Tax deduction at source (TDS), the taxman’s most preferred tool to ensure timely collection of taxes and widen the tax base, has over the years reaped its fruits.
The TDS regime originally introduced was based on well-drawn research to ensure collection of taxes, which otherwise the taxpayers would pay themselves based on the overall tax liability. Except for salary payments, all other payments are subject to withholding tax at specified rates on gross basis. In respect of salary, TDS is deducted based on total estimated tax liability of salaried individuals.
The gross-based rates for TDS should ideally be close to the overall tax liability on net basis so that any marginal difference can be paid by way of advance tax or self-assessment tax at the time of filing tax returns.
This article attempts to analyse as to whether there is a case for reducing the TDS rates so that the quantum and incidents of refunds can be reduced.
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Over the last few years, corporate tax rates and individual tax rates have been significantly reduced for all taxpayers. However, surprisingly, TDS rates during the last 40 years have remained more or less same or have increased.
Here are some illustrations:
• In 1973, TDS rate on contractual payments was 2% on gross payment when the corporate tax rate was as high as 65%. Since then, after almost 36 years, the TDS rate remains unchanged even though the corporate rate has come down to a rational 30%. Logically, the TDS rate should also have halved in proportion to the drop in corporate tax rates.
• Similarly, TDS provision for rental payments was introduced in 1994 at the rate of 20% on gross basis when the corporate tax rate was prevailing at 55%. This also remains unchanged over the years.
• Consider the case of individual taxpayers where the tax slabs have undergone significant changes. The effective tax liability in case of individual taxpayers having total income of Rs10 lakh was Rs2.74 lakh in 1998-99, which was lowered to about Rs2.11 lakh in 2008-09. On the contrary, instead of reduction in TDS rate, it was increased in 2007 from 5% to 10% in case of professional or technical payments.
The excess TDS causes an unnecessary cash trap for taxpayers, who have to wait till the time their tax return is processed to get their refunds. There seems to be a complete disconnect in the corporate tax regime and TDS regime and, hence, there is a need to revamp the TDS rates to streamline them.
The TDS regime for non-residents is also full of loopholes and is discriminative for non-residents belonging to countries with which India has not entered into a tax treaty, and are subject to TDS based on the rates provided under the Act.
In other cases of non-residents, the applicable TDS rate depends upon the rate provided under the tax treaty or under the Act, whichever is less. TDS rates need to be streamlined for non-residents to avoid any discrimination between countries with which tax treaty has been entered into by India and those with which it has not.
Ganesh Raj is tax partner, policy advisory group, Ernst and Young. This is the last of a four-part series on key issues which need to be addressed by the proposed overhaul of the direct tax code.
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