What is Section 194LBC?
Section 194LBC of the Income Tax Act of India governs the taxation of income distributed by a securitization trust to its unit holders. Here are the key points:
- Securitization Trust: This section applies to income distributed by a securitization trust, which is a special purpose vehicle (SPV) created to securitize assets.
- Tax Deduction at Source (TDS): The securitization trust must deduct tax at source when distributing income to unit holders. The deduction happens at the time of distribution.
- TDS Rate: The TDS rate varies based on the type of income and the unit holder’s tax residency status, with different rates for residents and non-residents.
- Compliance Requirements: The securitization trust must comply with Section 194LBC by deducting and depositing TDS correctly. It is also responsible for issuing TDS certificates to unit holders.
What is a Specified Entity?
Generally, a specified entity refers to an organization, institution, or entity identified under a legal or regulatory framework for specific purposes.
Here are some common contexts where the term is used:
- Taxation: In tax laws, a specified entity may include certain organizations, trusts, or entities subject to specific tax rules. For example, under Section 194LBC of the Indian Income Tax Act, a securitization trust qualifies as a specified entity for tax deduction at source (TDS).
- Regulatory Compliance: In financial regulations, specified entities refer to institutions that must follow specific compliance measures. Banks, financial institutions, and investment funds, for instance, may be classified as specified entities under anti-money laundering (AML) regulations, requiring them to implement strict compliance controls.
- Government Contracts: In public procurement, a specified entity could be an organization or company authorized to bid on government contracts. These entities must meet predefined eligibility criteria set by the government.
Applicability of Section 194LBC
Section 194LBC of the Income Tax Act, 1961, governs the taxation of income distributed by a securitization trust to its unit holders. Below are the key points regarding its applicability:
- Securitization Trust: This section applies specifically to income distributed by a securitization trust, a special purpose vehicle (SPV) created to securitize assets. These trusts issue securities backed by cash flows from underlying assets.
- Income Distribution: It applies when a securitization trust distributes income to unit holders. This income may come from sources such as interest, dividends, or other gains generated by the trust’s assets.
- Tax Deduction at Source (TDS): The securitization trust must deduct tax at source when distributing income. The TDS rate varies based on the type of income and the tax residency status of the unit holder.
- Reporting and Compliance: The trust is responsible for deducting and depositing TDS correctly and issuing TDS certificates to unit holders, ensuring compliance with Section 194LBC.
- Exemptions: Certain unit holders may be exempt from TDS under Section 194LBC if they meet specific conditions or obtain the necessary certifications.
What is a Unit Holder?
Unit hodler refers to an individual or an entity that holds units in a collective investment scheme, Real estate investment trust, mutual fund and pooled investment vehicle.
- Investment Scheme - Unit holders are participants in investment schemes with assets pooled together for investment purposes. These schemes include mutual funds, unit trusts, exchange traded funds, and collective investment vehicles.
- Ownership Interest - Individuals and entities have an ownership interest in underlying assets of the investment scheme, which is in proportion to the number of units they hold.
- Rights and Responsibilities - Unit holders have the right to receive dividends or distributions, participate in voting matters, and redeem or sell their units.
- Regulatory Framework - The obligations and rights of unit holders are governed by legal provisions governing the investment scheme. The legal provisions may include the scheme’s prospectus, trust deed, partnership agreement, outlining the rights and responsibilities of the Income Tax Act and relevant provisions.
- Income Distribution - Unit holders are the recipients of income distributed by the securitization trust. The taxation of this income and the TDS is governed by the regulations and provisions of the Income Tax Act.
What are the Exemptions Under Section 194LBC?
Under Section 194LBC of the Income Tax Act, 1961, certain exemptions apply to specified entities and transactions. These include:
- Resident Individuals and HUFs: Income distributed by a securitization trust to resident individuals or Hindu Undivided Families (HUFs) may be exempt from TDS, subject to specific conditions.
- Resident Non-Individuals: Domestic companies, firms, associations of persons (AOPs), and bodies of individuals (BOIs) may also qualify for TDS exemption if they meet the prescribed conditions.
- Tax Residency Certificate (TRC): Non-resident recipients from countries with which India has a Double Taxation Avoidance Agreement (DTAA) can claim benefits under the DTAA by providing a TRC issued by their tax authority. This may allow them to avail reduced tax rates or exemptions.
- Government Entities: Income distributed to the Central Government, State Governments, or local authorities is exempt from TDS under Section 194LBC.
What are the Consequences of Non-Compliance With Section 194LBC?
Failure to comply with Section 194LBC of the Income Tax Act, 1961, can lead to several consequences for both the securitization trust and its unit holders. These include:
- Penalties: If the securitization trust fails to deduct or deposit TDS on time, it may face penalties based on the severity and duration of non-compliance.
- Interest Charges: The trust must pay interest on the unpaid TDS amount, calculated from the due date of deduction until the actual payment.
- Disallowance of Expenses: Expenses related to income subject to TDS may be disallowed when computing taxable income if the trust fails to deduct or deposit TDS as required.
- Legal Action: Tax authorities may initiate legal proceedings, including audits and assessments, to recover unpaid taxes along with penalties and interest.
- Legal Action: Non-compliance can lead to the loss of certain tax benefits or exemptions that the trust and its unit holders might otherwise be eligible for.
- Reputational Risk: Violating tax laws can harm the securitization trust’s reputation, affecting its credibility with investors and stakeholders.
What are the TDS Provisions Under Section 194LBC?
For Resident Investors
When a securitization trust distributes income to a resident investor, the payer must deduct TDS at the following rates:
- 25% for individuals and Hindu Undivided Families (HUFs).
- 30% for other entities such as companies, firms, or associations of persons (AOPs).
TDS is deducted at the time of credit or payment, whichever is earlier to ensure tax compliance before income is transferred to the investor.
Budget 2025 Update: The budget 2025 has proposed to change this rate from 25% and 30% to 10% for all categories of persons. The new rates will be applicable from April 1, 2025.
For Non-Resident Investors
For non-resident investors, including foreign companies, TDS is deducted at the rates in force, which may vary based on India's tax treaties with the investor’s country. The deduction follows the same principle as for resident investors—whichever comes first, credit or payment.
Non-resident investors can benefit from lower withholding tax rates under applicable tax treaties, supporting international tax compliance and transparency.
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