The Income Tax Act has provisions to collect tax at the source of income to prevent tax evasion. This mechanism is known as Tax Deducted at Source or TDS. Under this scheme, tax is deducted by the payer at the time of making certain specified payments, such as salary, interest, dividends, rent, commission, and others, before the amount is credited or paid to the recipient. The objective is to ensure the timely collection of tax and reduce the burden of tax payment on the recipient at a later date.
The person responsible for making the payment, called the deductor, deducts tax at the prescribed rates and deposits it with the government within the stipulated time. The recipient receives the net amount after deduction of tax, but the tax deducted is treated as advance tax paid by the recipient and is adjusted against their total tax liability for the year. This system helps in bringing more transparency to the tax collection process and minimizes the chances of income escaping taxation.
Scheme of Tax Deduction at Source Explained with Example
To understand the scheme more clearly, consider the case of an individual named X, aged 29 years, who is a businessman. For the financial year 2025-26, X has a business income of Rs. 8,86,000. Additionally, he earns interest of Rs. 1,00,000 on a fixed deposit with Punjab National Bank, on which the bank has deducted tax at source amounting to Rs. 10,000. X also deposits Rs. 60,000 in a public provident fund.
When X files his income tax return, the tax is computed on the gross interest of Rs. 1,00,000, not just on the net amount received (Rs. 90,000 after TDS). The gross total income includes his business income and the gross interest. From this gross total income, deductions like Rs. 60,000 under section 80C are allowed, and the net taxable income is computed accordingly. Tax is calculated on this net income at the applicable rates, and the health and education cess is added.
Though Rs. 1,01,608 is computed as the total tax liability, X gets a credit of Rs. 10,000, which has already been deducted by the bank and deposited with the government. The bank provides X with Form No. 16A as a TDS certificate, which states the gross interest, tax deducted, and net interest paid. On filing his return and submitting this form, X’s final tax payable is reduced by Rs. 10,000. Hence, he only pays Rs. 91,608.
This example illustrates that TDS is a mechanism to collect tax in advance at the time of payment by the payer, reducing the tax burden on the recipient at the time of final assessment.
Payments Covered under the TDS Scheme
The TDS scheme covers various types of payments where income can be computed at the time of accrual. These include salaries paid to residents and non-residents, interest payments other than salary, dividends, rent, commission or brokerage, lottery winnings, winnings from races, professional fees, royalties, compensation payments, and payments to non-residents or foreign companies. Each category of payment has specific sections under the Income Tax Act, such as section 192 for salary, section 194 for dividends, and section 194A for interest on fixed deposits.
The scheme is designed to capture income from different sources and ensure tax collection from a wide variety of income streams.
TDS Rates and Special Provisions for the Financial Year 2025-26
TDS rates applicable during the financial year 2025-26 vary depending on the nature of payment and the status of the recipient. If the recipient does not furnish their Permanent Account Number (PAN) to the deductor, higher TDS rates apply, usually the normal rate or 20 percent, whichever is higher. This is mandated under section 206AA to encourage the furnishing of PAN and to prevent tax evasion.
Another provision, section 206AB, imposed higher TDS rates on non-filers of income tax returns. However, this provision was applicable only until March 31, 2025, and has been omitted from April 1, 2025. This means non-filers after this date are not subject to higher TDS rates under this section.
In cases where the recipient is located in a notified jurisdictional area, such as certain specified territories, the payer is required to deduct tax at the higher of the applicable rate or 30 percent, excluding surcharge and education cess, as per section 94A(5).
Surcharge and Health and Education Cess on TDS Payments
Surcharge on TDS is applicable only in specific cases during the financial year 2025-26. For salary payments exceeding Rs. 50 lakh but not exceeding Rs. 1 crore, a surcharge of 10 percent on TDS is applicable. This surcharge increases progressively with higher thresholds of salary payment, reaching up to 37 percent when the TDS subject amount exceeds Rs. 5 crore. Similar surcharge rates apply to payments or credits (other than salary) made to non-residents or foreign companies, with some variations.
Health and education cess, at 4 percent, is applicable on TDS deducted from salary payments and payments to non-residents or foreign companies, but is not applicable on payments to residents other than salary during this financial year.
Consequences of Default in Tax Deduction at Source
When a person responsible for deducting tax at source fails to deduct a deduction, fails to deposit the tax with the government, he is considered an assessee in default under section 201(1) of the Income Tax Act. This means that he is personally liable to pay the tax along with applicable interest and penalty. Additionally, prosecution proceedings may be initiated against him for such defaults.
The law also imposes a disallowance under section 40(a) of the Act on the expense on which tax was required to be deducted but was not. This means the deductor cannot claim the expenditure as a business expense when computing taxable income, thereby increasing his tax liability.
There is a time limit for initiating proceedings against the defaulting deductor. No order deeming a person to be an assessee in default shall be made after the expiry of six years from the end of the financial year in which payment or credit was made, or two years from the end of the financial year in which a correction statement was delivered, whichever is later. This time limit restricts the period within which the tax authorities can take action against defaults in TDS deduction or payment.
Important Points Related to TDS
Several key points need to be understood about TDS to ensure compliance and avoid confusion. First, tax is not deductible on the Goods and Services Tax (GST) component if GST is separately shown on the invoice. TDS is applicable only on the payment amount, excluding GST.
Secondly, in cases where an agent or an associate enterprise makes payment of technical fees, rent, commission, royalty, professional fees, or similar expenses on behalf of the assessee, and deducts tax properly, reimbursement of such payments by the assessee to the agent is not subject to further tax deduction. This avoids double deduction of tax on the same expense.
These provisions have been clarified through official circulars to ensure the correct application of TDS rules in complex payment scenarios.
Tax Deduction at Source from Salary under Section 192
Section 192 deals specifically with tax deduction at source on salary payments. The employer is responsible for deducting tax on the salary payable to the employee at the time of payment or credit.
Tax is deducted at the normal rates applicable to individuals, considering the applicable exemption limits. No tax is deductible if the employee’s estimated income is below the exemption threshold. The employee can request lower or no tax deduction by applying in Form No. 13 to the Assessing Officer, who may issue a certificate allowing such relief.
Employers can also adjust tax deduction amounts to account for any previous excess or deficiency in TDS during the financial year to ensure correct overall deduction.
Computation of Taxable Salary and Deduction of TDS
To compute taxable salary for TDS purposes, employers must consider various components such as basic salary, allowances, perquisites, and deductions under Chapter VI-A. House rent allowance exemption under section 10(13A) is calculated based on the rent paid by the employee. The employee must submit Form No. 12BAA containing details of rent paid, landlord information, and PAN of the landlord if rent exceeds Rs. 1,00,000 per annum.
Employers also consider deductions under sections like 80C, 80CCC, 80CCD, 80D, and others while calculating taxable salary for TDS. Tax is deducted based on the applicable income tax slabs for the financial year.
When an employee has multiple employers during a financial year, tax is deducted separately by each employer. However, the employee must submit Form No. 12B to one employer declaring income and TDS from other employers. The employer receiving Form 12B deducts tax on the aggregate income.
Submission of Evidence by Employee for Tax Deductions
Employees are required to submit evidence of claims for exemptions and deductions to enable accurate tax deduction by the employer. This is done using Form No. 12BB, which includes details for house rent allowance, leave travel concession, interest on home loan, and deductions under Chapter VI-A.
The employer relies on this information to compute taxable salary and deduct TDS correctly. This system ensures that employees receive appropriate tax reliefs through TDS itself, reducing the burden at the time of filing returns.
TDS Certificate for Salary and Related Income
Employers must provide TDS certificates in Form No. 16 to employees annually, by May 31 following the end of the financial year. This certificate contains details of salary paid, TDS deducted, and other relevant particulars.
Where salary exceeds Rs. 1,50,000, employers must also provide Form No. 12BA detailing perquisites and profits instead of salary. The certificate serves as proof of tax deducted and helps employees in filing their income tax returns.
Employee Stock Option Plan and TDS
Special provisions exist for TDS related to perquisites arising from Employee Stock Option Plans (ESOP) of start-ups eligible for deduction under section 80-IAC. Tax deduction on the perquisite value may be deferred and deducted within 14 days after the earliest of 48 months from the end of the assessment year in which the shares were allotted, the date of sale of such shares, or the date the employee ceases employment.
Tax is calculated based on the rates applicable in the year when the shares were allotted or transferred. This deferral provides relief to employees of start-ups by aligning tax deduction with actual gains realization.
Option for Old Tax Regime and Its Impact on TDS
For the financial year 2025-26, the new tax regime under section 115BAC is the default regime for tax deduction. If employees wish to pay tax under the old tax regime, they must notify the employer accordingly.
This intimation is solely for TDS purposes and does not constitute exercising the option under section 115BAC(6) in the income tax return, where the employee may choose a different regime. The employer deducts tax based on the declared option during the year.
Tax Deduction at Source from Withdrawal from Employees’ Provident Fund Scheme under Section 192A
Section 192A deals with tax deduction at source from premature withdrawals from the Employees’ Provident Fund (EPF) scheme. The trustees of the Employees’ Provident Fund Scheme, 1952, or any other authorized person responsible for payment of accumulated sums to employees, are required to deduct tax at source on taxable premature withdrawals.
Tax is deductible only if the employee has not completed continuous service of five years with the employer. However, certain exceptions apply where TDS is not required, such as if the employee has rendered continuous service of five years or more, has been terminated due to ill health or business closure, has transferred to a new employer maintaining a recognized provident fund, or has transferred the entire balance to a notified pension scheme.
Tax deduction applies only to the portion of the withdrawal that is includible in the employee’s total income. Tax is deducted at the time of payment at a flat rate of 10 percent. Surcharge and education cess are not applicable if the recipient is a resident, but they apply if the recipient is a non-resident.
There is a threshold limit under which no tax is deductible. If the taxable premature withdrawal is less than Rs. 50,000, no TDS is required. Employees cannot obtain a certificate for lower or nil deduction under section 197 in this case. However, a declaration in Form No. 15G (for individuals below 60 years) or Form No. 15H (for senior citizens) can be submitted to avoid TDS if the total income is below the taxable limit.
Tax Deduction at Source from Interest on Securities under Section 193
Section 193 mandates tax deduction at source on interest payable on securities held by residents. The payer of interest on securities is responsible for deducting tax at 10 percent on the interest amount.
Certain securities and interest payments are exempt from TDS. These include debentures issued by specified cooperative societies and public sector companies, interest on government securities, interest payable to insurance companies, and interest on debentures paid to resident individuals or Hindu Undivided Families up to a specified limit.
Interest payable to business trusts by special-purpose vehicles is also exempt. The exemption thresholds and types of securities eligible for exemption are prescribed under the law and updated periodically.
Tax Deduction at Source from Dividends under Section 194
Section 194 requires domestic companies to deduct tax at source when paying dividends to resident shareholders. The rate of deduction is 10 percent of the dividend amount. Tax must be deducted at the time of payment or credit of the dividend.
No TDS is deductible if the dividend amount is below the prescribed threshold, which is Rs. 5,000 up to March 31, 2025, and Rs. 10,000 thereafter. Certain entities, such as the Life Insurance Corporation of India, General Insurance Corporation, business trusts, and persons notified by the Central Government, are exempt from TDS on dividends.
The recipient’s PAN must be furnished to the payer to avoid higher rates of TDS. If PAN is not provided, tax is deducted at the higher rate prescribed under section 206AA.
Filing and Reporting Obligations for TDS Deductors
Deductors are required to file periodic statements of tax deducted and deposited. These statements must be submitted electronically within the prescribed due dates. The statements include details of deductees, amounts paid, tax deducted, and challan details of tax deposited.
Failure to file statements on time attracts penalties and interest. The deductor must also issue TDS certificates to the deductees, such as Form 16 for salary payments and Form 16A for other payments. These certificates serve as proof of tax deduction and assist deductees in filing their income tax returns and claiming credit for the tax deducted.
TDS returns are submitted to the government’s online portals, and the data is made available to deductees and the tax authorities through these systems. Deductors must ensure accuracy and timely compliance to avoid legal consequences.
Importance of PAN and Compliance with Sections 206AA and 206AB
Permanent Account Number (PAN) is crucial for TDS compliance. Deductors must obtain PAN from deductees to apply the correct rate of TDS. If PAN is not provided, tax is deducted at a higher rate as per section 206AA.
Section 206AB, effective until March 31, 2025, prescribed higher TDS rates on non-filers of income tax returns. Though this provision has been omitted from April 1, 2025, deductors must keep themselves updated on such compliance requirements.
The PAN of the deductee should be mentioned in all TDS-related correspondence and documents exchanged between the deductor and deductee to ensure transparency and proper credit of tax deducted.
Time Limits and Due Dates for TDS Deposit and Return Filing
Tax deducted at source must be deposited with the government treasury within the prescribed time frames to avoid interest and penalties. Generally, tax must be deposited by the seventh day of the following month in which the deduction is made. For deductions made in March, the deposit deadline is extended to April 30.
TDS returns must be filed quarterly, detailing all deductions made during the period. Failure to deposit tax or file returns on time attracts interest usectionction 201 n201(1A) and penalties under section 271C.
Deductors must adhere strictly to these deadlines to maintain compliance and avoid additional costs.
TDS on Payments to Non-Residents and Foreign Companies
The Income Tax Act mandates tax deduction at source on payments made to non-resident individuals, non-resident entities, and foreign companies under various provisions. These payments include fees for technical services, royalties, interest, dividends, and other income arising or accruing in India.
The rates of TDS on such payments are generally higher than those applicable to residents and are often governed by domestic law as well as applicable tax treaties between India and the recipient’s country of residence. Where a tax treaty exists, the beneficial rates under the treaty apply,, provided the recipient furnishes a Tax Residency Certificate and complies with prescribed documentation requirements.
The deductor is responsible for withholding tax at the applicable rates and depositing it with the government within the prescribed timelines. Failure to deduct or deposit tax attracts liability on the deductor.
Exemptions and Threshold Limits for TDS
The Income Tax Act provides certain exemptions and threshold limits below which tax deduction at source is not required. For example, no TDS is deductible on interest on securities if the interest amount is below a specified limit, and dividend payments below Rs. 10,000 are exempt from TDS.
Similarly, threshold limits exist for rent, commission, professional fees, and other payments. These limits are designed to reduce the compliance burden on small payments and ensure that the administrative costs of TDS do not exceed the tax collected.
It is important for deductors to be aware of these thresholds and exemptions to avoid unnecessary deduction of tax and compliance requirements.
Procedure for Obtaining Lower or Nil TDS Deduction Certificates
Under certain circumstances, the recipient of income may apply to the Assessing Officer for a certificate authorizing the payer to deduct tax at a lower rate or not to deduct tax at all. This application is made using Form No. 13.
The Assessing Officer considers factors such as the recipient’s estimated income, relief under tax treaties, or other reasons for lower tax liability before issuing such a certificate. The certificate is valid for the financial year specified and must be furnished to the deductor to enable lower TDS deduction.
This procedure is helpful for taxpayers who expect lower tax liability and wish to avoid cash flow issues arising from excess TDS.
Penalties and Prosecutions for Non-Compliance with TDS Provisions
Non-compliance with TDS provisions attracts severe penalties under the Income Tax Act. These include interest on late payment of tax, penalty for failure to deduct or deposit tax, and prosecution for wilful default.
Interest is levied from the date on which tax was deductible to the actual date of payment to the government. Penalties can be imposed up to the amount of tax deductible or deducted but not paid.
Prosecution proceedings may be initiated against defaulting deductors, which can result in fines or imprisonment depending on the gravity of the offence.
It is therefore essential for all deductors to understand their responsibilities and ensure timely and accurate compliance with TDS provisions.
Conclusion
Tax Deduction at Source (TDS) under Sections 192 to 194DA of the Income Tax Act is an important mechanism designed to ensure the timely and efficient collection of tax on various types of income. It applies to payments such as salaries, provident fund withdrawals, interest on securities, dividends, and payments to non-residents. The responsibility to deduct tax lies with the payer, who must deposit the tax with the government and provide the payee with appropriate certificates.
The scheme prevents tax evasion by collecting tax in advance and simplifies tax administration by spreading tax payments over the year. It balances the interests of both the government and taxpayers by providing credit for tax deducted while requiring compliance with prescribed rates, thresholds, and documentation.
Non-compliance with TDS provisions results in penalties, interest, and possible prosecution, emphasizing the need for careful adherence. Awareness of exemptions, filing requirements, and procedures to obtain lower deduction certificates helps taxpayers and deductors manage their tax liabilities efficiently.