Section 195 of the Income Tax Act is a provision designed to ensure that tax is collected at the source from payments made to non-residents that are chargeable to tax in India. This section applies when a person is responsible for paying any interest or other sum, not being salary, to a non-resident or a foreign company. The liability arises only if the income is chargeable to tax under the Income Tax Act. It is not the nature of the payment that determines the liability, but whether it is taxable in India.
Responsibility for Tax Deduction
The responsibility for deducting tax lies with the person making the payment. If the payer is an individual, they are considered the person responsible for paying. However, if the payer is a company, then the company and its principal officer are considered responsible. This includes payments to foreign companies, foreign individuals, or any non-resident entity.
Deduction on Consideration for Foreign Exchange Asset Transfer
In the case of a payment made to a non-resident Indian that represents the consideration for the transfer of a foreign exchange asset, the person responsible for paying is the authorised dealer. The dealer must ensure the correct deduction of tax before remitting or crediting the amount to the non-resident’s account.
Definition of Non-Resident Indian
For this provision, a non-resident Indian is defined as an individual who is a citizen of India or a person of Indian origin and is not resident in India. A person is considered of Indian origin if they or their parents or grandparents were born in undivided India.
Meaning of Foreign Exchange Asset
A foreign exchange asset refers to specific types of assets acquired or subscribed to using convertible foreign exchange. These assets include shares in Indian companies, debentures or deposits with Indian companies that are not private companies, securities of the Central Government, and any other asset specified by notification in the Official Gazette by the Central Government.
Nature of Payments Subject to TDS
Under section 195, the tax deduction obligation arises only when the sum paid or credited is chargeable to tax in India. This includes interest payments, payments for royalties, fees for technical services, dividends, and other types of income. Salary is specifically excluded from the scope of section 195 and is governed by separate provisions.
Payments Exempt from Deduction
There are certain circumstances in which payments to non-residents may not be subject to TDS under section 195. These include payments that are not taxable in India either due to provisions under the Income Tax Act or because of applicable tax treaties,,s which provide exemptions or reduced rates. However, it is generally advised to obtain a certificate under section 195(2) or a lower/nil deduction certificate under section 197 from the Income Tax Department before assuming exemption.
Judicial Interpretation and Advance Rulings
Various judicial decisions and advance rulings have clarified the application of section 195. For example, if a foreign company’s head office makes a payment outside India to a non-resident for services to be used in India, and the payment does not accrue or arise in India, then TDS under section 195 may not apply. The key factor is whether the income is deemed to accrue or arise in India under the Act.
Timing of Tax Deduction
The timing of tax deduction under section 195 is critical. Tax is to be deducted either at the time of credit of such income to the account of the payee or at the time of actual payment, whichever is earlier. If the amount is credited to a suspense account or any other account that may later be treated as the payee’s account, the tax is considered to be deducted at the time of such credit.
TDS on Interest Payable by Mutual Funds
Where interest is payable by mutual funds or specified companies to a foreign company or a non-resident (other than a foreign company), the tax must be deducted at the time of credit or payment, whichever is earlier. Even if the income is credited to a suspense account or similar account, it is still treated as credited to the payee’s account for TDS.
Payments Under Private Contracts
Private agreements between the payer and the payee regarding tax-free payments do not affect the obligation under section 195. Even if the payee agrees to bear the tax liability, the payer is still required to deduct tax at source. The liability to deduct tax arises under the statute and cannot be contracted away.
Deposit of Deducted Tax
Once tax is deducted under section 195, it must be deposited to the credit of the Central Government. The time frame and method for depositing the tax vary depending on who is making the payment and whether the tax is accompanied by a challan.
E-Payment Requirement
Since April 1, 2008, all corporate assessees and other assessees subject to audit under section 44AB are required to make TDS payments electronically. This can be done through internet banking or by using credit or debit cards via authorised banks. This rule applies irrespective of the financial year or assessment year.
Time Limit for Deposit of TDS
The timing of the deposit depends on whether the payer is a government entity or another kind of assessee. If the government deducts the tax and is not required to submit a challan, it must be deposited on the same day. If a challan is submitted, the tax must be deposited within seven days of the end of the month in which the tax was deducted. For all other deductors, the TDS must be deposited within one week from the end of the month in which it was deducted. If the tax is deducted in March, it can be deposited by April 30 of the following financial year.
Challan for TDS Payment
Tax deducted at source must be deposited using Challan Form ITNS 281. This form is used to report and deposit the TDS/TCS to the government and must be properly filled out with details such as the deductor’s TAN, the amount of tax deducted, and the mode of payment.
Claim for TDS Refund
If excess TDS has been deposited, the deductor can claim a refund by filing Form 26B electronically using a digital signature. This form is submitted under Chapter XVII-B of the Income Tax Act. Refunds are processed by the Income Tax Department after verification.
Issuance of TDS Certificates
Every person deducting tax under section 195 is required to issue a TDS certificate in Form 16A to the payee. This certificate must be issued every quarter and within the prescribed deadlines. Even if the payer bears the tax liability, they must still issue the certificate to the recipient.
Schedule for Issuing TDS Certificates
Form 16A must be issued by the following deadlines for each quarter. For the quarter ending June 30, the certificate must be issued by August 15. For the quarter ending September 30, the deadline is November 15. For the quarter ending December 31, it is February 15. For the quarter ending March 31, it is June 15 of the following financial year.
Filing Quarterly TDS Returns
A quarterly return must be submitted in Form 27Q by all deductors who deduct tax under section 195. This return applies to payments made to non-resident individuals or foreign companies. The due date for filing this return is July 31 for the June quarter, October 31 for the September quarter, January 31 for the December quarter, and May 31 for the March quarter.
Mode of Filing Returns
Quarterly returns must be filed electronically by certain classes of deductors. These include government offices, companies, those subject to audit under section 44AB, and those with more than 20 deductee records in any quarter. Others may choose between filing electronically or in paper form.
Methods of Uploading Returns
From February 19, 2013, electronic returns can be filed in three ways. First, uploading with a digital signature. Second, furnishing the return electronically along with the physical submission of Form 27A. Third, furnishing the return electronically along with electronic verification of Form 27A.
Mandatory Information in TDS Returns
When filing TDS returns, the deductor must provide their TAN and PAN (except when the deductor is a government office), PANs of all deductees, details of tax paid to the Central Government including the challan or book identification number, details of payments on which tax was not deducted due to certificate under section 197, and details of payments made to transport contractors who have submitted their PAN under section 194C.
Consequences of Default
Failure to deduct tax, pay tax, furnish returns, or issue certificates has serious consequences. These include disallowance of related expenses under section 40(a)(i), penalties under section 271C, interest under section 201(1A), and possible prosecution under section 276B. Even a failure to apply for a TAN under section 203A can attract penalties.
Disallowance of Expenditure
If tax is not deducted under section 195, specific expenses cannot be claimed as deductions when computing taxable income. These include annual charges or interest under section 25, and interest, royalty, or fees for technical services under section 40(a)(i). Such disallowance remains unless the tax is deducted and paid in a later year, in which case the expenditure is allowed in that year.
Relief Under the First Proviso to Section 201(1)
The Finance (No. 2) Act, 2019, introduced a relief provision with retrospective effect from the assessment year 2020-21. If the deductor fails to deduct tax but the recipient has filed a return, declared the income, and paid tax, then the deductor will not be treated as an assessee-in-default if a certificate from a chartered accountant is provided in the prescribed form.
Disallowance Under Section 40(a)(i)
Section 40(a)(i) disallows certain business expenditures if tax is deductible under section 195 and has not been deducted or, after deduction, has not been paid within the time allowed. The nature of the payments subject to disallowance includes interest, royalty, fees for technical services, or any other sum chargeable under the Act. The disallowance applies if the tax is payable outside India or within India to a non-resident, and the tax has not been deducted or deposited on or before the due date for filing the return under section 139(1).
Effect of Subsequent Deduction and Payment
If the payer deducts and deposits the tax in a later year, the expense that was earlier disallowed under section 40(a)(i) becomes allowable in the year in which the tax is paid. This provision ensures that while the deduction is denied initially due to non-compliance, the benefit is not permanently lost if compliance occurs subsequently.
Illustration of Disallowance and Allowance
Consider a company that makes a payment to a foreign company in one financial year without deducting tax. If the company later deposits the tax after the return due date, it cannot claim the deduction in that year. However, it can claim the deduction in the subsequent year when the tax is deposited. This is a direct application of section 40(a)(i).
Specific Judicial Interpretations
Courts have consistently held that section 195 applies only if the payment made to a non-resident is chargeable to tax in India. In cases where the income is not chargeable to tax in India, there is no obligation to deduct tax under section 195. The Supreme Court in GE India Technology Centre (P) Ltd. v. CIT held that if the sum is not chargeable to tax in India, no obligation to deduct tax arises under section 195.
Difference Between Deducting and Paying Tax
It is important to distinguish between failure to deduct tax and failure to pay tax after deduction. The consequences differ. If tax is not deducted at all, and the payee has paid taxes on the same income, then the deductor may not be treated as an assessee-in-default under the first proviso to section 201(1). However, if tax has been deducted but not paid, the deductor remains liable irrespective of the payee’s tax compliance.
Impact of Payee’s Tax Compliance
As per the amended provisions, if the non-resident payee has filed a return under section 139, included the income in that return, and paid the tax due, and if the deductor furnishes a certificate from a chartered accountant, then the deductor shall not be deemed to be in default. This provision aligns with the principle that tax should not be collected twice on the same income.
Illustration of Relief Under Section 201(1)
Consider a case where a company fails to deduct TDS on a commission payment made to a US company. If the US company includes the amount in its Indian tax return, pays the tax due, and the Indian company obtains a certificate from a chartered accountant in the prescribed format, the Indian company will not be considered an assessee-in-default. However, the deduction of the expense will be allowed only in the year in which the certificate is obtained.
Inapplicability of Relief When Tax Is Deducted but Not Paid
If the payer deducts tax but fails to deposit it, the relief under the amended section 201(1) is not applicable. In such cases, the deductor cannot claim the expense until the tax is deposited. The delay in deposit disqualifies the payer from claiming a deduction in the year of accrual and defers it to the year of actual deposit.
Illustration of Ineligible Deduction Due to Non-Payment
Suppose a company deducts TDS on royalty payment to a non-resident on December 8 but fails to deposit the tax until after the due date of filing the return. The non-resident includes the amount in their return and pays tax. Despite this, the company cannot claim the deduction in that year because the tax, although deducted, was not deposited on time. The amended provisions do not offer relief in such scenarios.
Disallowance of Interest Under Section 58
Section 58 disallows interest expenses payable outside India under the head income from other sources if tax is not deducted and paid under section 195. Even if tax is deducted or paid in a subsequent year, the deduction is not allowed. This provision differs from section 40(a)(i), which allows the expense in a later year upon tax payment. Section 58 is more stringent in this respect.
Special Cases Involving Mutual Funds
In the case of interest on mutual fund investments or specified companies payable to non-residents, the TDS provisions under section 195 apply as long as the payment is chargeable to tax in India. However, if the mutual fund is exempt under section 10(23D), the income may not be chargeable, and TDS may not be required. Each case must be evaluated based on the facts and taxability.
Relevance of Tax Treaties
Tax treaties play a significant role in determining the rate and applicability of TDS. If the relevant double taxation avoidance agreement provides for a lower rate or exemption, the payer can apply the treaty benefit. However, this must be backed by a Tax Residency Certificate from the payee and other prescribed documentation. The treaty provisions override the domestic law to the extent they are more beneficial to the assessee.
Certificate for Lower or Nil Deduction
Under section 197, the payee can apply to the Assessing Officer for a certificate permitting the payer to deduct tax at a lower rate or nil rate. The application must be supported with financial statements, income estimates, and other relevant documents. If granted, the certificate must be presented to the payer, who must comply with its terms.
Certificate Under Section 195(2)
If the payer believes that only a portion of the payment is chargeable to tax in India, they can apply to the Assessing Officer under section 195(2) to determine the appropriate portion on which tax should be deducted. The officer’s decision guides the payer in deducting tax only on the chargeable amount. This provision is especially useful in composite payments involving both taxable and non-taxable elements.
Importance of Section 195(2) Certificate
The certificate under section 195(2) provides legal protection to the payer against future claims of short deduction. Without such a certificate, the payer must deduct tax on the entire amount, even if only part of it is taxable in India. This ensures that the payer does not default under the provisions of section 195 and avoids being treated as an assessee-in-default.
Prescribed Forms and Filing Requirements
Various forms and returns are prescribed under the TDS provisions. For example, Form 27Q is used to file quarterly TDS returns for payments made to non-residents. The certificate of deduction must be issued in Form 16A. Refunds are claimed using Form 26B. Applications under section 197 must be made in Form 13. Proper compliance with form filing, due dates, and e-filing norms is essential to avoid penalties.
Impact of Non-Compliance
Failure to comply with TDS provisions under section 195 can lead to a range of consequences. These include being treated as an assessee-in-default under section 201(1), incurring interest under section 201(1A), penalties under section 271C for non-deduction, penalties under section 272A for non-filing of returns, and prosecution under section 276B for failure to pay deducted tax. Additionally, expenses can be disallowed under section 40(a)(i).
Interest Under Section 201(1A)
If a person fails to deduct the tax, interest is payable at the rate of 1 percent per month or part thereof from the date the tax was deductible to the date of actual deduction. If tax is deducted but not paid, interest is payable at the rate of 1.5 percent per month or part thereof from the date of deduction to the date of actual payment. Interest is mandatory and must be paid before filing the TDS return.
Penalties and Prosecution
Penalty under section 271C for non-deduction or short deduction is equal to the amount of tax not deducted. For failure to furnish TDS returns in time, a penalty of Rs. 200 per day under section 234E is applicable until the failure continues, subject to the amount of tax deductible. In cases of willful default, prosecution under section 276B may be initiated, which can result in imprisonment and a fine.
Compliance with TAN and PAN Requirements
All deductors must have a valid Tax Deduction Account Number. Failure to apply for or quote TAN in the TDS return can attract a penalty of Rs. 10,000 under section 272BB. Additionally, quoting the PAN of the payee in the TDS return and certificate is mandatory. Failure to quote the correct PAN can result in higher TDS deduction under section 206AA at 20 percent or higher specified rates.
Role of the Chartered Accountant’s Certificate
The relief provided under the first proviso to section 201(1) requires a certificate from a chartered accountant in the prescribed format. This certificate confirms that the payee has filed their return, included the relevant income, and paid taxes due. The form and verification requirements are specified under the Income Tax Rules and must be submitted within the prescribed timelines to avail the benefit.
Retrospective Application of Amendments
Although the Finance (No. 2) Act, 2019 made the changes effective from assessment year 2020-21, the courts have interpreted such amendments as declaratory and, therefore, retrospective. Various Supreme Court rulings have confirmed that provisions introduced to remove hardship or clarify the law are to be applied retrospectively, thereby benefiting past transactions and ensuring consistency in tax treatment.
Practical Considerations for Businesses
Businesses making payments to non-residents must establish strong internal controls to ensure compliance with section 195. This includes identifying payments requiring TDS, verifying taxability under Indian law and treaties, obtaining required certificates, deducting and depositing tax within deadlines, issuing certificates to payees, and filing accurate quarterly returns. Errors at any stage can result in financial and reputational risks.
Application to Various Types of Income
Section 195 of the Income Tax Act applies to various types of income earned by non-residents. These include interest payments, royalties, fees for technical services, dividends, rent, and other similar payments. It is essential to determine the nature of the payment correctly to apply the relevant TDS rate. For instance, interest paid on external commercial borrowings is typically subject to a reduced TDS rate, whereas royalties or fees for technical services may be taxed at higher rates unless reduced by a tax treaty. The payer must carefully assess tht nature before deducting tax.
Relevance of Double Taxation Avoidance Agreements (DTAAs)
India has entered into Double Taxation Avoidance Agreements (DTAs with several countries to prevent the same income from being taxed twice. These treaties often provide for reduced tax rates or exemption from tax in certain cases. Section 195(2) allows the payer to apply for a certificate determining the appropriate proportion of income chargeable under the Act. When a DTAA applies, the beneficial provisions of the treaty override the Income Tax Act provisions. However, the recipient must furnish a valid Tax Residency Certificate (TRC) from their country of residence to avail of the benefits under the DTAA. The payer must also obtain certain prescribed information and documentation to apply DTAA provisions.
Form 15CB and 15CA
To remit money outside India, the payer must comply with the procedural requirements laid down by the Income Tax Department and the Reserve Bank of India. The primary forms involved are Form 15CA and Form 15CB. Form 15CA is a declaration of the remitter regarding the TDS applicability on the payment. It is submitted electronically and contains details such as the remitter, remittee, nature and amount of remittance, and TDS rate applied. Form 15CB is a certificate from a Chartered Accountant (CA), certifying the details of the payment and the applicability of tax. It is required in cases where the payment exceeds a specified threshold or falls under certain categories. The requirement to submit Form 15CB depends on the type and value of the remittance, as defined under Rule 37BB. It ensures that proper taxes have been deducted before remitting funds abroad.
Consequences of Non-Compliance
Non-compliance with the provisions of Section 195 can lead to severe consequences. If a person fails to deduct tax at source or deducts less than required, they may be treated as an assessee-in-default under Section 201. This can result in recovery of the tax not deducted or short-deducted, along with interest and penalties. Interest under Section 201(1A) is levied at 1% per month for non-deduction and 1.5% per month for non-payment of the deducted amount. Further, penalty provisions under Sections 271C and 271H may apply for failure to deduct or report TDS. Additionally, disallowance of the expenditure under Section 40(a)(i) can impact the deductor’s tax liability. Therefore, proper compliance with TDS provisions on payments to non-residents is crucial.
TDS on Software and Digital Payments
One contentious area under Section 195 is the applicability of TDS on payments for software licenses and digital services. In recent years, there has been debate on whether such payments should be considered royalties or business income. If classified as royalties, they attract TDS under Section 195. However, if treated as business income and the non-resident has no permanent establishment in India, no TDS may be required. The Supreme Court in the Engineering Analysis Centre of Excellence Pvt. Ltd. case clarified that payments for off-the-shelf software are not royalty and hence not subject to TDS if the non-resident has no PE in India. This judgment has had significant implications for the software and IT industry, clarifying tax obligations and reducing litigation.
TDS on Commission and Brokerage Payments
Another area of complexity under Section 195 involves commission and brokerage payments to non-residents. The key issue is whether such income is deemed to accrue or arise in India. If the non-resident agent operates entirely outside India and provides services from abroad without any business connection or PE in India, such payments may not be taxable in India. Consequently, no TDS may be required under Section 195. However, tax authorities may scrutinize the facts to determine whether the income has a nexus with India. Judicial precedents have played a crucial role in shaping the interpretation of such payments. It is advisable to obtain a legal opinion or an order under Section 195(2) in case of ambiguity.
Application to Income Deemed to Accrue or Arise in India
Under the Income Tax Act, certain types of income are deemed to accrue or arise in India even if the non-resident does not have a place of business or residence in India. Section 9 of the Act lists such incomes, which include interest, royalties, fees for technical services, and capital gains from the transfer of assets located in India. When payments are made to a non-resident that falls under these categories, TDS under Section 195 becomes applicable. It is the payer’s responsibility to determine if the income is chargeable to tax in India under domestic law and applicable tax treaties.
Capital Gains and Section 195
Capital gains earned by a non-resident from the transfer of a capital asset located in India are subject to TDS under Section 195. The rates of deduction vary depending on the type of asset and the duration for which it was held. In the case of long-term capital gains, the rate is generally 20%, whereas short-term gains may attract a 30% rate or as specified under the relevant tax treaty. The payer needs to compute the gains accurately, which may necessitate the involvement of professional valuation services or chartered accountants. If the non-resident seller fails to pay the tax or the buyer does not deduct TDS, the liability may shift to the payer.
Payments to Non-Residents for Software and Technical Services
Payments made to non-residents for software usage, technical support, and similar services have been under litigation concerning their taxability in India. The core issue often lies in whether the payment is for the sale of a product or for the transfer of rights, which could qualify as royalty. If it qualifies as royalty or fees for technical services under Section 9(1)(vi)/(vii), then TDS under Section 195 must be deducted. Judicial decisions and tax circulars play a vital role in interpreting such cases, and payers must assess the nature of transactions carefully before concluding on TDS liability.
Double Taxation Avoidance Agreements (DTAA) and Their Impact
India has signed Double Taxation Avoidance Agreements with many countries to provide relief to taxpayers from being taxed twice for the same income. When payments are made to a non-resident, the payer must examine the provisions of the applicable DTAA. If the treaty offers beneficial tax rates or exemptions, those will override the domestic tax law under Section 90(2) of the Act. However, to claim treaty benefits, the non-resident must furnish a Tax Residency Certificate from the foreign government, and additional documents like Form 10F may be required. Misapplication of DTAA provisions may lead to penalties or disallowance of the expense.
TDS on Reimbursement of Expenses
Whether reimbursements of expenses to a non-resident attract TDS depends on whether the payment includes an income element. If the reimbursement is made on a cost-to-cost basis without any profit element and with proper supporting documentation, it may not be taxable in India, and hence, no TDS may be required. However, if the reimbursement includes service charges or management fees, it could be considered income in the hands of the non-resident and subject to TDS. Each case must be evaluated on its facts, and tax authorities may scrutinize the arrangements to determine their true substance.
Payments by Individuals and Non-Business Payers
While Section 195 applies to all payers, including individuals and Hindu Undivided Families, it only applies if the payment is made for business or professional purposes. Payments made by individuals for personal purposes, such as remittances to family members abroad, do not attract TDS under Section 195. However, once such individuals enter into transactions involving business payments or property purchases from non-residents, the obligation to deduct TDS arises. Awareness among individual taxpayers regarding this provision remains low, often leading to inadvertent non-compliance and penalties.
Penalties for Non-Compliance with Section 195
Failure to comply with the provisions of Section 195 can attract serious penalties and interest under the Income Tax Act. If the deductor fails to deduct tax or, after deducting,fails to deposit it with the government, interest under Section 201(1A) is levied. Additionally, the deductor may be deemed an assessee-in-default and held liable for the tax amount. Penalty under Section 271C may also be imposed for non-deduction or short deduction of tax. Therefore, compliance with TDS rules on payments to non-residents is crucial to avoid litigation and financial consequences.
Conclusion
Section 195 plays a pivotal role in ensuring that tax is collected at the source on payments made to non-residents for income chargeable to tax in India. Its scope extends across various transaction types, including royalties, technical fees, interest, and capital gains. Due diligence by the payer, including the analysis of DTAA provisions, proper documentation, and appropriate tax deduction, is essential. Procedural steps like obtaining Form 15CA/15CB, applying for certificates under Section 197, and understanding the taxability of income components are all vital for robust compliance. Given the complexities involved, professional advice is often necessary to navigate the requirements of Section 195 effectively.