Supreme Court clarifies tax deduction on commission for telecom services: Bharti Cellular vs. Assistant Commissioner of Income Tax (2024)

Case Background

The case involves appeals from various telecom service providers, including Bharti Cellular Limited (now Bharti Airtel Limited), and the Income Tax Department. The dispute arose from differing interpretations of Section 194H of the Income Tax Act, 1961, regarding the liability to deduct tax at source (TDS) on payments made to franchisees/distributors. Telecom companies sell prepaid SIM cards and recharge vouchers to distributors at a discounted price. The Income Tax Department argued that the difference between the discounted price and the selling price by the distributors is a commission or brokerage, which attracts TDS under Section 194H. The telecom companies contended that they are not paying a commission or brokerage, and the distributors are not their agents.

Timeline

Course of Proceedings

The High Courts of Delhi and Calcutta ruled that telecom companies were liable to deduct tax at source under Section 194H of the Income Tax Act, 1961. Conversely, the High Courts of Rajasthan, Karnataka, and Bombay held that Section 194H was not applicable in these circumstances. This divergence in opinion led to the appeals being filed before the Supreme Court of India.

Legal Framework

The core legal provision in question is Section 194H of the Income Tax Act, 1961, which mandates the deduction of tax at source (TDS) on commission or brokerage payments. The relevant portion of Section 194H states:

“194-H. Commission or brokerage. — Any person, not being an individual or a Hindu undivided family, who is responsible for paying, on or after the 1st day of June, 2001, to a resident, any income by way of commission (not being insurance commission referred to in Section 194-D) or brokerage, shall, at the time of credit of such income to the account of the payee or at the time of payment of such income in cash or by the issue of a cheque or draft or by any other mode, whichever is earlier, deduct income tax thereon at the rate of five per cent:
Provided that no deduction shall be made under this section in a case where the amount of such income or, as the case may be, the aggregate of the amounts of such income credited or paid or likely to be credited or paid during the financial year to the account of, or to, the payee, does not exceed fifteen thousand rupees:
Provided further that an individual or a Hindu undivided family, whose total sales, gross receipts or turnover from the business or profession carried on by him exceed one crore rupees in case of business or fifty lakh rupees in case of profession during the financial year immediately preceding the financial year in which such commission or brokerage is credited or paid, shall be liable to deduct income tax under this section.
Provided also that no deduction shall be made under this section on any commission or brokerage payable by Bharat Sanchar Nigam Limited or Mahanagar Telephone Nigam Limited to their public call office franchisees.”

Explanation (i) to Section 194H of the Income Tax Act, 1961, defines ‘commission’ or ‘brokerage’ as:

““commission or brokerage” includes any payment received or receivable, directly or indirectly, by a person acting on behalf of another person for services rendered (not being professional services) or for any services in the course of buying or selling of goods or in relation to any transaction relating to any asset, valuable article or thing, not being securities;”

The Court also referred to Section 182 of the Indian Contract Act, 1872, which defines an agent and a principal:

“182. “Agent” and “principal” defined. — An “agent” is a person employed to do any act for another, or to represent another in dealings with third persons. The person for whom such act is done, or who is so represented, is called the “principal”.”

The Court emphasized that the relationship between the payer and the recipient must be that of a principal and agent for Section 194H of the Income Tax Act, 1961, to apply.

Arguments

Arguments of the Telecom Companies:

• ✓ The telecom companies argued that they sell start-up kits and recharge vouchers to franchisees/distributors at a discounted price.
• ✓ They contended that the discount is not a commission or brokerage and that the franchisees/distributors are not their agents.
• ✓ The telecom companies emphasized that the distributors purchase the products and sell them at their own risk, thus acting as independent contractors.
• ✓ They highlighted that the distributors’ profit is the difference between their purchase price and their selling price, and the telecom companies have no control over the final selling price.
• ✓ The telecom companies argued that the relationship between them and the distributors is on a principal-to-principal basis, not a principal-agent relationship.

Arguments of the Income Tax Department:

• ✓ The Income Tax Department argued that the difference between the discounted price and the selling price by the distributors is in the nature of commission or brokerage.
• ✓ They contended that the distributors act on behalf of the telecom companies, making them agents.
• ✓ The department submitted that the telecom companies are liable to deduct tax at source under Section 194H of the Income Tax Act, 1961, on this commission or brokerage.
• ✓ The Revenue relied on the expression “payment received or receivable, directly or indirectly” in Explanation (i) to Section 194H of the Income Tax Act, 1961, arguing that even if the distributor receives payment from the end-user, it should be subjected to TDS.
• ✓ The department cited the decision in Singapore Airlines Ltd. v. Commissioner of Income Tax (2023) 1 SCC 497 to support their argument.

Issues Framed by the Supreme Court

The Supreme Court framed the following key issue:

1. Whether the discount offered by telecom service providers to their franchisees/distributors constitutes a “commission or brokerage” under Explanation (i) to Section 194H of the Income Tax Act, 1961, thereby obligating the telecom companies to deduct tax at source?

Treatment of the Issue by the Court

Authorities

The Supreme Court considered the following authorities:

Cases:

• ✓ Singapore Airlines Ltd. v. Commissioner of Income Tax (2023) 1 SCC 497 – Supreme Court of India. This case was distinguished by the Court as it involved a different business model and a clear principal-agent relationship.
• ✓ Bhopal Sugar Industries Limited v. Sales Tax Officer, Bhopal (1977) 3 SCC 147 – Supreme Court of India. This case was cited to highlight the distinction between a contract of sale and a contract of agency.
• ✓ Commissioner of Income Tax, Ahmedabad and Others v. Ahmedabad Stamp Vendors Association (2014) 16 SCC 114 – Supreme Court of India. This case reiterated the test for determining the principal-agent relationship in the context of Section 194H.
• ✓ Director, Prasar Bharati v. Commissioner of Income Tax, Thiruvananthapuram (2018) 7 SCC 800 – Supreme Court of India. This case discussed the inclusive definition of “commission or brokerage” in Section 194H.
• ✓ Commissioner of Income Tax v. Singapore Airlines Ltd. (2009) 319 ITR 29 – Delhi High Court. The Court noted that the Revenue did not challenge the Delhi High Court’s decision that TDS is not required on discounted tickets sold by airlines through travel agents.

Legal Provisions:

• ✓ Section 194H of the Income Tax Act, 1961 – This section mandates the deduction of tax at source on commission or brokerage payments.
• ✓ Section 182 of the Indian Contract Act, 1872 – This section defines an agent and a principal.
• ✓ Section 204 of the Income Tax Act, 1961 – This section defines the “person responsible for paying.”
• ✓ Section 4 of the Indian Telegraph Act, 1885 – This section pertains to the licensing of telecom service providers.

Judgment

How each authority was viewed by the Court:

• ✓ Singapore Airlines Ltd. v. Commissioner of Income Tax [(2023) 1 SCC 497]* was distinguished by the Court. The Court clarified that the facts of the case were different and that there was a clear principal-agent relationship in the Singapore Airlines case, which was not present in the current case.
• ✓ Bhopal Sugar Industries Limited v. Sales Tax Officer, Bhopal [(1977) 3 SCC 147]* was followed by the Court. The Court used this case to highlight the distinction between a contract of sale and a contract of agency, emphasizing that in a sale, the title passes to the buyer, while in an agency, the agent sells on behalf of the principal.
• ✓ Commissioner of Income Tax, Ahmedabad and Others v. Ahmedabad Stamp Vendors Association [(2014) 16 SCC 114]* was followed by the Court. The Court reiterated the test for determining the principal-agent relationship in the context of Section 194H, emphasizing the need for a legal relationship of principal and agent.
• ✓ Director, Prasar Bharati v. Commissioner of Income Tax, Thiruvananthapuram [(2018) 7 SCC 800]* was explained by the Court. The Court discussed the inclusive definition of “commission or brokerage” in Section 194H, but clarified that it does not negate the requirement of a principal-agent relationship.
• ✓ Commissioner of Income Tax v. Singapore Airlines Ltd. [(2009) 319 ITR 29]* was noted by the Court. The Court acknowledged that the Revenue did not challenge the Delhi High Court’s decision that TDS is not required on discounted tickets sold by airlines through travel agents.

What weighed in the mind of the Court?

The Supreme Court’s decision was primarily influenced by the following factors:

• ✓The absence of a principal-agent relationship between telecom companies and their distributors.
• ✓The distributors’ role as independent contractors who purchase and sell products at their own risk.
• ✓The fact that the telecom companies do not pay or credit any income to the distributors.
• ✓The need to avoid an interpretation of Section 194H that would unduly burden businesses.
• ✓The understanding that the term “indirectly” in Explanation (i) to Section 194H does not extend to payments received by distributors from third parties.

Sentiment Analysis of Reasons Given by the Supreme Court

Ratio of Fact:Law

The Court emphasized the factual aspects of the business model and the legal interpretation of the relevant provisions.

Logical Reasoning:

The Court considered alternative interpretations of Section 194H of the Income Tax Act, 1961, but rejected them as they did not align with the factual and legal framework of the case. The Court emphasized that tax laws should be interpreted pragmatically and realistically and that the obligation to deduct tax at source should not be extended to situations where the conditions of Section 194H are not met.

The Court’s decision was unanimous, with both judges concurring on the final judgment. The reasoning was based on a thorough analysis of the facts, the legal provisions, and the authorities cited. The Court highlighted that the distributors act as independent contractors, not agents, and that the discount offered by the telecom companies is not a commission or brokerage.

The Court quoted the following from the judgment:

“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 agent-payee. 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.”

“Deduction of tax at source is a substantial source of the direct tax revenue. The ease of collection and recovery is obvious. Deduction and deposit of tax at source checks evasion and non-payment of tax. It expands the tax base. However, the assessee as a deductor is not paying tax on his/her income, and collects and pays tax otherwise payable by the third party. Liability of the third party to pay tax when not deducted remains unaffected. Failure to deduct tax at source has serious and quasi-penal consequences for an assessee. The deduction of tax provisions should be programmatically and realistically construed, and not as enmeshes or by adopting catch-as-catch-can approach.”

“Thus, the term ‘agent’ denotes a relationship that is very different from that existing between a master and his servant, or between a principal and principal, or between an employer and his independent contractor. Although servants and independent contractors are parties to relationships in which one person acts for another, and thereby possesses the capacity to involve them in liability, yet the nature of the relationship and the kind of acts in question are sufficiently different to justify the exclusion of servants and independent contractors from the law relating to agency. In other words, the term ‘agent’ should be restricted to one who has the power of affecting the legal position of his principal by the making of contracts, or the disposition of the principal’s property; viz. an independent contractor who may, incidentally, also affect the legal position of his principal in other ways.”

Key Takeaways

• ✓ Telecom companies are not required to deduct tax at source under Section 194H of the Income Tax Act, 1961, on the income earned by their distributors from the sale of prepaid SIM cards and recharge vouchers.
• ✓ The relationship between telecom companies and their distributors is that of a principal-to-principal, not a principal-agent.
• ✓ Distributors act as independent contractors, buying and selling products at their own risk.
• ✓ The discount offered by telecom companies to their distributors is a trade discount, not a commission or brokerage.
• ✓ The judgment clarifies the scope of Section 194H and provides guidance for similar commercial relationships.

Directions

No specific directions were given by the Supreme Court in this judgment.

Development of Law

The ratio decidendi of this case is that a principal-agent relationship is a prerequisite for the applicability of Section 194H of the Income Tax Act, 1961. The Supreme Court clarified that the term “indirectly” in Explanation (i) to Section 194H does not extend to payments received by distributors from third parties. This judgment establishes that distributors in the telecom sector, who act as independent contractors, do not fall under the purview of Section 194H. This decision clarifies the legal position concerning tax deductions on payments made to distributors, providing a clearer understanding of the obligations of telecom companies.

Conclusion

The Supreme Court’s judgment in the case of Bharti Cellular Limited vs. Assistant Commissioner of Income Tax clarifies that telecom companies are not required to deduct tax at source under Section 194H of the Income Tax Act, 1961, on the income earned by their distributors. The Court held that the relationship between telecom companies and their distributors is that of a principal-to-principal, not a principal-agent. This decision provides clarity on the interpretation of Section 194H and offers significant relief to telecom companies. The judgment also emphasizes the importance of distinguishing between different types of commercial relationships and the need for a pragmatic interpretation of tax laws.