestic law.

During the court proceedings, the tax authorities informed that a tax survey under Section 133A(2A) showed that specific software and technology companies sent money overseas without deducting the required TDS. They stated that without PAN details, a 20% deduction automatically applies under Section 206AA.

However, the companies argued that all remittances were made towards technical and software development services rendered by non-residents under the applicable DTAA. Since the foreign payees were eligible for treaty benefits, the firms maintained that deducting more than 10% would contravene international tax rules.

The Supreme Court’s verdict brings much-needed clarity to technology exporters and businesses making payments overseas. The court has confirmed that the rules in Double Tax Avoidance Agreements (DTAA) take precedence over conflicting parts of the Income Tax Act. This decision aligns India’s tax system with global standards and makes it easier to understand for cross-border transactions.

As a result, this ruling is likely to significantly affect tax compliance and attract more foreign investment. Experts believe it will encourage multinational collaborations by reducing the risk of double taxation and restoring investor confidence in India’s adherence to international tax treaties.

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