2024 (4) TMI 1261 - HC - Income Tax

TDS u/s 194H - payments made to distributors or franchisees - HELD THAT - Undisputedly the aforesaid questions stands answered in favour of the assessee in light in Bharti Cellular Ltd 2024 (3) TMI 41 - SUPREME COURT we hold 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 prepaid coupons or starter-kits to the distributors. Section 194H of the Act is not applicable to the facts and circumstances of this case. Accordingly the appeals filed by the assessee - cellular mobile service providers challenging the judgments of the High Courts of Delhi and Calcutta are allowed and these judgments are set aside.

Summary

1. ISSUES PRESENTED and CONSIDERED

The core legal question considered by the Court was whether the Income Tax Appellate Tribunal erred in its interpretation of Section 194-H of the Income Tax Act, 1961, specifically in the context of payments made to distributors or franchisees. The issue revolved around the applicability of tax deduction at source (TDS) under Section 194-H on commissions or brokerage payments made by the assessee to such entities.

2. ISSUE-WISE DETAILED ANALYSIS

Issue: Applicability of Section 194-H of the Income Tax Act, 1961, on payments made to distributors/franchisees and whether such distributors/franchisees qualify as "agents" under the said provision.

Relevant Legal Framework and Precedents: Section 194-H mandates deduction of tax at source on commission or brokerage payments made by a person to an agent. The legal interpretation of "agent" under this provision was central to the dispute. The Supreme Court's recent authoritative judgment in Bharti Cellular Ltd. v. CIT was pivotal, as it addressed the distinction between agents and independent contractors/distributors/franchisees in the context of TDS obligations under Section 194-H.

Court's Interpretation and Reasoning: The Court relied extensively on the Supreme Court's elucidation in Bharti Cellular Ltd., which clarified the legal distinction between an agent and an independent contractor such as a distributor or franchisee. The Court noted that a distributor operates as an independent contractor who purchases goods on his own account and sells them independently within a designated territory. The distributor's profit arises from the margin between purchase and sale prices, unlike an agent who acts primarily as a communicator or intermediary creating contractual relationships on behalf of the principal.

The Court highlighted that franchise agreements, although closely regulated and detailed, still generally establish an independent contractor relationship rather than an agency. The franchisee's operations, despite restrictions, are governed by the terms of the contract and the degree of control exercised by the franchisor. The Court emphasized that the term "agent" under Section 194-H should be narrowly construed to mean a person who has the power to affect the legal position of the principal by making contracts or disposing of the principal's property. The Court referred to specific indicia outlined in paragraph 8 of the Supreme Court judgment Bharti Cellular, which include the extent of control, fiduciary relationship, and authority to bind the principal.

Key Evidence and Findings: The factual matrix revealed that the distributors/franchisees purchased goods or prepaid coupons/starter kits on their own account and sold them independently to customers. There was no fiduciary relationship or authority to bind the principal in contracts with third parties. The distributors were not required to render accounts to the principal, reinforcing their status as independent contractors rather than agents.

Application of Law to Facts: Applying the legal principles, the Court concluded that the distributors/franchisees did not fall within the ambit of "agents" as defined under Section 194-H. Consequently, the payments made to them did not attract TDS under this provision. The Court found that the Income Tax Appellate Tribunal's contrary interpretation was erroneous.

Treatment of Competing Arguments: The Revenue's argument that distributors/franchisees should be treated as agents for the purpose of TDS was rejected. The Court noted that the Supreme Court in Bharti Cellular had already settled this issue in favor of the assessee, clarifying that distributors and franchisees are independent contractors and not agents. The Court did not find any merit in the Revenue's contention and relied on the binding precedent to resolve the dispute.

Conclusions: The Court held that Section 194-H does not apply to payments made to distributors/franchisees who operate as independent contractors. Therefore, there was no obligation on the assessee to deduct tax at source on such payments. The appeals were allowed, and the orders of the Income Tax Appellate Tribunal were set aside to the extent they held otherwise.

3. SIGNIFICANT HOLDINGS

The Court preserved the following crucial legal reasoning from the Supreme Court judgment in Bharti Cellular Ltd.:

"The distributor buys goods on his account and sells them in his territory. The profit made is the margin of difference between the purchase price and the sale price. The reason is, that the distributor in such cases is an independent contractor. Unlike an agent, he does not act as a communicator or creator of a relationship between the principal and a third party."

"An independent contractor is free from control on the part of his employer, and is only subject to the terms of his contract. But an agent is not completely free from control, and the relationship to the extent of tasks entrusted by the principal to the agent are fiduciary."

"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."

"In view of the aforesaid discussion, we hold 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 prepaid coupons or starter-kits to the distributors. Section 194H of the Act is not applicable to the facts and circumstances of this case."

The Court's final determination was that the Income Tax Appellate Tribunal erred in holding that Section 194-H applied to payments made to distributors/franchisees. The appeals were allowed, and the Tribunal's orders were set aside insofar as this issue was concerned.