Section 195 vs Reimbursement to Non-Residents: When TDS Applies and When It Does Not (With GST RCM Implications)

Section 195 vs Reimbursement to Non-Residents: When TDS Applies and When It Does Not (With GST RCM Implications)

With increasing globalization, many Indian businesses work with consultants, employees, and representatives located outside India. A common situation arises where a non-resident individual pays certain expenses on behalf of an Indian company (such as software subscriptions or SaaS tools) and the Indian company later reimburses the amount.

This raises two important tax questions:

1. Does Section 195 require TDS on such payments to a non-resident?

2. Does GST Reverse Charge Mechanism (RCM) apply on the underlying expense?

This article explains the clear distinction between Fees for Technical Services (FTS) and pure reimbursements, and when Section 195 applies or does not apply, along with the GST implications.

Understanding Section 195 – Payments to Non-Residents

Under the Income-tax Act, 1961, Section 195 governs Tax Deduction at Source (TDS) on payments to non-residents.

The provision states that TDS must be deducted when:

Any sum chargeable under the provisions of the Income-tax Act is paid to a non-resident.

The crucial phrase here is “sum chargeable under the provisions of the Act.”

This principle was clarified by the Supreme Court in the landmark case:

GE India Technology Centre Pvt Ltd v. CIT

The Court held that:

TDS under Section 195 is required only if the payment contains income chargeable to tax in India.

Therefore, the correct analysis is:

1. Determine whether the payment is taxable in India.

2. If taxable → Section 195 applies.

3. If not taxable → No TDS obligation.

When Income of Non-Residents Becomes Taxable in India

Under the Income-tax Act, income of a non-resident becomes taxable in India only if it:

• Accrues or arises in India, or

• Is deemed to accrue or arise in India

These deeming provisions are mainly contained in Section 9 of the Income-tax Act.

Key categories include:

Among these, Fees for Technical Services (FTS) is the most relevant when analysing payments for consulting or IT-related services.

Fees for Technical Services (FTS): Why Section 195 Often Applies

Under Section 9(1)(vii), income from managerial, technical, or consultancy services paid by an Indian resident is deemed to accrue or arise in India.

This rule applies even if the services are performed outside India, unless the services are utilized for a business carried on outside India.

Examples of FTS

Typical services that may fall under FTS include:

• IT consulting

• Software architecture advisory

• Cybersecurity consulting

• Technical implementation support

• Systems integration services

• Management consulting

In such cases:

Therefore, physical location of the consultant does not eliminate taxability if the service qualifies as FTS.

When Section 195 Does NOT Apply

Not every payment to a non-resident attracts TDS. Section 195 does not apply in certain situations.

1. Pure Reimbursement of Expenses

If a person merely pays expenses on behalf of the Indian company, and the company reimburses the exact amount without markup, the payment does not constitute income.

Typical characteristics of genuine reimbursement:

• Expense belongs to the company

• Exact amount reimbursed

• No service fee or profit element

• Proper documentation available

In such cases:

Thus, pure reimbursements do not trigger TDS.

2. Business Income Without Permanent Establishment

If the payment represents business income of the non-resident, taxation depends on applicable tax treaties.

For example, under the India–USA Double Taxation Avoidance Agreement:

Business income of a foreign resident is taxable in India only if the enterprise has a Permanent Establishment (PE) in India.

If the non-resident:

• Performs services outside India

• Has no office or fixed place of business in India

Then:

Example: Reimbursement of SaaS Expenses

Consider the following situation.

An Indian company asks a representative in the USA to purchase a software subscription (for example, AI tools or SaaS services). The individual pays using a personal card and later receives reimbursement.

Since the payment does not represent income, Section 195 does not apply.

GST Implications – Reverse Charge Mechanism (RCM)

While reimbursement may not trigger TDS, GST implications must be analysed separately.

Most software subscriptions or AI tools are supplied by foreign service providers.

Under the Integrated Goods and Services Tax Act, 2017, an import of services occurs when:

1. Supplier is located outside India

2. Recipient is located in India

3. Place of supply is in India

If these conditions are satisfied, the transaction qualifies as import of service.

Reverse Charge Mechanism on Imported SaaS Services

Under GST law, import of services attracts GST under Reverse Charge Mechanism (RCM).

This means:

• Foreign supplier does not charge GST

• Indian recipient must pay GST directly

Applicable GST rate for most SaaS / software services:

18% IGST

Important point:

Even if the payment is made by an individual and later reimbursed, GST liability still arises if the service is used by the Indian company.

Illustration

Software subscription purchased from a foreign SaaS provider.

If the service is used for business purposes, the company may claim input tax credit, subject to GST conditions.

Compliance Best Practices

To ensure proper compliance, companies should maintain:

• Invoice from the foreign service provider

• Proof of payment made by the individual

• Reimbursement documentation

• Accounting entries supporting reimbursement

• GST RCM payment records

Proper documentation helps demonstrate that the payment is a pure reimbursement and not taxable income of the individual.

Final Takeaway

The applicability of Section 195 depends on whether the payment contains income taxable in India.

In summary:

• Technical or consultancy services (FTS) paid to non-residents are usually taxable in India and attract TDS under Section 195.

• Pure reimbursements without income element do not attract Section 195.

• However, where the underlying transaction involves foreign SaaS or software services, the Indian company must discharge GST under Reverse Charge Mechanism.

Need assistance with cross-border payments or GST RCM compliance?
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