In a significant ruling impacting foreign companies operating in India, the Supreme Court has clarified that tax deducted at source (TDS) on payments to non-resident entities cannot exceed 10% if a Double Tax Avoidance Agreement (DTAA) specifies such a limit. This pronouncement overrides the Income Tax Department's practice of demanding a higher 20% TDS in cases where the foreign entity has not furnished a Permanent Account Number (PAN).

The apex court's decision came in response to appeals filed by the Income Tax Department against various information technology companies, including Mphasis, Wipro, and Manthan Software Services. The department had sought a 20% TDS, arguing that these companies had failed to provide PANs, as required by Section 206AA of the Income Tax Act.

However, the Supreme Court upheld the Karnataka High Court's 2022 order, stating that the DTAA rate, which in some cases is 10%, would take precedence over Section 206AA. The court emphasized that the TDS provisions in the Income Tax Act 1961 must be interpreted in conjunction with the DTAA when calculating tax liability. It asserted that if a foreign recipient is eligible for treaty benefits, the TDS deduction cannot exceed the 10% cap stipulated in the DTAA.

The Supreme Court's ruling reinforces the principle that DTAAs, which India has signed with numerous countries, are designed to prevent double taxation and promote international trade and investment. These agreements typically provide for lower tax rates or exemptions on certain types of income, such as dividends, interest, and royalties.

The revenue department had argued that during a survey under Section 133A(2A)A, it was found that these assessees were making remittances to non-resident entities without deducting TDS. It further contended that every payee was required to furnish a PAN, and in the absence of one, the applicable tax rate should be 20% according to Section 206-AA(1)(iii).

The companies, which provide software support and development services, argued that the DTAA provisions should prevail. The Supreme Court agreed, stating that any interpretation allowing the taxing authority to demand more than 10% would be inconsistent with the treaty. This decision aligns with a previous ruling by the Delhi High Court in July 2022, which also held that Section 206AA cannot override DTAA provisions.

This ruling provides clarity and certainty for foreign companies receiving payments from Indian entities. It affirms that the beneficial provisions of DTAAs will be respected, even if the foreign company does not have a PAN. However, foreign companies must ensure they meet all other requirements to claim DTAA benefits, such as providing a Tax Residency Certificate (TRC) and Form 10F.

The Supreme Court's decision is expected to reduce tax-related disputes and promote a more favorable environment for foreign investment in India. It also underscores the importance of carefully considering DTAA provisions when determining TDS obligations on cross-border payments.