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Published on:

August 23, 2024

Udeetta Sarma

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‍Section 195 of Income Tax Act: Tax Deduction on Payments to Non-Residents

The Income Tax Act is one of the most complex laws for both Individuals and Companies operating in India, more so when it comes to International transactions. Here is one such important provision: Section 195 of Income Tax Act, which deals with tax deduction at source on amounts payable to non-residents. This blog will provide insights about Section 195 like its applicability, TDS (Tax Deducted at Source) mechanism, rates and compliance required.

What is Section 195 of the Income Tax Act?

Section 195 of the Income Tax Act provides for the deduction of tax at source on any sum payable to a non-resident, not a company, which is chargeable under the provisions of this act. The idea behind this section is that income, that has a source in India (such as the presence of a business establishment or PE), should be taxed even if it cannot fully be detected through TDS. The matter of chargeability is in wide scope under Section 195 which covers payments such as interest, royalties, fees for technical services or any other sum that falls within the purview of the Income Tax Act.

Applicability of Section 195

Any person such as Individual/HUF/Firm/Company etc who is required to make payment to non-resident. The payments included in this section are the ones on which tax is deductible in India. If a payment to a non-resident has no element of income chargeable under the provisions of the Income-tax Act, Section 195 does not apply.

In addition to understanding income tax, you may be interested in exploring tax planning strategies. To learn more about this topic, check out our blog post "Old vs New Tax Regime" on our website.

Types of Payments Covered

1. Interest

Interest payment to a non-resident.

2. Royalty

Payments for the use of, or right to use, intellectual property.

3. Technical fees

amounts paid for management, technical or consultancy services

4. Other Payments

Any other sum chargeable under the provisions of the Income Tax Act.

TDS Under Section 195

TDS is a process where the person responsible for making payment of income charges or pays a certain percentage of government-related tax before he hands over that total amount in the same position. It is akin to a citizen parting with the tax on behalf of an alien. In this new method, the tax gets deducted at source (TDS) itself by way of payment and through that only it takes care that non-residents discharge their tax liabilities in India more efficiently as well as immediately.

TDS Rates Under Section 195

The TDS rates under Section 195 vary depending on the type of payment. Following are some of the typical TDS rates:

1. Interest: 20%

2. Dividends: 20%

3. Royalties: 10%

4. Fees for Technical Services- 10%

5. Any Other Income: Rates as per the concerned Double Taxation Avoidance Agreements (DTAAs), if any, or rates specified in the Income-tax Act; whichever is beneficial to the taxpayer

Double Taxation Avoidance Agreement (DTAA)

For the avoidance of double taxation of income, India has signed DTAAs with many countries. If payment is covered under DTAA (Double Taxation Avoidance Agreement), then the TDS rate that has been prescribed in that DTAA can be availed by non-residents. You need to give needed papers like Tax Residency Certificate (TRC) as proof of DTAA's benefits.

Procedure for Deducting TDS Under Section 195

1. Obtaining a TAN

The deductor should have a TAN (Tax Deduction and Collection Account Number) before deducting the TDS. TAN is a ten-digit alphanumeric number issued to persons who are required to deduct or collect tax on payments made by them under the Indian Income Tax Act, of 1961

2. Determining the TDS Rate

Identify the correct TDS rate as per the nature of payment and provisions of the Income Tax Act/DTAA, whichever is applicable.

3. Deducting the Tax

The deductor has to apply the rate given in some sections of income tax law at which he must withhold on payment is credited or paid, earlier-wards.

4. Depositing the Tax

First, you have to create the deposited tax that apart from Tax interest and penalty (if any) should be credited into the Central Government account within the time limit The last date to Deposit TDS is generally the 7th of the subsequent month. Due Date for Payments made in March is April 30

5. Filing TDS Return

Quarterly returns in Form 27Q should be filed by the deductor. Deadline for TDS Return Filing :

Q1 (April - June): July 31

Q2 (July- September): October 31

Q3 (October - December): January 31

Q4 (January - March): 31 May

6. Issuing TDS Certificate

TDS certificate in Form 16A shall be issued by the deductor to the non-resident. This certificate is the proof of tax deduction and can be used by the non-resident to claim credit for such taxes in their country or outside India.

Challenges and Compliance

1. Determination of Taxability

A crucial difficulty under the provisions of Section 195 is to ascertain whether the payment made attracts tax in India or not. In this passport, one needs a solid grasp of Indian tax laws and provisions of the DTAAs.

2. Issuing of No Objection Certificate (NOC)

At times, the non-resident can also approach to Income Tax Department for a No Objection Certificate (NOC) which will enable him /her to lower or nil the rate of TDS. This is a process that involves documentation and justification.

3. Penalties for Non-Compliance

If you disobey the rules of Section 195, there are some pretty stiff fines. In addition to having to pay interest on late payments, they will not be able to claim the expense as a deduction and in very few cases may even face legal action. Following the law is key to avoiding these problems.

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Conclusion

Under Section 195 of the Income Tax Act, payments to non-residents are subject to tax deduction at source so that income that accrues or arises in India is subjected to Indian taxation. Thus for individuals and businesses transacting at the international level, it becomes vital to have an understanding regarding the provisions of Section 195 along with TDS rates as well as compliance requirements under this section.

Compliance can be followed by abiding by the rules and using all benefits according to DTAAs which in turn saves from any kind of fines. Moreover, with the increasing global transactions, Section 195 is here to stay and its importance in recent times has been on the increase therefore taxpayers should make themselves well aware of these provisions I ensure smooth compliance.

In essence, it enables India to maintain revenue neutrality without jeopardizing cross-border business activity and Section 195 should be viewed as a valuable tool in the vast armoury of Indian tax laws. The consequences of failing to do so are severe, especially if you happen to be an individual who is making a one-time payment or even a business that frequently engages in international payments.

FAQ

1. What is Section 195 of the Income Tax Act?

This section says that TDS is to be deducted from payments that are out of India but still taxable under Indian law.

2. Who needs to comply with Section 195?

Every person or entity (Individual, HUF, Firm, Company etc) makes payment to non-residents.

3. What are the common TDS rates under Section 195?

Interest: 20%

Dividends: 20%

Royalties: 10%

Technical Services: 10%

Other Income: under the DTAA or IT Act

4. What is a TAN and why is it needed?

The deductor shall have a TAN (Tax Deduction and Collection Account Number) to deduct TDS.

5. What happens if I don't comply with Section 195?

Possible penalties include interest on the sums they failed to pay or were late in paying, but also denial of tax relief for some expenses and possible prosecution.

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Updated on:

August 30, 2024