Summary: Tax Deducted at Source (TDS) provisions under the Indian Income Tax Act, 1961, are crucial for efficient tax collection but have become increasingly complex and burdensome. With over thirty provisions and rates ranging from 0.1% to 40%, taxpayers face significant challenges in categorizing payments correctly, such as distinguishing between “commission” and “discount” or “fee for professional services” versus “technical services.” The recent introduction of Section 194R, which mandates TDS on benefits and perquisites, adds further complexity, particularly regarding the classification of rewards and loyalty points. The e-commerce sector also grapples with the onerous task of withholding TDS on gross sales under Section 194-O, even if transactions are directly completed by buyers and sellers. Additionally, the threshold for TDS on online gaming winnings under Section 194BA is considered excessively low, exacerbating compliance issues. Recommendations include streamlining TDS provisions, increasing thresholds, and reducing rates to alleviate the compliance burden, particularly for small taxpayers and creditors. Simplifying and consolidating the numerous TDS provisions and leveraging technology for better compliance and enforcement could improve the system’s efficiency and fairness, ensuring it adapts to the evolving business landscape.
Tax Deducted at Source (TDS) provisions within the Indian Income Tax Act of 1961 (IT Act) have long served as a fundamental aspect of the country’s tax framework. In this system, a payer, also known as a deductor, is entrusted with the responsibility to ensure the deduction and timely deposit of taxes to the government, thereby preventing potential penalties and adverse repercussions. Through the TDS mechanism, the Indian tax authorities efficiently collect taxes directly from the sources of income.
As India’s business landscape continues to evolve, with the emergence of modern players like digital platforms and the online gaming sector, the TDS provisions have undergone continual updates to keep pace. This adaptability reflects the comprehensive nature and broad applicability of these provisions. However, with time, the TDS provisions have grown in complexity, currently comprising over thirty provisions with varying rates ranging from 0.1% to 40%.
Some cases where a payer faces challenges on a regular while striving to comply with the TDS provisions with possible solutions for the same are discussed below.
Categorisation conundrum
Taxpayers are often entangled with litigation where the classification of payments into different categories and whether the provisions of Tax Deducted at Source are applicable. These disputes usually revolve around the determination of “commission” or “discount” from a range of payments or deciding if the transaction is about the “goods” or the “capital asset” or “work contract” or “contract of sales.” Other controversies revolve around determining if “reimbursement” is a “benefit” or “perquisite” or deciding the distinction between “fee for professional services” and “fee for technical service”.
These distinctions depend on various factors, such as the service’s nature, agreement terms, the parties’ relationship, and disclosures in their financial records. For example, in Section 194J of the IT Act, discerning whether a payment falls under FPS or FTS can be complex and time-consuming due to their resemblances. Consequently, disputes often arise over the applicable TDS rate, whether it’s 10% or 2%.
To illustrate the complexities further, consider the ambiguity surrounding payments for professional and technical services. The similarity between these services often results in prolonged litigation over TDS rates, causing unnecessary legal battles for taxpayers.
While complete elimination of these problems may not be feasible, the Government must recognize and address them proactively. For instance, the multitude of tax withholding provisions for similar types of expenditures, such as interest, commission, winnings, FTS, and FPS, should be streamlined. These provisions should be consolidated to the greatest extent possible based on the overarching nature of the expenses they aim to cover.
Similarly, the confusion regarding the categorization of services as FTS or FPS, coupled with different TDS rates (2% and 10%), could be mitigated by prescribing a single rate, as was the case previously. This simplification would eliminate unnecessary complexity and uncertainty in tax compliance.
Moreover, issuing detailed guidelines periodically by the Government to address emerging issues or ambiguities faced by taxpayers during TDS calculations is recommended. This proactive approach would enhance clarity and facilitate smoother compliance for taxpayers.
Section 194R Implications: Threshold and Rate Review
The inclusion of a new provision in the IT Act, section 194R, by the Finance Act in 2022 has heightened the practical difficulties payers face. This provision requires TDS deduction for any “benefits” or “perquisites” received in business or profession. However, the broad definition of benefits and perquisites has perplexed taxpayers about whether or not it applies to transactions involving rewards and loyalty points, and incentive programs. As a result, taxpayers are re-evaluating their reward structures to comply.
This ambiguity may result in future tax litigation based on the distinction between the taxpayers and the tax provision authorities on the applicability of the regulation.
In order to address these objections, the Government needs to rationalise the scope of the provision. The annual threshold of 20,000 INR is considered to be low and should be increased to 5,000 INR per year. Moreover, the current 10% withholding rate is very burdensome. Since the purpose of the provision is to monitor the granting of benefits or perks, it would be better to reduce the withholding rate to 2%. This adjustment would alleviate the compliance burden on taxpayers while still achieving the intended regulatory objectives.
Third-Party Burden
Section 194-O of the IT Act is relevant to e-commerce operators who need to deduct TDS on the transaction of goods or services taxable through their digital platforms. However, this deduction is made on the entire amount of gross sales by the e-commerce participant. The most concerning aspect is the Explanation earlier Section 194-O makes it obligatory on the payer to deduct even if the buyer pays the seller, that is, the e-commerce participant directly, but it is still the onus of the e-commerce operator to make and deposit TDS. Burdensome impulses on e-commerce participant’s entities include such that these platforms need to continue monitoring transactions to comply with this electronic payment order since payment alerts may be delayed for obvious reasons.
Furthermore, aside from not withholding TDS in these cases, e-commerce operators are required to comply with several other TDS-related obligations. As indicated, even when the transaction is completed by the buyer with the seller directly, TDS returns and TDS certificates need to be submitted. With regard to the existing problem, the government could then review the obligations that e-commerce operators have in this case and analyze the benefits derived from this measure. Specifically, this would allow erasing the tax evasion and improve the obligation to the government while ensuring fairness in the overall taxation of e-commerce transactions.
Thresholds Reassessment in IT Act
Under the Finance Act 2023, TDS was initiated on Net Winnings (NWS) from any online games at a 30% rate under section 194BA of the IT Act. The provision did not have any minimum threshold to apply TDS. Subsequently, a 100 Rupee monthly limit was introduced under a CBDT circular dated 22 May 2023. However, the nominal threshold has differentiated minor winnings under TDS. This has primarily increased the compliance burden for online gambling companies. On the other hand, Section 194B of the IT Act deals with TDS on Winnings from Lottery Card Games or Betting with a 10 INR threshold.
Hence, the nominal threshold of INR 100 per month imposed under Section 194BA is unreasonably high when other similar provisions are considered. This unjustified distinction further compounds the compliance burden on online gaming companies. Therefore, it is critical to bring fairness and proportionality in the taxation of online gaming when compared to other forms of gaming. Additionally, the annual threshold limit of TDS under various IT Act provisions needs to be reviewed immediately. These limits have not been revised for many years leading to high compliance costs even for small taxpayers. For example, the threshold of INR 30,000 under section 194C or 194J of the IT Act is low and needs to be hiked.
Furthermore, as already mentioned, a large number of taxpayers – about 80% – and most of them are either individuals or Hindu Undivided Families – remain in the less-than-5-per-cent-tax-rate bracket. Yet, the TDS rates for this category exceed 10%, which is counterproductive and sometimes breaks even 20%. It is only reasonable to lower these rates to avoid taxpayers’ wasted time struggling for refunds in the future. This decision contributes to the tax system’s rationality and justice, especially for those in the smaller taxpayer category.
Debt Write-off: Double Blow for Creditors
Section 194R of the IT Act places the obligation of tax withholding on any benefit or perquisite provided by a creditor or lender when they write off or forgive a trading debt or loan extended to a party unable to fulfill its obligations, for any reason, such actions could be seen as the creditor or lender providing a “benefit” through such waivers or write-offs.
However, the CBDT Circular issued on September 13, 2022, stipulates that such waivers are only exempt from TDS when one-time settlements are made by banks with borrowers. It’s essential to recognize that writing off liabilities or loans is a prevalent practice in business transactions.
However, it does seem unfair to make it the job of creditors or lenders to withhold TDS when they are already struggling to recover their debts. It essentially adds insult to injury. Therefore, the tax authorities must review this provision and consider the practical implications on creditors and lenders.
Way forward
TDS serves as a crucial mechanism for tax authorities to collect taxes promptly, enabling funds to be available for various nation-building endeavors. With the advancement of automation, TDS has emerged as the primary tool for tax collection, facilitating early tax remittance to the government. Moreover, it functions as a means to trace transaction trails by analyzing the filings submitted by parties involved.
Over time, the government’s track transactions have increased significantly due to electronic data sharing between different departments, government bodies, and financial institutions. The government should harness technology to identify tax evaders and simplify compliance for small-scale taxpayers, businessmen, and traders. With India’s rapid progress, the compliance burden is growing steadily. It’s crucial not to discourage new compliant taxpayers they don’t understand or fear the consequences. Instead, efforts should focus on encouraging voluntary compliance, driven by taxpayers’ willingness rather than fear.
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