The tax deduction at source (TDS) framework provides an efficient and effective way for the government to collect taxes. More importantly, for a country like India, seeking to expand its taxpayer base, the TDS provisions play an important role in achieving the objective.
In fact, a Ficci-PwC Total Tax Contribution survey indicates that taxes collected on behalf of the government by the participants (41% of companies constituting the S&P Nifty and Nifty Junior indices) constitute nearly two-thirds of the total taxes paid by these participants to the government. Obviously, the survey covered all taxes and not just income tax, but it is still an important indicator of the relative contribution.
TDS provisions under the current law are complex, with multiple overlaps, and this leads to ambiguity and confusion. While the proposed direct tax code is a sincere attempt at rationalizing and simplifying these provisions, with the obvious intent of reducing litigation, we seek to highlight certain seemingly unintended (but practical!) consequences arising out of the proposed changes so as to facilitate a constructive redressal dialogue.
Expanding the scope…too wide? The code enlists the specified payments subject to TDS under the third schedule (domestic payments) and fourth schedule (cross-border payments). The TDS rate ranges from 1-30% on domestic payments and from 10-35% for cross-border payments. In the context of domestic payments, there are obvious items such as salary, interest, rent, professional fees, etc, which seem well defined. The schedule provides for a residuary item, “any other income”. Clearly, this is too sweeping. Can it be intended to cover all conceivable payments in the normal course of trade and commerce?
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Let us consider an extreme example: purchase of stationery. Undoubtedly, the purchase price would include the income (margin) element of the vendor in the normal course. So, would such payment be subject to TDS? If so, whether the 10% TDS is on the gross purchase price or only the income element therein? There would be several other questions. In case the vendor is incurring a loss, how would the TDS provisions apply? How would the corporate payer evaluate all of these on a practical basis? Would the vendor at all share his profit margins? Can the company rely on him? Further, there does not seem to be a minimum benchmark over which the TDS provisions would be triggered. Thus, theoretically and in the extreme, even a Re1 payment could potentially attract TDS.
Take another case of sale proceeds from capital assets, say, shares. This may also be covered within the ambit of the residuary clause. Similar issues arise as discussed above.
Illustration: Jayachandran/ Mint
Additionally, for the sale of shares on the stock exchange, how would the provisions apply? Would the onus for TDS compliance lie on the buyer or the stock exchange clearing and settlement unit or the broker? Again, a flat 10% TDS on the gross sale proceeds seems harsh and unreal. Imageing the case of a day trader if every sale of shares attracts a 10% gross level withholding; this could spell the death knell for him, from a cash flow perspective. On the other hand, if the TDS were to apply on the income element (embedded in the sale proceeds) only, how would data flow on cost/expense deduction be made available on a real-time basis?
While the expanded scope may be warranted in certain specific cases, the practical incongruence of its applicability in general seems to suggest that the consequences seem unintentional. If so implemented, this would take a huge toll on trade and commerce.
Businesses would look forward to the provisions being ring-fenced adequately when the provisions are finalized.
Cross border payments…at a disadvantage? In respect of payments to non-residents, the current law allows for applicability of the relevant tax treaty provisions in determining, firstly, whether the subject payment is at all taxable and, hence, subject to withholding and if so, secondly, for application of the lower rate at which taxes are to be withheld. The code does not contain a specific provision to this effect.
As borne out from clarifications by various finance ministry officials at code-related public conferences, the intention does not seem to be to override tax treaty provisions. Nonetheless, the absence of a specific provision to apply the lower/nil withholding as per the tax treaty could lead to ambiguity. This may lead to mandatory withholding on non-resident payments at the rates provided under the DTC even where the income is either not taxable or taxable at a lower rate in the hands of the non-resident, under an applicable tax treaty.
While the additional taxes would be ultimately refunded, it may entail compliance and administrative costs, for both the taxpayer and the government, which is sought to be avoided by the code.
Clearly, this needs to be clarified to the effect that the treaty rates will apply for TDS purposes.
Lower withholding certificate: Typically, business receipts, which are taxable in India due to the presence of a permanent establishment or fixed base or business connection of the non-resident in India, are subject to tax on a net income basis.
In order to obviate withholding on gross basis in such cases, the current law provides for the issuance of a lower withholding tax certificate by the tax authorities on an application made either by the non-resident recipient or the Indian payer.
The code seems to have done away with this current regime to apply for a lower withholding tax certificate. This could cause undue hardship for both in terms of either a higher tax deduction for the non-resident where taxes are withheld on the gross receipts, or a dilemma for the Indian payer in determining the net income amount for applying the TDS rates. Especially for the latter, the consequences of any alleged non-compliance could be very grave.
One hopes that the TDS rules to be prescribed under the code provide for this window.
This is the first of a two-part series.
Ketan Dalal is executive director and Vishal Shah is associate director, PricewaterhouseCoopers. Your comments and feedback are welcome at email@example.com