The Tax Deducted at Source (“TDS”) provisions under the Indian Income Tax Act of 1961 (“IT Act”) have been the cornerstone of the country’s tax architecture. A payer (or a deductor) is expected to be vigilant at the time of entering into any transaction, so that the required taxes are duly deducted and deposited with the Government where required, to avoid any adverse implications including penal consequences later. TDS mechanism, under Indian tax laws, has been a useful tool to collect taxes, targeting income at source itself.
These provisions continue to be upgraded with each passing year to capture the evolving business landscape and modern players such as the digital platforms, online gaming sector, etc. The number and ambit of TDS provisions under the IT Act showcase the all-encompassing nature and reach of such provisions. However, over the years, these provisions have become nuanced and complicated, and at present they encapsulate more than thirty provisions, laying down withholding rates ranging from 0.1% to 40%.
We have tried to capture below a few illustrative cases where a payer faces challenges on a regular basis while striving to comply with the various TDS provisions. We have also tried to provide possible solutions to simplify such issues:
Taxpayers frequently find themselves entangled in legal disputes over the categorisation of different kinds of payments and applicability of TDS provisions thereon. There are numerous legal battles saturated merely around the issue of classification, such as payment in the nature of “commission” versus “discount” or purchase of “goods” versus “capital asset” or “works contract” versus “contract of sale” or “reimbursement” versus “benefit/ perquisite” or fee for professional services (“FPS”) versus fee for technical services (FTS”). These classifications vary depending on a host of factors, such as the nature of service, terms of the underlying arrangement or agreement, relationship between parties, disclosure in their respective books of accounts, etc. To exemplify the complexities, consider TDS deduction under Section 194J of the IT Act, as the determination of what constitutes FPS versus FTS can be perplexing and a time-consuming task due to similarities in such services. This often leads to unnecessary litigation regarding the rate at which TDS would be applicable, i.e. 10% or 2%, as the case may be.
While perhaps these problems cannot be eliminated altogether, the Government needs to make a conscientious effort to acknowledge them and strive to solve them. For instance, to the extent possible, the multiplicity in tax withholding provisions in case of similar nature of expenditure, such as those dealing with interest, commission, winnings, FTS and FPS, etc., should be eliminated. These provisions should be clubbed to the maximum extent possible as per the broad nature of the expenditure sought to be covered by them. Similarly, the ambiguity around the classification of various services as FTS or FPS followed by different rates of TDS i.e. 2% and 10% may also be avoided by prescribing one single rate, like it was a couple of years ago, since they do not appear to serve any logical purpose. Further, it is recommended that the Government issues detailed guidelines at regular intervals, w.r.t emerging issues or ambiguities faced by taxpayers at the time of calculating TDS.
Impact of introduction of Section 194R
The practical challenges faced by a payer have only increased post the introduction of a new provision i.e. Section 194R in the IT Act by the Finance Act, 2022, which requires deduction of TDS on any “benefits” or “perquisites” received during the course of business or profession. Owing to the wide and far reaching implications of use of general terms like benefits or perquisites, taxpayers are still grappling with the potential applicability of this provision on transactions involving any kind of rewards, loyalty points, incentive programme, etc., causing taxpayers to re-evaluate their reward structures. The said provision could become a bugle for future litigation with adverse consequences flowing for the unassuming taxpayer, merely due to difference in interpretations of the law adopted by the tax authorities and the taxpayer.
The Government should rationalise the threshold for applicability of these provisions, as the present annual threshold of INR 20,000 is rather low and it should be fixed at a more rational level, for instance, at INR 5 lakh per year. Further, a withholding rate as high as 10% is quite onerous and considering that the said provision was brought as a means of tracking the provision of any benefits or perquisites, the TDS rate may be brought down to say 2%.
Burden on third party instead of payer or payee
Section 194-O of IT Act deals with e-commerce operators deducting TDS on sale of goods or provision of service, or both, facilitated through their digital/ e-platforms. It is levied on the e-commerce participant’s gross amount of sale. Interestingly, as per the Explanation to Section 194-O of IT Act, even if payment is directly made by the buyer to the seller, i.e. the e-commerce participant, the e-commerce operators are still responsible for withholding TDS, which could be daunting for them. It would leave the e-commerce operators on a constant look out to comply with this responsibility which could be exhausting since certain updates about payment might not be in their knowledge immediately or there might be a time lag. In addition to deducting TDS in such cases, e-commerce operators also need to undertake various TDS related compliances, such as filing of TDS returns and issuance of TDS certificates even though the transaction was undertaken between the buyer and the seller.
The Government may need to rethink the responsibility placed on e-commerce operators in such circumstances and the benefits derived from these changes.
Revisiting the thresholds or rates under the IT Act
Vide the Finance Act, 2023, TDS was introduced on net winnings from any online game at 30% under Section 194BA of the IT Act, without prescribing a lower threshold for applicability of the said provision. A minimal threshold of INR 100 per month was introduced later vide a CBDT Circular dated May 22, 2023. By prescribing such a low threshold, minor winnings have also been subjected to TDS, thereby increasing the compliance burden of online gaming companies exponentially. This is despite there being a threshold of INR 10,000 in similar provisions, such as Section 194B of the IT Act, dealing with TDS on winnings from lottery or card games or betting, etc. Therefore, a minimum threshold of INR 100 per month seems egregious in the said provision as compared to other similar provisions.
In fact, at a holistic level, annual threshold limits for TDS under various provisions under the IT Act merit an urgent review as they have not been reviewed and upgraded for many years. These provisions have placed a disproportionate compliance burden on small taxpayers. For instance, the threshold limit of INR 30,000 in Section 194C or 194J of IT Act is miniscule and should be raised. Further, around 80% of the taxpayers, who are either individuals or HUFs, fall in the average tax bracket of less than 5% and TDS rates applicable on them are very high, which should ideally be reduced from the existing 10% or higher rates, to avoid wastage of their time and resources on claiming a refund later.
Write-off of debt entails double whammy for creditors
Section 194R of the IT Act, requiring tax withholding on any benefit or perquisite, seeks to place the burden on a creditor or a lender who is in the process of writing-off or waiving a trading debt or loan given to a party who is unable to discharge its obligations, due to any reason. Such waivers or write-offs may be construed as “benefit” provided by such creditor or lender. As per the CBDT Circular dated September 13, 2022, such waiver shall be outside the ambit of TDS only in case of one-time settlements entered into by the banks with the borrower. It may be appreciated that a write-off of a liability or loan is not uncommon in business transactions and putting the burden of withholding TDS on creditors or lenders who are already unable to recover their debts is like adding insult to injury. Hence, it needs to be reviewed by the tax authorities.
Our suggestions regarding the way forward
TDS is an important way of collecting taxes. With increased automation, it is increasingly becoming the primary tool for tax authorities to collect taxes at the earliest and making them available to the Government for various nation building activities. It also operates as a tool to detect transaction trails of parties by going through the filings made by them. The Government’s ability to monitor transactions through data sharing among various departments, Government bodies and financial institutions in an electronic manner has enhanced exponentially in the past many years. The Government may consider leveraging technology and utilising its own monitoring mechanisms to detect various transactions in the coming years in order to reduce reliance on TDS as a measure to monitor transactions.
Also, as discussed earlier, the Government should try to leverage technology to detect tax evaders and should also make life easier for small time taxpayers and businessmen, including traders. As India is progressing rapidly and the compliance burden is also increasing at a decent pace, no effort should be made to discourage the newbie compliant taxpayers from complying with the law because of their lack of understanding and fear of adverse repercussions. Efforts should be made to make taxpayers compliant voluntarily, out of their volition, and not because of their fear.
 Section 193 and Section 194A of IT Act
 Section 194D, Section 194G and Section 194H of IT Act
 Section 194B, Section 194BA and Section 194BB of IT Act
 CBDT Circular No. 5/2023 dated May 22, 2023
 CBDT Circular No. 18/2022 dated September 13, 2022