What is Section 195 of the Income Tax Act?
When Indian businesses or individuals make payments to non-residents, tax laws ensure that such payments are not left untaxed. Section 195 of the Income Tax Act, 1961, plays a crucial role here. It states that any payment made to a non-resident that is taxable in India must have Tax Deducted at Source (TDS) before remittance. This law ensures tax collection on cross-border transactions at the very source of income. Without it, foreign companies and individuals could earn from India without contributing to its tax revenue.
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Who is a Non-Resident?
A non-resident is someone who does not qualify as a resident under Section 6 of the Income Tax Act. This includes individuals, foreign companies, or any entity earning income from India but residing abroad.
For example, a foreign consultant providing services to an Indian firm, or a software company licensing its product in India, is considered a non-resident for tax purposes.
Exceptions for Indian Citizens and Persons of Indian Origin (PIOs)
Indian citizens or PIOs living abroad may still qualify as residents based on days of stay in India. If they stay beyond 182 days in a financial year, they could be treated as residents. This exception ensures fairness in taxation for NRIs and expatriates.
What is Section 195 and Why is it Important?
Section 195 is not just about compliance—it safeguards India’s taxation rights. Its importance can be understood from three angles:
- It prevents loss of revenue when foreign entities earn income from India.
- It makes the payer responsible, ensuring the government collects tax upfront.
- It promotes global fairness by aligning with Double Taxation Avoidance Agreements (DTAAs).
Key Features of Section 195
The section is designed to be comprehensive. Some key highlights include:
- Applies only to non-residents (except salaries).
- Covers multiple payment types, including royalties, interest, dividends, and professional fees.
- TDS is to be deducted at payment or credit, whichever happens earlier.
- No minimum exemption limit applies.
Who Should Deduct TDS on Payments to Non-Residents?
The responsibility of deducting TDS lies on every payer, whether it is an individual, company, partnership firm, trust, or government department. The only requirement is that the sum paid must be taxable in India.
For instance, if you buy property from an NRI, you as the buyer must deduct TDS before making payment.
Example to Understand Section 195
Suppose an Indian company pays $50,000 in technical service fees to a U.S.-based consultant. If the TDS rate is 10%, the Indian company must deduct $5,000 before making the transfer.
- Amount payable to consultant: $45,000
- TDS deposited to Indian government: $5,000
- This ensures India collects tax on the income before it leaves the country.
How is TDS Deducted Under Section 195?
The deduction process involves several steps:
- Identify whether the payment is taxable under Indian law.
- Determine the applicable rate (as per the Income Tax Act or DTAA).
- Deduct TDS at the time of credit or payment, whichever is earlier.
- Deposit the deducted amount to the government using Challan 281.
- File returns and issue a certificate to the payee.
Is There a Threshold Limit for TDS Deduction Under Section 195?
Unlike domestic TDS provisions, Section 195 has no threshold limit. Even a payment of a few thousand rupees may require TDS deduction if it is taxable. This strictness ensures that all taxable transactions are captured.
Types of Payments Covered Under Section 195
Section 195 applies to a wide range of transactions. These include:
- Interest on loans or deposits
- Royalties for software, IP, or trademarks
- Fees for technical services like consultancy or engineering
- Dividends paid to foreign shareholders
- Payments to NRIs for property sales
TDS Rates Applicable Under Section 195
The rates differ depending on the type of income. Some examples include:
- Interest: 20%
- Royalties: 10%
- Technical fees: 10%
- Dividends: 10%
- Any other income: As per Income Tax Act or DTAA
Taxpayers should always check DTAA benefits, as rates are often reduced under treaties.
Compliance and Reporting Requirements Under Section 195
Compliance is strict and involves multiple layers:
- Deducting TDS correctly.
- Depositing it with the government on time.
- Filing quarterly TDS returns through Form 27Q.
- Issuing certificates in Form 16A.
Failure at any stage can result in penalties.
Payment and Filing Process for TDS Under Section 195
Deductor Requirements
The payer must obtain a TAN (Tax Deduction Account Number) and keep proper records of foreign payments.
TDS Deduction and Deposit Procedure
TDS must be deducted at payment/credit and deposited using Challan ITNS 281 through online banking or authorized banks.
TDS Return Filing
Quarterly returns must be filed via Form 27Q to report details of payments made to non-residents.
TDS Certificate Issuance
After filing, the deductor must issue Form 16A to the non-resident, confirming TDS deduction and deposit.
Common Scenarios Where Section 195 is Applicable
- An Indian startup hiring foreign IT consultants.
- A company paying license fees for international software.
- Dividend distribution to foreign shareholders.
- Buying property from an NRI seller.
Declaration of Foreign Payment Information
To remit money abroad, banks require proof of tax compliance. This includes:
- Form 15CA – declaration of remittance details.
- Form 15CB – certification by a Chartered Accountant in certain cases.
These forms ensure banks do not release funds without proper tax checks.
TDS Returns and Certificate Overview
The quarterly TDS return (Form 27Q) must include transaction details. Post filing, Form 16A is issued as proof of deduction. Both documents are vital for transparency and for the non-resident to claim credit in their home country.
Consequences of Non-Compliance With Section 195
Non-compliance can be costly:
- Interest under Section 201(1A) on late payment.
- Penalty equal to the amount of tax not deducted.
- Disallowance of expenses while computing taxable income.
- In extreme cases, prosecution.
Conclusion
Section 195 ensures India rightfully collects tax on foreign remittances. It places the duty on the payer, making the process more effective. With globalization increasing, businesses must stay vigilant, understand DTAA benefits, and ensure full compliance to avoid penalties.
As a Chartered Accountant with over 12 years of experience, I am not only skilled in my profession but also passionate about writing. I specialize in producing insightful content on topics like GST, accounts payable, and income tax, confidently delivering valuable information that engages and informs my audience.
Frequently Asked Questions (FAQs)
- Who is liable to deduct tax under Section 195?Any person or entity making payments to a non-resident that are taxable in India must deduct TDS.
- What happens if TDS is not deducted under Section 195?The payer may face penalties, interest, disallowance of expenses, and even prosecution.
- Is Form 15CA/15CB required for all foreign remittances?Form 15CA is generally required, while Form 15CB is mandatory if the payment exceeds certain limits or requires CA certification.
