The Indian income tax framework has undergone multiple changes in the past decade with a sharp focus on widening the tax base, improving compliance, and ensuring that persons deriving income report and discharge their liability appropriately. A recurring challenge for the authorities has been the existence of individuals and entities with substantial financial transactions but negligible or no filing of income tax returns. To address this persistent gap, the Finance Act, 2021 introduced two special provisions, Sections 206AB and 206CCA, which became effective from 1st July 2021.
These provisions mandate deduction or collection of tax at higher rates in cases where persons fail to file their income tax returns despite being liable. Such persons are termed as specified persons. The underlying objective is deterrence: when higher tax is withheld or collected at the source, individuals and businesses are encouraged to file their returns to avoid losing liquidity and suffering higher withholding.
To make the compliance process practical for tax deductors and collectors, the Central Board of Direct Taxes issued Circular No. 11/2021 on 21st June 2021. Through this circular, it introduced a dedicated digital utility named Compliance Check for Sections 206AB and 206CCA. This functionality was designed to help those responsible for deduction or collection verify the return filing status of counterparties. Over time, this functionality has undergone refinements to align with rationalizations brought by subsequent amendments, most notably by the Finance Act, 2022. We explored the background and context of Sections 206AB and 206CCA, the compliance framework that necessitated their introduction, and the initial rollout of the compliance check mechanism.
Legislative Background
Evolution of Withholding Provisions in India
India’s direct tax system has long relied on Tax Deducted at Source (TDS) and Tax Collected at Source (TCS) to secure early collection of revenue and create a transaction trail. Over the years, the scope of these provisions has steadily expanded. Payments ranging from salaries, interest, dividends, rent, professional fees, contracts, and e-commerce transactions are subject to TDS. Similarly, TCS applies to the sale of goods, liquor, scrap, foreign remittances, and a variety of transactions.
Despite this expansive framework, a substantial proportion of taxpayers either under-report or completely avoid filing their income tax returns. Data analysis over successive financial years revealed that while large sums of tax were deducted or collected on behalf of many individuals, returns were not being filed by them. The disconnect undermined the overall integrity of the tax base.
To deal with this challenge, the government considered multiple measures. One was to introduce penal withholding or collection rates specifically targeted at those who, despite substantial transactions and tax deductions, chose to stay outside the return filing system. This culminated in the insertion of Sections 206AB and 206CCA by the Finance Act, 2021.
Introduction of Sections 206AB and 206CCA
Section 206AB covers situations where tax is required to be deducted under various provisions of the Income-tax Act. Section 206CCA deals with cases where tax is to be collected at source. Both sections stipulate that if the payee or collectee is a specified person, the rate of TDS or TCS shall be higher than the normal statutory rate. The definition of specified person in the original enactment covered individuals who had not filed their returns for the previous two years and who had aggregate TDS and TCS of fifty thousand rupees or more in each of those years.
The logic was straightforward. A person with such high levels of tax already deducted or collected at source was clearly a significant participant in the economic system. If such a person did not file their return, the higher withholding would ensure revenue safety and simultaneously create a strong incentive for compliance.
Challenges for Deductors and Collectors
Practical Difficulties
While the concept was sound, the practical difficulties faced by tax deductors and collectors were evident. In a large organization, thousands of payments are made daily to suppliers, contractors, professionals, landlords, and others. For each such transaction, verifying whether the counterparty qualified as a specified person was a complex task. Without a reliable and easily accessible mechanism, the compliance burden on businesses would have been overwhelming.
Risk of Error and Penalty
Failure to deduct or collect tax at the correct rate could result in the deductor being treated as an assessee in default, exposing them to recovery proceedings, interest, and penalties. Conversely, applying higher rates unnecessarily could strain business relationships, create cash flow difficulties for payees, and lead to disputes. The balance required an authoritative and user-friendly tool.
Introduction of Compliance Check Functionality
Launch by CBDT
Recognizing the challenges, the CBDT launched a digital functionality named Compliance Check for Sections 206AB and 206CCA in June 2021, days before the provisions came into effect. The objective was to provide a single source of truth to tax deductors and collectors. Through this functionality, they could verify whether a given PAN belonged to a specified person.
How the Utility Worked
The functionality was made available through the income tax portal. Deductors could check the return filing status of a single PAN or upload a bulk list for verification. The system would respond by indicating whether each PAN belonged to the category of specified persons.
This automation significantly reduced uncertainty. Organizations could now integrate compliance check results into their internal payment systems, ensuring that TDS and TCS were applied at the correct rates. The utility also helped small businesses and individual deductors who otherwise lacked the resources for manual verification.
Early Experience with Sections 206AB and 206CCA
Impact on Taxpayers
The immediate impact of these provisions was noticeable. Many individuals who earlier ignored return filing despite substantial tax deductions began filing to avoid higher withholding. The deterrent effect worked effectively, particularly among professionals, contractors, and small businesses with sizable cash flows.
At the same time, some taxpayers expressed concerns regarding the rigidity of the two-year return filing requirement. For example, even if a person had filed the most recent return, non-filing in one of the earlier two years could still classify them as a specified person. This created situations where otherwise compliant taxpayers were penalized for older defaults.
Compliance Improvements
For the authorities, the provisions and the accompanying compliance check utility created a more accountable environment. Deductors were assured of a reliable verification system, and the revenue department could expect an improved compliance culture among individuals who had previously slipped through the cracks.
The Rationale for Rationalization
Review of Initial Implementation
After observing the first year of implementation, policymakers reviewed feedback from industry, tax professionals, and various stakeholders. While the provisions achieved the intended push towards compliance, they also created friction in certain cases where the non-filing related to older years but the current compliance was regular.
Further, it was observed that some payments such as those covered under sections 194-IA, 194-IB, and 194M were primarily made by individuals or in one-off transactions. Applying the higher rate provisions in such cases created unnecessary hardship without substantially enhancing compliance.
The Need for Simplification
Therefore, a case was made for rationalizing the definition of specified persons and limiting the scope of these sections. The intention was to strike a balance between enforcement and ease of doing business.
Rationalization of Sections 206AB and 206CCA under the Finance Act, 2022
After the initial rollout of Sections 206AB and 206CCA in July 2021, both taxpayers and businesses had almost a year to experience their implications. While the provisions served their primary purpose of encouraging non-filers to come into the compliance net, they also generated practical challenges. Industry representations, professional feedback, and government reviews highlighted areas where modifications could make the law more balanced and easier to implement without compromising the objective of widening the tax base.
The Finance Act, 2022 introduced a set of rationalizations in these provisions. These amendments simplified the definition of specified persons, exempted certain transactions from the higher deduction and collection mechanism, and refined the functioning of the compliance check tool. We focus on the rationale, the amendments made, and their wider impact on stakeholders.
Feedback from the First Year of Implementation
Issues Faced by Taxpayers
One of the main concerns raised during the first year of operation was that a person could be classified as a specified person even if they were compliant in the most recent year but had missed return filing in one of the previous two years. For instance, if a taxpayer filed their return for assessment year 2021-22 but had defaulted for assessment year 2020-21, the law still treated them as a specified person. This created an anomaly where the taxpayer was penalized for an old lapse despite being regular in current filings.
Another challenge related to payments made under certain sections where the payer was not a business entity but an individual. In such cases, applying higher rates of deduction was disproportionately burdensome.
Issues Faced by Deductors and Collectors
For businesses responsible for large-scale deductions and collections, maintaining accurate checks across multiple years increased operational complexity. Even though the compliance check functionality was provided, it still required careful tracking and updating across different assessment years. In practice, deductors sought a simpler system where only the most recent filing status determined whether higher rates applied.
Rationalization under the Finance Act, 2022
Simplification of Specified Person Definition
The most significant change introduced by the Finance Act, 2022 was the amendment of the definition of a specified person. Instead of requiring non-filing for the previous two years, the law was amended so that only the most recent return filing status would determine whether a person falls under this category.
This change meant that if a taxpayer failed to file their return for the last year but filed returns for earlier years, they would still be treated as a specified person. On the other hand, if the taxpayer filed their return for the last year, they would not be penalized for lapses in older years. The new definition aligned better with the objective of encouraging immediate compliance rather than penalizing past defaults indefinitely.
Exemptions for Certain Transactions
The second key rationalization was the exclusion of certain payments from the applicability of Sections 206AB and 206CCA. Specifically, tax deducted under sections 194-IA, 194-IB, and 194M was carved out.
- Section 194-IA relates to deduction of tax on payment for transfer of immovable property.
- Section 194-IB covers deduction of tax on rent payments by individuals or Hindu Undivided Families not subject to audit.
- Section 194M applies to individuals or Hindu Undivided Families who make payments to contractors or professionals but are not required to deduct tax under section 194C or 194J.
These provisions generally involve individuals who are not regular businesses. Bringing them within the ambit of higher deduction rates created unnecessary hardship and confusion. By exempting them, the government simplified compliance for ordinary citizens who are not part of the regular withholding ecosystem.
Impact on the Compliance Check Functionality
With the rationalized provisions, the compliance check functionality also had to be updated. The earlier version was designed to track non-filers across two years, but after the amendment, it needed to operate on the basis of the most recent year alone. The Central Board of Direct Taxes revised the underlying logic accordingly and communicated the changes to stakeholders.
Detailed Examination of the New Compliance Framework
Start of the Financial Year Process
At the beginning of every financial year, a list of specified persons is prepared based on the return filing status for the immediately preceding year. This ensures clarity from day one of the financial year and enables deductors and collectors to apply the correct rates consistently.
Removal from the List upon Filing
If a person categorized as a specified person files a valid return during the year, their name is removed from the list. This ensures that compliance at any point during the financial year provides immediate relief. The system is dynamic and updates automatically upon successful filing and verification.
Relief for Low TDS and TCS Cases
Another rational feature is the consideration of aggregate TDS and TCS in the immediately preceding year. If the total amount falls below fifty thousand rupees, the person is automatically excluded from the specified list. This recognizes that the purpose of the provisions is to target substantial non-filers, not individuals with small amounts of tax deducted or collected.
Implications for Tax Deductors
Reduced Compliance Burden
For tax deductors, the rationalized framework is easier to manage. Instead of maintaining records across two preceding years, they only need to verify the most recent year. This reduces administrative costs, especially for large organizations with thousands of transactions per month.
Assurance from Updated Utility
The compliance check functionality, being updated regularly, provides assurance to deductors that the status is accurate. Since the list is static at the beginning of the year with only removals happening during the year, deductors have greater certainty in planning their processes.
Implications for Taxpayers
Incentive for Current Year Compliance
Taxpayers are now primarily judged by their most recent filing behavior. This provides a strong incentive to stay compliant in the present rather than worrying about past defaults. It also ensures that a one-time lapse in an earlier year does not permanently affect their transactions.
Relief for Small Taxpayers
For those with aggregate TDS or TCS below fifty thousand rupees, the provisions no longer apply. This provides significant relief for small taxpayers and individuals with modest transactions who were inadvertently caught in the compliance net.
Broader Policy Objectives
Encouraging Voluntary Filing
The rationalization is consistent with the government’s broader goal of nudging taxpayers toward voluntary compliance. Higher deduction and collection rates act as a deterrent for non-filers, while immediate relief upon filing ensures that compliant taxpayers are rewarded.
Balancing Enforcement with Ease of Doing Business
The changes introduced by the Finance Act, 2022 reflect an attempt to balance strict enforcement with a smooth business environment. By excluding individuals engaged in occasional transactions and reducing the compliance horizon to one year, the law becomes more predictable and less onerous.
Industry Response
Positive Reception
Industry bodies and professionals generally welcomed the rationalization. The simplification of the specified person definition was particularly appreciated as it directly reduced the burden of continuous monitoring. The exclusion of sections 194-IA, 194-IB, and 194M was also acknowledged as a pragmatic step that avoids penalizing non-business individuals.
Continued Caution
At the same time, businesses continue to exercise caution. Deductors remain liable for correct application of rates, and therefore strict reliance on the compliance check functionality is necessary. Organizations have integrated these checks into their enterprise resource planning systems to automate verification.
Administrative Efficiency
Streamlining Revenue Department Processes
From the perspective of the revenue department, the new framework reduces administrative complexity. Monitoring one year instead of two simplifies database management and reduces the chances of errors in generating the list of specified persons.
Alignment with Digital Governance
The updates also align with the broader vision of digital governance. Automated compliance checks, dynamic updates upon filing, and seamless integration with the tax portal reflect the government’s strategy of leveraging technology for better administration.
Preparation of the Specified Persons List
Basis for Identification
At the start of financial year 2022-23, a fresh list of specified persons was prepared by considering return filing and tax payment data from the previous year 2020-21. The list included those who had not filed their return of income for assessment year 2021-22 and whose total TDS and TCS in the previous year 2020-21 amounted to fifty thousand rupees or more.
This approach ensured that the list was comprehensive from the outset of the year. It provided clarity for deductors, who could rely on a stable database while executing transactions from the very first day of the financial year.
Static Nature of Additions
One of the distinguishing features of the updated framework is that no new names are added to the list during the course of the financial year. Once the list is generated at the beginning, it only undergoes reductions when taxpayers become compliant or when their aggregate TDS and TCS status changes. This prevents confusion and ensures certainty for deductors in applying the correct rates.
Removal of Names from the List
Filing of Return for Assessment Year 2021-22
If a specified person files a valid return of income for assessment year 2021-22 during the financial year 2022-23, their name is removed from the list immediately on the date of filing and verification. This mechanism incentivizes taxpayers to complete pending obligations promptly, as the relief is granted instantly.
Filing of Return for Assessment Year 2022-23
In cases where filing for assessment year 2021-22 is not possible during financial year 2022-23, relief is provided by considering the return filing for assessment year 2022-23. Once such a return is filed and verified, the taxpayer’s name is removed from the list. This provision acknowledges practical limitations and ensures that compliant behavior in the current year is adequately rewarded.
Aggregate TDS and TCS Threshold
Another method of removal is based on the aggregate TDS and TCS in the immediately preceding year 2021-22. If the total is less than fifty thousand rupees, the taxpayer is removed from the list of specified persons. This review is carried out on the first statutory due date for return filing under section 139(1), which for the financial year 2022-23 was 31st July 2022. By linking removal to a statutory date, the framework maintains objectivity while offering relief to small taxpayers.
Belated and Revised TDS/TCS Returns
The functionality also accounts for belated or revised TDS and TCS returns filed during the financial year 2022-23. If such returns reduce the aggregate amount of TDS and TCS below the threshold or reflect compliance that was not earlier recorded, the concerned person is removed from the list. This provision ensures that the system is responsive to genuine corrections and updates in data.
Operational Flow of the Updated Logic
Start of the Year
At the beginning of the financial year, deductors can access the compliance check functionality to obtain the status of their vendors, suppliers, or other parties. The list of specified persons serves as the authoritative source for applying higher rates under Sections 206AB and 206CCA.
Mid-Year Updates
During the financial year, as taxpayers file their returns or as revised data becomes available, the list dynamically updates by removing compliant taxpayers. Deductors are expected to periodically recheck the status of their counterparties to ensure that the most recent position is applied to transactions.
Certainty of Non-Additions
Because no new names are added during the year, deductors need not worry about sudden changes in obligations mid-year. This provides stability and allows for easier system integration, as companies can align their enterprise resource planning systems with the official list.
Implications for Deductors and Collectors
Simplified Monitoring
Deductors benefit from a simplified monitoring process. With the list being static in terms of additions, the primary responsibility is to check for removals, which reduces the complexity of ongoing compliance.
Reduction in Disputes
By relying on an official digital tool updated in real time, deductors are less likely to face disputes with taxpayers over classification as specified persons. The system-generated status serves as a clear reference point in case of disagreements.
Integration with Business Systems
Businesses with large volumes of transactions have been able to integrate the compliance check functionality into their digital workflows. Automated verification reduces manual effort and ensures that higher deduction rates are applied only where legally required.
Implications for Taxpayers
Incentive for Prompt Filing
Taxpayers who fall within the specified category have strong incentives to file their pending or current returns quickly. Since removal from the list is immediate upon valid filing, the benefit of lower deduction or collection rates is realized instantly.
Relief for Small Taxpayers
Taxpayers with low levels of TDS and TCS benefit significantly from the threshold mechanism. If their aggregate falls below fifty thousand rupees, they are automatically removed, sparing them the burden of higher deductions despite being non-filers.
Transparency in Status
The updated system ensures transparency for taxpayers. They can verify their own status through the portal and take corrective action if needed. This minimizes uncertainty and promotes voluntary compliance.
Broader Policy Significance
Promoting a Compliance-Oriented Ecosystem
The updated functionality reflects the government’s emphasis on using technology to encourage compliance. By providing real-time updates and clear conditions for removal, the system motivates taxpayers to remain up to date with their filings.
Balancing Enforcement with Fairness
The framework balances strict enforcement with fairness. On one hand, non-filers face the financial consequence of higher deduction or collection. On the other hand, compliant behavior, whether through current year filing or updated data, results in immediate relief.
Alignment with Digital India Vision
The enhanced functionality is consistent with the broader Digital India vision, which focuses on creating transparent, technology-driven systems for governance. The automated nature of updates and the integration with online portals underscore this alignment.
Administrative Benefits
Improved Data Accuracy
By considering belated and revised TDS and TCS returns, the functionality ensures that administrative records remain accurate. This reduces mismatches and disputes, contributing to smoother tax administration.
Reduced Workload for Officials
With an automated system in place, tax officials need not manually track compliance for each taxpayer. Instead, the functionality manages data dynamically, freeing administrative resources for more critical enforcement tasks.
Industry and Professional Perspectives
Acceptance of the Updated Logic
Tax professionals and industry associations have largely welcomed the updated logic. The absence of new additions during the financial year is seen as a significant relief, ensuring greater predictability in compliance obligations.
Recommendations for Further Enhancements
Some professionals suggest that further enhancements could include automated alerts to taxpayers when their names are removed from the list. Such notifications would strengthen transparency and reduce the need for repeated manual checks.
Illustrative Scenarios
Scenario of a Business Vendor
A company engaged a vendor who failed to file their return for assessment year 2021-22 and had substantial TDS in the previous year. At the start of financial year 2022-23, the vendor appeared on the specified persons list. Midway through the year, the vendor filed their return for assessment year 2022-23. Immediately upon filing, the vendor’s name was removed, and the company no longer had to deduct at a higher rate for subsequent payments.
Scenario of a Small Individual Taxpayer
An individual had an aggregate TDS of forty-five thousand rupees in the previous year 2021-22. Even though they did not file a return, their name was removed from the list automatically on the due date for filing under section 139(1). This provided them relief without requiring any additional action.
Scenario of Revised Returns
A large corporation filed a revised TDS return reflecting corrected data, which reduced the aggregate TDS of one of its contractors below the threshold. Upon processing of the revised return, the contractor’s name was removed from the specified persons list, providing immediate compliance relief.
Conclusion
The journey of Sections 206AB and 206CCA, from their introduction in the Finance Act, 2021 to their rationalization under the Finance Act, 2022, reflects a broader shift in India’s tax framework towards greater accountability, transparency, and digital integration. At their core, these provisions were designed to address the persistent challenge of non-filers of income tax returns who nonetheless have significant tax deducted or collected on their behalf. By applying higher rates of deduction or collection, the law creates a strong disincentive for non-compliance, while simultaneously encouraging timely return filing.
The initial compliance check functionality released in 2021 was a significant step forward in easing the burden on tax deductors and collectors. However, as experience revealed practical limitations and concerns, the 2022 rationalization introduced necessary refinements. The exclusion of certain sections such as 194-IA, 194-IB, and 194M from the ambit of these provisions, and the shift to considering only the previous year’s return filing status instead of two years, ensured that the law remained fair, proportionate, and practical.
Equally important was the amendment to the functionality itself for financial year 2022-23. By preparing a list of specified persons at the beginning of the year and making it static in terms of additions, the CBDT provided stability and predictability for deductors. At the same time, dynamic removals based on return filing, TDS/TCS thresholds, or belated and revised returns ensured that compliant taxpayers were not unfairly penalized. This balance between rigidity and flexibility is the hallmark of a responsive compliance system.
For deductors and collectors, the updated functionality significantly reduced complexity, disputes, and administrative workload. With reliable data accessible in real time, businesses could integrate the system into their workflows, ensuring accurate application of higher deduction or collection rates only when required. For taxpayers, the framework created clear incentives to file returns on time, while also safeguarding small taxpayers whose obligations were below the prescribed threshold.
From a policy perspective, these developments underscore the government’s commitment to building a compliance-oriented tax ecosystem underpinned by technology. The ability to provide real-time updates, ensure transparency, and encourage voluntary compliance aligns perfectly with the vision of a digital, accountable governance system. Moreover, it demonstrates how policy refinements, when coupled with robust digital tools, can lead to outcomes that are both efficient and equitable.
Looking ahead, the experience of implementing Sections 206AB and 206CCA provides valuable lessons for future reforms. The use of targeted disincentives for non-filers, coupled with responsive digital functionalities, can serve as a model for other areas of compliance. As taxpayers and businesses continue to adapt to a rapidly digitalizing tax environment, these provisions stand as an example of how technology and legislation can work together to promote compliance while minimizing administrative friction.
In conclusion, the evolution of Sections 206AB and 206CCA and the corresponding compliance check functionality represent more than just a technical adjustment in tax law. They symbolize the shift towards a modern, technology-driven tax administration that prioritizes fairness, certainty, and efficiency. By balancing enforcement with facilitation, the framework strengthens the integrity of the tax system and fosters a culture of responsible compliance among taxpayers.