Section 195 of the Income Tax Act: TDS on Payments to NRIs Explained

What is Section 195 of Income Tax Act?

Section 195 requires any person making a payment to a non-resident Indian (other than salary) to deduct TDS (Tax Deducted at Source) if the income is taxable in India. This provision applies to NRIs, foreign companies, and any non-resident entity. It covers payments such as interest, royalty, dividends, capital gains, and fees for technical services.

Who is a Non-Resident?

A person is considered a non-resident in India if they do not qualify as a resident under Section 6 of the Income Tax Act.

A person becomes a resident in India for a financial year if they meet either of the following conditions:

• They stay in India for 182 days or more during the financial year, or
• They stay in India for 60 days or more in the financial year and for 365 days or more in the four immediately preceding financial years.

Exceptions to Condition (2)

For an Indian citizen or a Person of Indian Origin (PIO) whose total income excluding foreign income exceeds ₹15 lakhs in a financial year:

• The 60-day limit in condition (2) is replaced with 120 days.

For an Indian citizen leaving India for employment abroad or as a crew member of a ship:

• The 60-day limit in condition (2) is replaced with 182 days.

In addition, an Indian citizen or PIO earning more than ₹15 lakhs (other than foreign-source income) is treated as a resident if they are not liable to tax in any other country.

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What is FEMA Act?

An NRI (Non-Resident Indian) refers to someone with Indian citizenship or origin residing outside India. However, there are slight variations in the definitions used by the Foreign Exchange Management Act (FEMA) and the Income Tax Act.

FEMA (Foreign Exchange Management Act):

• Focuses on physical presence in India.
• An NRI is someone resident outside India who is a citizen of India OR a Person of Indian Origin (PIO). [Reserve Bank of India]
• A PIO is defined as:
  • A citizen of a country other than Bangladesh or Pakistan who:
    Held an Indian passport at any time.
    Had a parent or grandparent who was a citizen of India.
• The spouse of an Indian citizen or PIO.

FEMA uses a time-based rule. Generally, an NRI is someone who spends 182 days or less in India during the preceding financial year. However, this rule has exceptions:

• The 182-day limit doesn't apply if the purpose of your visit indicates an intention to stay in India for an uncertain period.
• Examples include taking up employment, starting a business, or any other reason suggesting a long-term stay.

Income Tax Act:

The Income Tax Act determines residency based on various factors, including:

• An Indian citizen or person of Indian origin is considered an NRI if they spend less than 182 days in India during the previous financial year.
• Even if they spend 182 days or more in India, they can be considered NRI if they were present in India for less than 60 days in the previous year and for a total of less than 365 days in the four preceding years.

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Who Deducts TDS on Non-Residents under Section 195 of Income Tax Act?

Any person (resident or non-resident) who pays any sum other than salary to a non-resident not being a company or to a foreign company is required to deduct tax under this section.

• Individuals
• HUFs
• Non-resident Indians
• Partnership firms
• Individuals with exempted income in India
• Foreign companies
• Juristic individuals

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Applicable Situations for TDS Under Section 195 of Income Tax Act

TDS under Section 195 must be deducted in two scenarios:

1. When the income is credited to the payee’s account.
2. During the actual payment transaction.

The deduction should occur at whichever event happens earlier. Income credited to interest payable, suspense accounts, or other accounts is considered credited to the payee’s account.

For government or public sector bank income, TDS should only be deducted at the time of actual payment, whether through cash, cheque, or draft.

As per Section 5(2)(b), the total income of a Non-Resident Indian (NRI) includes all income accrued, arisen, or deemed to have accrued or arisen in India.

Tax must be deducted on all amounts accruing or arising as specified under Section 195 of the Income Tax Act.

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What is the Threshold Limit to Deduct TDS u/s 195?

There is no threshold limit to deduct TDS under section 195. The payer is responsible for deducting tax only when such payment is made to the non-resident of India. Hence, tax deduction is not required for income that is exempt or falls outside the scope of taxation under the Income Tax Act unless explicitly notified by the government.

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TDS Rate under Section 195 of Income Tax Act

The rate of tax deduction u/s 195 TDS shall be either of the below rates, whichever is beneficial to you:

• Specified in the Double Taxation Avoidance Agreements between India and the country of the payee.
• Specified in the Income Tax Act.

Surcharges and education cess must be added to the rates provided by the Act at the relevant rate. There is no need to add a surcharge or education cess if the payment is made according to DTAA rates. The following are the rates:

Further, if the payee doesn’t have a PAN, then the TDS will be deducted at a higher rate under Section 206AA.

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Penalties for Non-Compliance with Section 195 of Income Tax Act

• If TDS is not deducted on payments to a non-resident, the expense may be disallowed under Section 40(a)(i).
• If TDS is deducted but not deposited within the prescribed time, interest @ 1.5% per month or part thereof is levied from the date of deduction to the date of deposit.
• If TDS is not deducted, interest @ 1% per month or part thereof is charged under Section 201(1A) from the date on which tax was deductible to the date on which it is actually deducted.
• A penalty under Section 271C may be levied equal to the amount of TDS that was not deducted or paid.
• In cases of short deduction of TDS, a penalty may be levied equal to the amount of short deduction.
• The deductor may also be treated as an “assessee in default” under Section 201.
• In severe cases involving failure to deposit TDS after deduction, prosecution under Section 276B may also apply.

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Ways to Deduct Section 195 TDS

Below are the steps to deduct TDS under Section 195:

• The person making the payment to the non-resident (deductor/buyer) must obtain a TAN (Tax Deduction Account Number) under Section 203A of the Income Tax Act before deducting TDS. The deductor must also have their own PAN and the PAN of the NRI.
• The deductor must deduct TDS at the time of making the payment to the NRI.
• The deducted TDS must be deposited using a TDS payment challan on or before the 7th of the month following the month in which TDS was deducted.
• TDS can be deposited online or through government-authorised banks using Challan 281.
• After depositing TDS, the buyer must file the quarterly TDS return electronically using Form 27Q.

Due Dates for Filing Form 27Q (TDS Return)

After filing the TDS return, the deductor must issue the TDS certificate (Form 16A) to the NRI within 15 days from the TDS return due date for that quarter.

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