The Supreme Court of India has held that, “the assessees would not be under a legal obligation to deduct tax at source on the income/profit component in the payments received by the distributors/franchisees from the third parties/customers, or while selling/transferring the pre-paid coupons or starter-kits to the distributors.”
It was also held that, “Section 194-H of the Act is not applicable to the facts and circumstances of this case.”
The bench of Justices Sanjiv Khanna and SVN Bhatti emphasized that there is no legal obligation for the assessees to deduct tax at source on the income/profit component in payments received by the distributors/franchisees.
The assessees, Bharti Airtel Limited – cellular mobile service providers, had entered into franchise/distribution agreements related to their prepaid connections, selling start-up kits and recharge vouchers at a discounted price to franchisee/distributors. The dispute arose regarding whether the assessees should deduct tax at source on the income/profit component in payments received by franchisees/distributors from third parties/customers.
Contrary opinions existed among High Courts, with Delhi and Calcutta ruling in favor of tax deduction, while Rajasthan, Karnataka, and Bombay held otherwise. The matter was brought before the Supreme Court by both the Revenue and the assessees.
The assessees contended that they were not paying commission or brokerage to franchisees/distributors and that they were not acting as agents for them. On the other hand, the Revenue argued that the difference between the discounted price and sale price constituted income for franchisees/distributors, making them agents eligible for tax deduction under Section 194-H.
The court noted that the obligation to deduct tax at source arises when the legal relationship of principal-agent is established, as per Section 182 of the Contract Act, 1872. It observed that although the discounted price is negotiated between the assessees and franchisee/distributor, the sale price received by the latter is at their sole discretion, and the assessees have no control over it. The income of franchisee/distributor is not credited by the assessees, and they are not privy to transactions between distributors/franchisees and third parties.
The Supreme Court held that Section 194-H is not applicable in this case, emphasizing that the deduction of tax provisions should be realistically construed. The court rejected the suggestion of periodic information requests from assessees, stating it as an unfair obligation beyond statutory mandate.
The top court allowed the assessees’ appeals against Delhi and Calcutta High Court judgments while dismissing the appeals filed by the Revenue concerning other judgments.
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